Does "Flash Boys" Prove That The Markets Are Rigged?

[Reub]

Michael Lewis' new book, Flash Boys: A Wall Street Revolt, seems to indicate that investment markets are rigged against small investors through high-frequency trading. Does it make sense for any of us to even participate in a "rigged" game?

http://www.forbes.com/sites/johnwasik/2 ... ck-market/

"Investment firms loved the idea of HFT because the profits were infinite. You could buy and sell in a flash. You could buy a stock then short it. You could arbitrage by buying other stocks as others went up or down. You could buy what others were buying, take a quick profit, then dump it. The possibilities were infinite and legal.

Regulators haven’t caught up to it, although the FBI, New York state attorney general and other so-called watchdogs are finally sniffing around. It was like found money for the trading firms that made the investment running fiber optic “pipe”? from New York to Chicago and various exchange servers."

[Ad Orientem]

"Nah, it's a racket. Those Wall Street guys are all crooks."
-Al Capone when asked if he invested in the stock market

[craigr]

If you are passively indexing and holding long term what HFT guys are doing is of virtually zero consequence to you. It is only a problem if you are trying to trade against them, which is something an individual investor should never attempt. I think these HFT operations are largely just pushing money around the table between each other in many cases.

[murphy_p_t]

even though not directly relating to HB's recommendation of having as few counter-parties between you and your money...this kind of thing inclines me to look even more favorably on that recommendation hearing these kind of things...

[moda0306]

If you are passively indexing and holding long term what HFT guys are doing is of virtually zero consequence to you. It is only a problem if you are trying to trade against them, which is something an individual investor should never attempt. I think these HFT operations are largely just pushing money around the table between each other in many cases.

It does if the game gets so rigged that the goals of the stock market get skewed against creating long-term value for their shareholders.

The less that long-term outlook holds, the less long-term earnings we absorb with that 25% of our portfolio.

[Pointedstick]

All the more reason why ZIRP is a terrible social policy in a nonzero inflation environment. Stuff like this scares the bajeezus out of risk-averse savers. But what else are they gonna do? Put everything in 5-year CDs yielding 2.5%?

Say what you want about monetary policy, but forcing savers to chase yield in the financial and real estate markets is a terrible social policy, IMHO. Conservative, risk-averse savers should be able to get a reasonable rate of return without having to risk getting fleeced in an environment where there are people whose entire line of work is taking advantage of the uninformed. Not everyone is like us.

[moda0306]

PS,

Why should someone get higher than 2.5% in a nominally risk-free account if there is sub-2% inflation?

I guess a more precise way to ask my question would be, "What real return should people be able to get without taking any risk?"

And I realize EVERYTHING is subject to some risk... But this can never change. I'm talking about savings accounts, cd's, t-bills & notes, and I/ee-bonds.

[Pointedstick]

PS,

Why should someone get higher than 2.5% in a nominally risk-free account if there is sub-2% inflation?

I agree, 30-year treasuries should be yielding much less!

I guess a more precise way to ask my question would be, "What real return should people be able to get without taking any risk?"

And I realize EVERYTHING is subject to some risk... But this can never change. I'm talking about savings accounts, cd's, t-bills & notes, and I/ee-bonds.

Like I said, it's a matter of good social policy. It is good for society when people are encouraged to conserve and save on their own by creating social institutions that create "risk-free" returns on savings. Due to the money illusion, people think about things in nominal terms, not real ones, so all else being equal, a nigher nominal yield encourages more saving, and a real one is even better. When people are encouraged to save their money, it increases their personal resilience, reducing the likelihood that they will need to rely on private charity or government assistance during hard times. And if they can earn a reasonably significant risk-free real return on their conservative savings, they will be able to retire on their own power without needing to, again, rely on private charity or government assistance.

These things all seem like social "goods" to me in that I view self-reliance and independence as virtues, and particularly, as virtues upon which this country was founded and whose reinforcement the government should undertake as a matter of policy, if it has to undertake the reinforcement of any virtue at all (which we know it does given that it is a government).

The government has already monopolized and regulated the banking and finance industries, so it's not like there is any semblance of a free market. Thus, they determine everything, and IMHO they should use this power to encourage savings by creating a higher risk-free rate of return.

And of course, I am not wearing my anarcho-capitalist hat here. This is technocrat-Pointedstick talking right now.

[moda0306]

PS,

If we're getting out of pure fairness and into social psychology/policy of the debate here, it could get a little gummy, but I'll play .


Regarding the 30 year treasury, I was talking about 2.5% in the CD.  I'm assuming you meant 5-7 year CD at the latest.  I don't think that's unreasonable at all from a "natural" standpoint on the cost of capital, especially considering people engaged debt contracts with an explicit statement from the fed that they were going to use interest rates to balance a 2% inflation target against a ?% "natural" unemployment rate.

30 year rates should simply do their thing as the market predicts out what short-rates will be into the future.  Trying to make them "do" anything else than that with QE or whatever is trying to drive a car by pulling on your seat-belt.  But that's another debate about the "effectiveness" of trying to control the long end of the curve... we can leave that alone for now .

But since savings must equal investment, to simply "encourage savings" is only one side of the coin.  First off, a much better way to increase private-sector savings than trying to increase interest rates (which actually potentially decreases investment and therefore savings) is to actually run adequate deficits at the federal level so the private sector actually CAN save, net of investment.  Or, investment can be encouraged through lower interest rates, and actually do a better job (in some conditions) of increasing the "will to save," because it's the production of REAL value that truly represents "savings."

Simply put, and I think this can get wide agreement, true "savings," is going to be the surplus of wealth created that can be used for future production/benefit/use/etc.  Not the paper we give people either by 1) running federal deficits, or 2) raising interest rates for savers.  The thing I love about MR proponents, is that most of them see private production and individual "time" to do what we want as the true form of savings and wealth, and government/fiat-currency is just one thing that can potentially facilitate that.

This doesn't mean that deficits and interest rates don't matter (holy mother-effing hell do they!), but they only matter in the context of expanding our overall production as a society, and "encouraging saving," as it might appear to exist in a vacuum, is only one pall piece of that, because what is "savings" in paper/interest-rate form without production... it's called "hyperinflation." 

[Pointedstick]

From a macroeconomic perspective, I largely agree with you. But again, I'm wearing my technocrat hat right now, and technocrats are generally economically illiterate.

My point is that paper wealth actually does matter due to the money illusion. Smart people schooled in economics like you and me and probably everybody else here know better, but we represent a tiny fraction of the population. For most people, as long as inflation is low enough that it's difficult to notice and doesn't get griped over much (I would say this is probably under 4%), then what they care about is the number in their bank accounts going up. Same with real productivity. As long as it's generally rising, I think people are happy with it. So as a technocrat advocating matters of social policy, I would encourage the monetary powers-that-be to crank the risk-free interest rate as high as possible until the point that its direct or indirect effects pushed inflation above 4% or caused net investment to fall to levels where people started to notice it and feel sad.

If interest rates fall too low while real productivity rises very high, I think you can get in a situation like we have now: it predominately benefits the top earners and wealth-holders who benefit from heavy technological automation and have high incomes and the intestinal fortitude or intelligence and education to invest in a portfolio as head-scratching as the PP. Meanwhile most people are seeing their jobs disappear, their incomes stagnate, their savings get eroded by inflation, and their general life prospects become gloomy.

As a matter of social policy, this is a really bad state of affairs. There are more than 300 million privately-owned firearms in this country, most of them clustered in the hands of the politically conservative whose favored jobs (farming, mining, transportation, manufacturing, energy, etc) tend to suffer the most in this climate. It shouldn't take a genius to realize that you shouldn't allow this group to get too pissed off.


To hammer home my point a bit more, among all four of my son's grandparents, there are two PhD holders, a Masters degree holder and a Bachelors degree holder. Very smart, well-educated people. But all four of them routinely have difficulty distinguishing between nominal and real returns and they are all scared to death of the financial markets, all preferring to hold money in cash and CDs. Bonds longer than 10 years scare them, and forget about gold.

I am talking much more about behavioral economics than MR.

[moda0306]

From a macroeconomic perspective, I largely agree with you. But again, I'm wearing my technocrat hat right now, and technocrats are generally economically illiterate.

My point is that paper wealth actually does matter due to the money illusion. Smart people schooled in economics like you and me and probably everybody else here know better, but we represent a tiny fraction of the population. For most people, as long as inflation is low enough that it's difficult to notice and doesn't get griped over much (I would say this is probably under 4%), then what they care about is the number in their bank accounts going up. Same with real productivity. As long as it's generally rising, I think people are happy with it. So as a technocrat advocating matters of social policy, I would encourage the monetary powers-that-be to crank the risk-free interest rate as high as possible until the point that its direct or indirect effects pushed inflation above 4% or caused net investment to fall to levels where people started to notice it and feel sad.

If interest rates fall too low while real productivity rises very high, I think you can get in a situation like we have now: it predominately benefits the top earners and wealth-holders who benefit from heavy technological automation and have high incomes and the intestinal fortitude or intelligence and education to invest in a portfolio as head-scratching as the PP. Meanwhile most people are seeing their jobs disappear, their incomes stagnate, their savings get eroded by inflation, and their general life prospects become gloomy.

As a matter of social policy, this is a really bad state of affairs. There are more than 300 million privately-owned firearms in this country, most of them clustered in the hands of the politically conservative whose favored jobs (farming, mining, transportation, manufacturing, energy, etc) tend to suffer the most in this climate. It shouldn't take a genius to realize that you shouldn't allow this group to get too pissed off.

PS,

You're almost more frustrating to debate than an anarcho-capitalist.  Now I have to figure out how to debate PS the Social Engineering expert.  Dare I say you make a better central planner than libertarian?  Or maybe I'm just bad at debating people refer to complex social arrangment preferences within their premises in formulating ideal policy.

JK

I think what you're saying is totally legit.  It's why I favor (when I put my "central planner" hat on) a modest low inflation rate... maybe 3%.  Overall I trust CPI mostly, but LOVE the fact that there are other measures, and will drop my trust if I deem it to be a scam.  I think that breaking even in REAL terms is fair AND psychologically preferable IF we have 2%+ inflation, which would leave people earning about 3% in a 3% inflation environment.

ZIRP isn't really ZIRP, though.  People can get 1% in savings, 2% in CD's, and keep up with inflation with I-bonds, or get 3.5% over 20 years with EE bonds. EDIT: (This sounded kind of dumb... I just wanted to point out the real numbers in the real world for real people).

And keep in mind, having some money in the market isn't the end of the world... it's just something of a rigged game.  So is the interest rate environment... play them both, because they're both rigged a bit differently, for different benefits, and then hedge them both by having a paid off house with gold in the gun safe .

It shouldn't have to be that hard, on some levels, but growing/retaining wealth has always had difficulties associated with it.  It just seems like you only get imbalanced messages from parties with imbalanced motivations.  Diversification and balance is always going to be the solution.  That's why the PP is such a gem.  It pretty much breaks all the financial BS that can occur into two vectors with 4 extremes that we cover our bases with.  It's so simple once you get your head around it, but I'd blame the confusion on the financial industry as much as government (and the public in general).

But in the end, any subsidy to savers is punishment to entrepreneurs who don't have the capital to see their idea to fruition.  If we are to contribute to true "savings," making money a super robust store of wealth is an awful idea.  Because money is just the means with which we exchange, economically.  Run the "financials" on taking the risk of developing a new widget-manufacturing plant if you have to borrow at 5% real and expect a 1% increase in sales price every year due to inflation vs borrowing @ 2% real and expecting a 3% rise due to inflation.

I'm not saying "debt is a great thing and we should encourage people to get into it," but, to put it crudely, if someone's brain and balls are bigger than their bank account, debt is the best tool to maximize that person's potential.    When we see entrepreneurs whose debt disappears quickly into the size of their business due to a phenomenal idea quickly brought to market, it can be easy to forget that "loose" lending could likely have made that idea possible to begin with.  Hell... God forbid... the SBA might have been involved!

There's two sides to this coin... but you're not going to get either side if you don't have the coin in the first place... which is why I'm for sending out stimulus checks every month until we have either 4% unemployment or 4% inflation, then stop.  How's that for social engineering!

[Libertarian666]

To hammer home my point a bit more, among all four of my son's grandparents, there are two PhD holders, a Masters degree holder and a Bachelors degree holder. Very smart, well-educated people. But all four of them routinely have difficulty distinguishing between nominal and real returns and they are all scared to death of the financial markets, all preferring to hold money in cash and CDs. Bonds longer than 10 years scare them, and forget about gold.

I am talking much more about behavioral economics than MR.

Right. Intelligence and education are no guarantee of success in investing (or in anything else, really).

[Reub]

Besides, we all know that the government should be the only one allowed to rig the markets.

[moda0306]

Besides, we all know that the government should be the only one allowed to rig the markets.

Especially if it involves installing or supporting a puppet government in a Muslim or Latin country with lots of oil. 

[Pointedstick]

PS,

You're almost more frustrating to debate than an anarcho-capitalist.  Now I have to figure out how to debate PS the Social Engineering expert.  Dare I say you make a better central planner than libertarian?  Or maybe I'm just bad at debating people refer to complex social arrangment preferences within their premises in formulating ideal policy.

JK

Haha, happy to frustrate! 

And keep in mind, having some money in the market isn't the end of the world... it's just something of a rigged game.  So is the interest rate environment... play them both, because they're both rigged a bit differently, for different benefits, and then hedge them both by having a paid off house with gold in the gun safe .

It shouldn't have to be that hard, on some levels, but growing/retaining wealth has always had difficulties associated with it.  It just seems like you only get imbalanced messages from parties with imbalanced motivations.  Diversification and balance is always going to be the solution.  That's why the PP is such a gem.  It pretty much breaks all the financial BS that can occur into two vectors with 4 extremes that we cover our bases with.  It's so simple once you get your head around it, but I'd blame the confusion on the financial industry as much as government (and the public in general).

This is the core of what I'm getting at! The powerful and clever and wealthy have never really had difficulty accumulating or growing wealth. They're on the right-hand side of quite a few bell curves. And I daresay we are probably members of that group so it's important to keep in mind how skewed our perspectives are.

Nations seem most stable and prosperous when the people in the middle of the bell curves have access to wealth as well. If wealth accumulation is too difficult, they can't do it, even if it might seem easy to you and me ("Duh, just assemble a conditionally rebalanced, diversified portfolio of volatile assets held in equal proportions!"  ).

When it gets too hard for an average person to work hard and save, I think they get demoralized and some stop trying. They live for the moment and become income streams for entrepreneurs peddling hedonism or novelty, or else they go on welfare, and I think this becomes more true the easier-accessed and more generous the social safety nets. In this respect, it's probably a good thing that welfare programs make no sense and involve labyrinthine bureaucracies!

I think, if you ask me, that in our nation we focus too much on the top and the bottom and not enough on the middle. We have a top-heavy economy full of startups and entrepreneurs and all it's doing it pushing up housing prices in Seattle and San Francisco. And meanwhile the Democrats, seeing this, are trying to take money from them and give it to all the homeless people they walk over to visit the Whole Foods.

Despite all their middle-class rhetoric, Republicans are all for benefiting the top and Democrats deliver primarily for the bottom. But both of these situations can turn dangerous. I think that an accurate historical reading shows that when the top becomes too powerful, the result is often a bloody revolution that institutes communism or fascism or something similarly awful that hurts everyone. And if the bottom gets too powerful relative to the top, then the top flees or is killed, and the whole country collapses as it turns out that the top was responsible for making a lot of things work and then you get communism or fascism anyway as they try to figure out how to run a country and naturally gravitate towards egalitarianism and strongman rule.

But in the end, any subsidy to savers is punishment to entrepreneurs who don't have the capital to see their idea to fruition.  If we are to contribute to true "savings," making money a super robust store of wealth is an awful idea.  Because money is just the means with which we exchange, economically.  Run the "financials" on taking the risk of developing a new widget-manufacturing plant if you have to borrow at 5% real and expect a 1% increase in sales price every year due to inflation vs borrowing @ 2% real and expecting a 3% rise due to inflation.

This is a great point. There's a careful balance for the central planner to walk, that's for sure. If it were up to me, I would implement something like an easily-signed-up-for-and-accessed government checking account that paid, say, CPI+1.5%, and s savings account that paid CPI+3% with some extra restrictions (only 2 withdrawals a month or something). It would basically be like an I or EE bond in account form. I like the "Post Bank" idea. But these accounts would only be accessible to individuals, and this would of course have to be harshly enforced with guns and dungeons.

[moda0306]

Tenn,

Thanks for that.  You're good with these graphs .  Far better than my rambling run-on paragraphs that tell 1/10th the story in twice the time.