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LQD: Tax Wall Street's Speed Freaks into Oblivion

by NBBooks Tue Jul 28th, 2009 at 08:36:53 AM EST

U.S. economist and editor of The American Prospect Robert Kuttner brings up the obvious solution to the problem of Goldman Sachs - or any other firm - reaping "profits" from computer-directed milli-second trading -- called High-Frequency Trading -- which as far as I'm concerned, is front-running, plain and simple.

Consider for a moment some first principles. The legitimate and efficient function of financial markets is to connect investors to entrepreneurs, and depositors to borrowers. There is no legitimate reason whatever for this to be done by the millisecond. At bottom, the process is pretty simple. The intermediary--the bank, savings institution, or investment bank makes its fees for making a judgment about risk and reward. How likely is the loan to be paid back? How high an interest rate should it charge? How should a new issue of securities be priced? The investor decides whether to indulge a taste for risk or for prudence.

But the hyperactive trading markets and creations of recent decades such as credit default swaps and high speed trading algorithms add nothing to the efficiency of financial markets. They add only two things--risk to the system, and the opportunity for insiders to reap windfall profits.

Therefore, whether or not Goldman's lawyers have figured out how it can engage in High Frequency Trading and stay within the law, there is a strong case that this entire brand of financial engineering should be prohibited. The whole game should be slowed down. Bona fide investors should get in line under the rule of first come, first served. Anything else should be considered illegal market manipulation. No dummy transactions. There is absolutely no gain to economic efficiency from having prices of securities change in milliseconds, and much gain to the opportunities for manipulation. . . .

. . . it is a mark of Wall Street's stranglehold on politics that the most sensible of remedies seem impossibly radical. One very good way to damp down the dictatorship of the traders, and raise some needed revenue along the way, would be through a punitively high transactions tax on very short term trades. Genuine investors should get favored fax treatment. Pure traders should be taxed, and very short term manipulation taxed into oblivion.

If the financial crisis has proven anything, it is that capital markets have become an insiders' game in which trading profits crowd out the legitimate business of investment. The whole business-models of the most lucrative firms on Wall Street are a menace to the rest of the economy. Until the Obama administration recognizes this most basic abuse and shuts it down, it will be more enabler than reformer.

 


Display:
Tyler Durden has pointed out several reasons why HFT is a bad idea here and here.  Also see my recent diary, where these and others links appear.  

A Tobin tax on just HFTs could effectively make it unprofitable and/or generate ~$100 million per month in tax revenues, as they might be willing to pay that for the combined advantages that the current system provides them.   The greater crime is renting millisecond  "look ahead" privileges to insiders who have super computers co-located on exchange floors and are able to use the time advantage to game the market.

One of Tyler's later articles shows how our TARP money is enabling, and perhaps encouraging, the recipients to engage in a massive short squeeze that punishes the bears, drives up prices of squeezed stocks, and benefits TARP recipients, but may be having the effect of driving some of the big institutional investors out of both lending stocks to short sellers and other financial market investments.  

 

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Jul 28th, 2009 at 02:41:46 PM EST
Agree 100%. Speculators are just stealing money. Taxing these gains away, would be the best way to return the money back to the real economy.
by kjr63 on Tue Jul 28th, 2009 at 03:38:03 PM EST
Can you 100% identify who is a speculator and who isnt?

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$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Wed Jul 29th, 2009 at 05:19:24 AM EST
[ Parent ]
That's the wrong question. The fact that the markets make no distinction between speculation and investment is part of the problem.

And yes, buying and holding would slow down the market. A two to four week period would be about right, as a random guess, to eliminate predatory shorting, exploratory non-trades and pumping and dumping.

If traders don't care enough about the companies whose shares they trade to keep them for that long, they can always go find something useful to do.

As for computers and speedy trading - just because something can be done, doesn't mean it should be done. No one has a problem with the illegality of using a botnet to trawl for credit card numbers. And yet for some reason anything that happens on a stock market is supposed to be immune from legal oversight - why, exactly?

At the very least HSTs could be taxed. The fact that they're not, and the fact that they've been allowed to happen at all, is a political problem and not a technological one.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Jul 29th, 2009 at 05:40:11 AM EST
[ Parent ]
HSTs HFTs
by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Jul 29th, 2009 at 05:41:22 AM EST
[ Parent ]
And yes, buying and holding would slow down the market. A two to four week period would be about right, as a random guess, to eliminate predatory shorting, exploratory non-trades and pumping and dumping.
How exactly? The only thing a four week holding period would do is that the speculation tricks would begin four weeks later. Remember Henry Ford's great invention, the assembly line? It takes a long time to build one car, but if you start thousands in staggered intervals, then they come out the other end every couple of minutes. The same principle can apply to stocks with a holding period. An investor can still short a share, since he doesn't own it in the first place, he'll just borrow one from someone with an elapsed period. Pumping and dumping is a scam that works regardless of a holding period, etc. Finally, and perhaps most importantly, stock is only one type of security. Speculation is rife on all sorts of other contracts which wouldn't have a four week holding period.

And yet for some reason anything that happens on a stock market is supposed to be immune from legal oversight - why, exactly?
I never argued that, in fact I agree entirely with your sentiment. But we can't go back to a pre-computer world. In truth, the pre-computer stock market is no panacea either. For example, during the 1929 crash, the stock tickers were hours late in printing up-to-the-minute prices. Think of this as a crude form of holding period. Investors had the choice: act quickly with no clue at all of the current price, or wait some time to at least read the price of a few hours ago, and act too late anyway. A more serious problem with getting rid of computers is that the huge numbers of transactions would be curtailed, and accounted for by armies of clerks with pencil and paper.



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$E(X_t|F_s) = X_s,\quad t > s$

by martingale on Wed Jul 29th, 2009 at 07:05:38 AM EST
[ Parent ]
Because at some delay time the balance of risk moves from second-guessing random market movements - some of which are driven by insider trading and privileged knowledge - to second-guessing likely company performance in the real economy.

That point may not be a month, but I'm finding it hard to believe that enforced extended buy and hold, perhaps combined with strict volume limits, would have no effect at all on market dynamics.

Obvious manipulative plays can always be banned.

Of course no one likes the idea of not being able to sell instantly if the market tanks. But perhaps the market is much less likely to tank if no one is allowed to buy and sell instantly.

Once you eliminate predatory shorting and other games, real world conditions and disasters become the main driver of the markets. So you then have an incentive to minimise real world environmental risks too.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Jul 29th, 2009 at 07:45:02 AM EST
[ Parent ]
I'm sorry, theres' something I don't understand about your shorting claims.

Say company A intends to own a particular stock over a long period. The speculator sells the stock, then borrows it from company A. At some later time, perhaps immediately, he buys the stock from company C, which has owned it for a long time (so it is allowed to sell it now). It's true that the investor can't sell the newly acquired share again for four weeks (say), but so what? He keeps it until company A demands it back, or else he gives it back to company A straightaway. Since company A intends to keep the stock for a long period anyway, the inconvenience of not being able to sell within the current month is meaningless to it. And even in the contrary case, suppose company A actually wants to sell the share within the month. An equivalent transaction could be performed using an appropriate derivative.

In fact, with the appropriate derivatives, one could simulate a stock market without the holding period restriction on top of the real stock market which has the restriction. An outside observer would see shares being exchanged every day, but the actual shares involved would be choreographed so that each share gets bought/sold at four week intervals.

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$E(X_t|F_s) = X_s,\quad t > s$

by martingale on Wed Jul 29th, 2009 at 08:51:01 AM EST
[ Parent ]
The claim isn't about possible workarounds, which I'm sure are almost limitless, but about a generic requirement for owners to hold stock.

At the moment you're saying 'Yes, but to recreate a market you could...'

I'm sure this is true, but you're thinking like a market person who makes a living out of doing tricks like these.

If there's a blanket ban on all tricks - buyers must own stock, borrowing is not allowed, derivatives are only allowed for commodity deals where the buyer collects the commodity at the end of the deal - this all becomes froth and fantasy. Which is what it really is anyway.

The challenge is to couple finance back to the real economy. It does not need further schemes for further decoupling.

Currently the guiding principle is that all decoupling is good by definition, because it then becomes possible to make good money out of froth and fantasy.

If the markets are run on the principle that decoupling is very actively discouraged, irrespective of the forms it takes or may take, there's some danger of making markets manageable rather than cyclically horrific.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Jul 29th, 2009 at 09:31:23 AM EST
[ Parent ]
The claim isn't about possible workarounds, which I'm sure are almost limitless, but about a generic requirement for owners to hold stock.
What long term effect does such a requirement have, if abundant workarounds exist? Shouldn't regulation aim to solve the root cause of the problem permanently? I'm suggesting workarounds precisely because I do not see how these ideas solve anything at all.

I'm sure this is true, but you're thinking like a market person who makes a living out of doing tricks like these.
Or maybe just a mathematician who doesn't mind seeing t's crossed and i's dotted once in a while :)

there's a blanket ban on all tricks - buyers must own stock, borrowing is not allowed, derivatives are only allowed for commodity deals where the buyer collects the commodity at the end of the deal - this all becomes froth and fantasy. Which is what it really is anyway.
How would you blanket ban all tricks? One man's trick is another man's legitimate insurance contract. IIRC, as long as put and call options are allowed, *any* complex claim can be replicated in principle. They represent universal building blocks for contracts. And what about middle-men? The reality of specialization in society means that you get people who don't own stock directly but act with it like they do on behalf of others. So you must allow even more tricks for this system to function.

Currently the guiding principle is that all decoupling is good by definition, because it then becomes possible to make good money out of froth and fantasy.
Yes, but remember that good money itself is fantasy. It's been so ever since governmnents went off the gold standard. There are no physical limits to the growth of the money supply. In this sense, there is no "real" economy.

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$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Wed Jul 29th, 2009 at 07:32:39 PM EST
[ Parent ]
How would you blanket ban all tricks?

Easy as an atom bomb.  Legislate a few defined financial market procedures and make any innovations subject to legal review and challenge prior to implementation.  Make any unapproved procedures felonies.  Define in law the purpose of financial markets as providing investment capital to socially useful projects and set up regulatory procedures accordingly.  This would be like dropping a neutron bomb on Wall Street, but that, arguably, would be a good thing.  When you have a giant parasite on the body politic the parasite needs to be destroyed.

In an earlier diary, (you only really have to look at the first graph), NBBooks delineated rather well how existing US financial markets have become so polluted by financial manipulators as to be toxic to the purposes of legitimate investment, the very function which they use to justify their existence, and we have recently discussed the lengths to which companies go to avoid exposing themselves to the "discipline" which Wall Street imposes.  

The benefits of the decisions to allow the existing system, which were decisions not to regulate and to remove regualation, accrue entirely to the benefit of the most successful manipulators in the financial markets, Goldman Sachs far and away.  How does letting Goldman suck more and more of the wealth of the nation into the hands of its small number of employees serve any purpose that that of those employees?

This is not a math problem with a logical solution.  Capital and capitalization is the organizing principle of modern societies. The effects of the existing situation are not morally neutral.  If your political and moral compass indicates that it is appropriate for Goldman to own the US Department of Treasury, to rent the US Senate, to dominate and intimidate the rest of Wall Street and to suck the life out of the rest of the economy, then, in effect you are saying that the cleverest thief wins, that who ever can most effectively grab and most ruthlessly use power is the legitimate ruler of our society.  You are saying that you prefer a system that logically leads, at best, to a thinly disguised autarchy over a system of limited pluralistic democracy. If that is your preference, be glad because if we are not already there we are within shouting distance, but I seriously doubt this is really your desire.

The first impulse is always to see as impossible something that we really don't want to do anyway and if we want to do something we tend to see it as inevitable.  The first step towards getting out of Hell is believing that it can be done.  Monarchies, dictatorships and oligarchies all have been overthrown.  The existing system too can be ended and replaced with a better system.  I know that the existing system will be replaced.  I do not believe that it is inevitable that it will be replaced with something better.  But if we care about our future and that of our children we have to work for a better future.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Jul 29th, 2009 at 09:43:53 PM EST
[ Parent ]
How would you blanket ban all tricks?
Easy as an atom bomb. Legislate a few defined financial market procedures an make any innovations subject to legal review and challenge prior to implementation. Make any unapproved procedures felonies. Define in law the purpose of financial markets as providing investment capital to socially usef projects and set up regulatory procedures accordingly. This would be like dropping a neutron bomb on Wall Street, but that, arguably, would be a good thing. When you have a giant parasite on the body politic the parasite needs to be destroyed.
You're arguing for a whitelist approach. Let me ask you: does the proposed whitelist include the simplest kind of put and call options? If so, then you've lost. General claims can be built up from only those(*), so your whitelist stops nothing at all, however many pages the legislation comes out to be.

Thus by the above, you are really arguing for a world in which no kind of puts/calls are allowed in any form, period. I am not opposed to such a world, but if you have to argue your case and someone points this out, what do you say?

The ordinary use of a put/call is a kind of insurance: it is entered into for protection against wild stock price fluctuations at some future time.

This is not a math problem with a logical solution. Capital and capitalization is the organizing principle of modern societies. The effects of the existing situation are not morally neutral. If your political and moral compass indicates that it is appropriate for Goldman to own the US Department of Treasury, to rent the US Senate, to dominate and intimidate the rest of Wall Street and to suck the life out of the rest of the economy, then, in effect you are saying that the cleverest thief wins, that who ever can most effectively grab and most ruthlessly use power is the legitimate ruler of our society.
All I'm saying is that the math says no to simple minded ideas that sound good but leak like a sieve. I'm not defending Goldman at all, rather I am saying that (as I see it) Goldman will laugh off these puny attempts if some US legislators do actually try them. It would be much more effective to just kill Goldman outright, or nationalise them and convert them into a nonprofit.

(*) Technically for those who want more details: a convex function f has an integral representation in terms of the functions (x - k)_+, and the latter are used to define call options. Thus one can build arbitrary differences of convex functions of an underlying asset using combinations of puts and calls, and this is plenty enough for any practical purpose of speculation, I should think.

--
$E(X_t|F_s) = X_s,\quad t > s$

by martingale on Thu Jul 30th, 2009 at 12:23:42 AM EST
[ Parent ]
I am not a trader.  If puts and calls open Pandora's Box, unless a safe remedy can be found, I would ban them, had I the power.  I agree that GS should die--by  the Sherman Anti-Trust act or a new law if required.  Their continued existence seems incompatible with the rule of law and a properly functioning representative democracy.  The financial services industry, Goldman Sachs and the epigoni, is the only part of the society that has any true representation at present.

If most of the financial industry were to disappear it would mostly mean that a lot of people would have to start making honest livings.  All of the vaunted innovation has only led to the impairment of the economy and the enrichment of the individuals comprising the financial industry.  I do not see how recovery is possible while continuing to feed a parasite of that magnitude.  

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Jul 30th, 2009 at 02:00:19 AM EST
[ Parent ]
If puts and calls open Pandora's Box, unless a safe remedy can be found, I would ban them, had I the power.
Yet doing so if you could would open you up to the counterargument that these options are just insurance, eg why should ordinary people or companies be exposed to the full risk of owning stocks with fluctuating prices when an option can limit the potential fluctuations for its holder, and thus bring a measure of financial certainty in planning for the future? You must be able to answer this question (convincingly) in the negative or the proponents of the markets can use this argument.

In some ways this is as difficult as the gun debate, namely how do you convince people that nobody should be allowed to own guns, when the gun lobby responds by asking why should people live at the mercy of burglars and armed attackers with no protection?

If most of the financial industry were to disappear it would mostly mean that a lot of people would have to start making honest livings.
I doubt it. I believe it would involve a lot of pain and misery throughout, which I'm ok with. But clearly, governments around the world have been scared to death of the pain it would bring to their countries, which is why they largely preferred to guarantee the gamblers' debts.

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$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Thu Jul 30th, 2009 at 02:54:24 AM EST
[ Parent ]
martingale:
Yet doing so if you could would open you up to the counterargument that these options are just insurance, eg why should ordinary people or companies be exposed to the full risk of owning stocks

Why should ordinary people or companies be exposed to the full risk of devastating cyclical market mood swings?

I believe it would involve a lot of pain and misery throughout, which I'm ok with.

With the current system, there's already plenty of pain and misery throughout.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Jul 30th, 2009 at 04:59:48 AM EST
[ Parent ]
Why should ordinary people or companies be exposed to the full risk of devastating cyclical market mood swings?
Indeed, that is where serious questions must be asked about the true value of the financial services sector, and the wisdom of relying on it for pension funds, corporate finance, etc. vis-a-vis alternatives. There is also the question of the immediate consequences of decoupling by shutting large parts of it down.

With the current system, there's already plenty of pain and misery throughout.
But is it sufficient to catalise major political change? I doubt it. People are far from having lost everything they can, yet. If Russian society under Yeltsin is any indication, it can get a lot worse until someone decides to really put the screws on the financial oligarchs.

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$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Thu Jul 30th, 2009 at 06:27:06 AM EST
[ Parent ]
  • Make put and call options subject to the doctrine of insurable interest. Outside hedging - which should always be subject to the doctrine of insurable interest - puts and calls serve no legitimate purpose that I can see. That kills non-linearity and extra margin (the two most troublesome aspects of puts and calls) dead in one blow, without harming the legitimate functions of these tools.

  • Similarly, make commodities markets open only to participants who actually have the capacity to make or take delivery, and do not permit them to purchase more futures than what they can take delivery of.

  • Enact a blanket prohibition on naked shorting of any kind.

  • Make over-the-counter securities and commodities derivatives legally unenforceable. Security and commodity derivatives need to go on exchange. Make all attempts by private players to deploy their own economic power to force compliance with such contracts a form of blackmail.

  • Oh, and a blanket 2-5 % Tobin tax on all exchange transactions should kill much of the excessive liquidity dead.

Similar schemes can easily be devised for blowing out an atom bomb over black-hat speculation in other markets.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Jul 30th, 2009 at 02:21:57 AM EST
[ Parent ]
Jake,
If puts and calls open Pandora's Box, unless a safe remedy can be found, I would ban them...

You illustrate why I included the "if"!  I have repeatedly called for a requirement of "insurable interest in CDSs and extending it to puts and calls should be obvious, but it wasn't to me at the time I wrote the comment.  Thanks.


"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Jul 30th, 2009 at 10:46:41 AM EST
[ Parent ]
This idea that things should be slowed down doesn't make much sense. What would be an acceptable time tic for the stock market? And why not half of that, or double that?

Moreover, distinguishing humans from machines/algos is not a useful idea either. Where does the human end, and the algo begin? If the computer performs sanity checks on human transactions, does that count as humand or algorithmic? If the human is tired of doing the same thing every day, and feels a simple program might automate much work, does that count as human or algorithmic? If the program becomes so complex and powerful that it represents the distilled knowledge of a roomfull of experts, does it count as human or algorithmic?

Like the atomic bomb, there's no point in hoping to turn back the clock. Computers exist, and they are fast, and they are expertly programmed.

Where there is an argument I think is in asking what conditions are needed to ensure that markets reflect their purpose. For example, hedging theory uses ideas of non-anticipating processes, ie processes which literally cannot depend on future events in a technical sense. All of derivative pricing is built on that idea, so that if you drop the non-anticipatory requirement, then the world that is implied does not behave in a "known" way, ie the theoretical justifications proposed by economists and marketeers do not apply. In this way, it makes sense to outlaw HFT, not because computers are too fast, but because the market as we know/expect it breaks down because of it.

As another example, one might argue that markets must have a minimum size in terms of numbers of interacting agents. Any technological or legal process which creates an effectively smaller market size should be outlawed, because the minimum size guarantee of purpose is not ensured. This is in effect what the argument about people vs computers boils down to. In HFT, too few interactions between agents exist, because the bulk of market participants (including all humans and some computers) cannot act/react in this timeframe. Conversely If everybody used computers which can act/react in milliseconds or less, then the size of the market during the HFT timeframe would increase, and this would guarantee the purpose of the market. In this scenario, there would be no realtime human actors, but that clearly wouldn't matter.

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$E(X_t|F_s) = X_s,\quad t > s$

by martingale on Wed Jul 29th, 2009 at 05:18:34 AM EST
This idea that things should be slowed down doesn't make much sense. What would be an acceptable time tic for the stock market? And why not half of that, or double that?

That's essentially a political decision. Liquidity contains an inherent tradeoff between the ability of investors to monetise their investment (lack of which ability acts as a disincentive to investing) on the one hand, and black-hat speculation on the other hand.

It seems reasonably obvious that nobody needs day-to-day liquidity in his investments, or even week-to-week, so the tradeoff here is fairly one-sided. When you get into several months, it becomes more iffy, because you get a larger downside (and possibly also a smaller upside).

Such tradeoffs are inherently political. And the fact that this decision is currently made by programmers and traders professional gamblers at Goldman rather than in democratically accountable parliaments does not make it any less political.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Jul 29th, 2009 at 10:49:00 AM EST
[ Parent ]
If it's merely a political decision, then politicians have spoken loud and clear for the last 30 years. Unfortunately, they haven't spoken on the side of longer time tics.

It seems reasonably obvious that nobody needs day-to-day liquidity in his investments, or even week-to-week, so the tradeoff here is fairly one-sided. When you get into several months, it becomes more iffy, because you get a larger downside (and possibly also a smaller upside).
I don't see it.

Firstly, there is the physical constraint from the volume flow of transactions. With millions of market participants performing one or two transactions every day or every week only, for example, the total number of transactions in a single day is still huge. So there has to be constant activity to balance the books, unless you can limit the number of market participants to a handful.

Secondly, modern replication strategies require frequent rebalancing of portfolios down to the smallest time interval possible. Whatever that time interval is chosen to be, expect millions of shares to be bought and sold during that interval market wide. The volume of transactions will not lessen if the time interval is increased, it will stay exactly the same at best and might probably even increase.

Such tradeoffs are inherently political. And the fact that this decision is currently made by programmers and [S:traders:S] professional gamblers at Goldman rather than in democratically accountable parliaments does not make it any less political.
I would say that there is a strong practical component involved. Politicians cannot legislate physical reality. Unfortunately, the one thing they should be doing, which is to allow the gamblers to lose their shirts and die, they do not wish to do.

--
$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Wed Jul 29th, 2009 at 07:59:11 PM EST
[ Parent ]
If it's merely a political decision, then politicians have spoken loud and clear for the last 30 years. Unfortunately, they haven't spoken on the side of longer time tics.

I am quite comfortable with the fact that this is a political problem. Because, as I have noted elsewhere, political problems are somebody's fault, and can be rectified by removing the somebody whose fault it is and replacing him with someone who isn't a problem.

Firstly, there is the physical constraint from the volume flow of transactions. With millions of market participants performing one or two transactions every day or every week only, for example, the total number of transactions in a single day is still huge. So there has to be constant activity to balance the books, unless you can limit the number of market participants to a handful.

Not the regulator's problem.

Ban OTC transactions and enforce a Tobin tax on all on-exchange transactions. Then you don't have to care whether a transaction takes place to balance books or to shift ownership around.

Secondly, modern replication strategies require frequent rebalancing of portfolios down to the smallest time interval possible.

Modern replication strategies are a bug, not a feature.

But, again, not the regulator's problem. Under a Tobin Tax scheme, individual participants can have precisely the amount of liquidity that they are willing and able to pay for.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Jul 30th, 2009 at 01:53:57 PM EST
[ Parent ]
I am quite comfortable with the fact that this is a political problem. Because, as I have noted elsewhere, political problems are somebody's fault, and can be rectified by removing the somebody whose fault it is and replacing him with someone who isn't a problem.
Or not. That's the rub, isn't it? If it's purely a political problem, then to solve it one has to convince one's compatriots to vote in the way that one would like them to vote. How's that been working out for the last 30 years? For that matter, how did that work out in the years since 2000?

I continue to believe that a serious deterioration is first necessary to focus people's minds. I hope I'm wrong.

Ban OTC transactions and enforce a Tobin tax on all on-exchange transactions.
Ban OTC? How are you going to do that? Those are essentially private agreements between two parties. Would you like any two companies who wish to enter into any contract to ask the government regulator for permission first? You can shut down the OTC Bulletin Board and you could outlaw any contract which contains the words over-the-counter if you like, but what is that going to accomplish realistically? OTC is not the actual stock exchange, and the same can be accomplished by two people sitting in an office to sign a document, or two computers talking to each other directly. Worse, derivatives are not usually about trading stock directly, but about rights and obligations regarding the behaviour of people and companies owning stock. It's meta. It's an agreement about what the parties will do at particular event times.

Modern replication strategies are a bug, not a feature.
Why? A replication strategy is only a sequence of trades, such as any person might do. The difference is in the player's mind. Whereas a casual investor has no idea what the end result of his investment strategy will be, beyond a nebulous hope of increasing his wealth, the replication strategy is designed to create a specified function of the underlying stock. That's all.

Any sequence of trades over time generates some function of the underlying stocks, bonds, etc. If you can write down what function you would like to get, then it is a matter of solving an engineering style control problem to get an approximation of this function within the feasibility constraints represented by the number of allowed trades and asset classes. In other words, you could have a stock market that allows a single time tic per day, or any number of silly constraints, and you could replicate regardless.

How do you control what's in a person's mind? How do you argue politically that companies cannot choose what to buy or sell when they want to? How do you convince your compatriots to vote for somebody who will impose those restrictions? It doesn't sound easy to me.

Under a Tobin Tax scheme, individual participants can have precisely the amount of liquidity that they are willing and able to pay for.
And Tobin concerns exchange trades only, right? What private companies agree between each other about what they will or will not do on the exchange is not covered, right?



--
$E(X_t|F_s) = X_s,\quad t > s$

by martingale on Thu Jul 30th, 2009 at 10:15:12 PM EST
[ Parent ]
Ban OTC? How are you going to do that?

Same way you do with gambling, price fixing cartells or any other contract the government wants to get rid off. Ban the action and give it suitable punishments, make it possible for government to seize assets if the action is revealed, and refuse to let the criminals use the governments resources to uphold the contracts.

Illegal activities will always still happen, but it will be riskier and less profitable. And thus probably less common.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Jul 31st, 2009 at 04:44:14 AM EST
[ Parent ]
Ban OTC? How are you going to do that?

Simple. You cannot legally change ownership of anything that is traded on an exchange without notifying the exchange and paying the Tobin Tax.

The same way that you cannot legally change ownership of a house without notifying the local zoning authority and paying stamp duty.

Private agreements that, at some future point in time, securities that are traded on exchange will change hands should be similarly unenforceable, unless they are registered with the exchange. Precisely the same way that I cannot hold you to a promise you make to sell me your house at some agreed-upon time at some agreed-upon price, unless the contract has been signed and notarised.

Contracts between private third parties require the government to enforce them. So if the government ceases to enforce certain kinds of contracts, they cease to have meaning as contracts and become much vaguer kinds of promises. Private enforcement of such promises is what's known as "blackmail" and it is usually frowned upon in polite society.

Why? A replication strategy is only a sequence of trades, such as any person might do. The difference is in the player's mind. Whereas a casual investor has no idea what the end result of his investment strategy will be, beyond a nebulous hope of increasing his wealth, the replication strategy is designed to create a specified function of the underlying stock.

Yes, and that's the problem. It works on the stock price to generate revenue, rather than the underlying cash flow.

Which is a bug, not a feature.

And Tobin concerns exchange trades only, right? What private companies agree between each other about what they will or will not do on the exchange is not covered, right?

Correct. But if such agreements are not enforced by the state, the first time any party finds itself in a losing bet he can simply walk out without further discussion.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Jul 31st, 2009 at 05:27:28 AM EST
[ Parent ]
Simple. You cannot legally change ownership of anything that is traded on an exchange without notifying the exchange and paying the Tobin Tax.

Exchanges? Who needs exchanges?

Where's the exchange in the world of FX?

Exchange trading would disappear into "dark pools" of liquidity in five minutes. A lot already has.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Jul 31st, 2009 at 07:10:20 AM EST
[ Parent ]
Where's the exchange in the world of FX?

Basel.

It's not a very effective exchange, as a number of SE Asian countries will attest, but it's there.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Jul 31st, 2009 at 07:24:55 AM EST
[ Parent ]
Basel??

CLS Bank is the closest thing there is and it's not even remotely possible to operate at the requisite level of granularity.

There is not a cat in hell's chance of a Tobin Tax without a new clearing network created - or evolving - from the ground up.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Jul 31st, 2009 at 07:40:14 AM EST
[ Parent ]
Because existing exchanges would resist?  Because capital would flee to "dark pools" and engage in legally unenforceable transactions?  Well, various mafia's do seem to be able to do business, but...

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Jul 31st, 2009 at 01:49:07 PM EST
[ Parent ]


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