Open (political) season on traders

October 15, 2016 11:00 AM
Just before its convention this past July, the Democratic Party released its 2016 Party Platform.

Just before its convention this past July, the Democratic Party released its 2016 Party Platform. It contained many ideas that just about everyone can support. For example, “Fight for economic fairness and against inequality.” Who can disagree with that? And Wall Street should not be allowed to sell “trillions in risky financial instruments” that require a taxpayer bailout when they collapse, as happened in 2008. 

I agree with that, too. But how did the platform go from there to calling for a “financial transactions tax (FTT) on Wall Street to curb excessive speculation and high-frequency trading (HFT)?” 

I’m not sure why traders in general, and HFT specifically, became the logical scapegoat for the 2008 crisis. That event was spurred by the widespread collapse of heavily leveraged products whose stellar credit ratings turned out to be wildly inaccurate. HFT produced no such products, was never “too big to fail” and didn’t take a dime of TARP bailout money. But, the idea of stopping harmful 2008-like Wall Street speculation by punishing the act of trading is somehow being accepted as reasonable and overdue.

You can sort of see how it happened. While on the campaign trail in his failed bid to become the Democratic presidential candidate, Senator Bernie Sanders (I-VT) used traders and “Wall Street Speculators” interchangeably. Despite the beneficial role modern traders play in continuously providing the market with abundant and inexpensive liquidity, they were cast as unscrupulous opportunists. The rhetoric has been effective in moving large groups of people to believe that anything that throws sand in the gears of these traders is fair game. Now the Democrats are trying to agree on just how much sand.

Senator Sanders, no pun intended, even has a bill, S.1373, before the Senate calling for an FTT that would raise $300 billion per year by taxing every stock, bond and derivatives trade in the United States. In justifying the bill, he cites a study that claims an FTT would also cut market activity by as much as 50% by only encouraging the “productive” trading of companies raising capital to fund expansion and create jobs. Any trading outside of that, including, presumably, that which takes place to accurately price listed companies and provide a ready market for those who want to buy and sell shares in them, is not productive. I find that a particularly reckless hypothesis on which to base a tax on the deepest and most liquid securities market in the world. 

Democratic Presidential Candidate Hillary Clinton, for her part, wants a much smaller and targeted FTT centered on yet-unspecified excessive levels of order cancellations. While I can’t see that bringing crowds to their feet at a political rally, it can be quietly effective in its simplicity and intellectual appeal. After all, setting a maximum level of order cancellations seems like a perfectly logical way to reduce market activity that does not produce trades. 

However, a multi-university study examined one year’s worth of trading and found, “The only thing occurring during high levels of cancellation activity is HFT firms seeking the correct price level. This is good for the market. It means that HFT firms process information and help improve price discovery without the need for intermediate executions.” In short, these “cancel” and “replace” orders help algorithmic traders quickly establish the true price of a stock, as opposed to investors buying at unstable prices to achieve this.

But what if, in spite of all the data to the contrary, the unthinkable happened and market making was taxed out of existence. Who would be left to pay the tax? Therein lies the insidious nature of the FTT. The answer is the investors who are left in the markets — the pension funds of hard-working Americans and the mutual funds that help individuals invest for college, a new home or a secure retirement. Every taxpayer should be wary when politicians assure them that their proposed tax is on “other people” as it almost never is. 

Regardless of the accusations, motivations and political positioning, the FTT, by its stated purpose in the Democratic Party Platform, would deliberately add friction to trading. Ultimately this would serve to throttle back the world’s best engine of capital formation, economic growth and job creation. It would also unwind the virtuous cycle that promotes wealth and creates the conditions for economic prosperity. In the final analysis, I really don’t know why any politician would seek to harm those who have helped make our markets the best in the world.

About the Author

Bill Harts is CEO of Modern Markets Initiative, an advocacy effort organized by some of the industry’s leading quantitative trading firms. @modernmarkets