Flash frenzy
Gary Weiss on Wall Street
A new brand of superfast trading is sweeping Wall Street, aided by a regulatory loophole. Flash trading proves that, a year after the financial crisis, absolutely nothing has changed
For people who rarely get out of the office, Wall Streeters whine a lot these days about “level playing fields.” Leave us alone, they say, keep the government out of our business, let us do our own job of keeping the markets “fair and efficient” all by ourselves.
Setting aside for a moment the most obvious irony—that a lot of these firms wouldn’t be in business if the U.S. government hadn’t stepped in to save their skins this time last year—what’s become clear in recent weeks is that even as Wall Street talks about a level field, it’s busy doing everything in its considerable power to tilt the field in its own favour. The rise of what’s called “flash trading” is the latest case in point, helping to generate a new round of record profits for Wall Street firms like Goldman Sachs and J.P. Morgan while every other investor sits on the sidelines wondering how they missed out. And once again—just as in the subprime mess and the derivatives meltdown—American regulators have, to date, proved as ineffective as ever.
To make money the superfast flash way, you need two things: computing power, which Wall Street firms have in abundance, and access to the stock exchanges and electronic trading networks that allow flash trading. Just as individual investors need to work through specialists to get in on the action on the floor of the New York Stock Exchange, so, too, are there gatekeepers in the world of flash trading. And so far, at least, only the biggest firms are being let in.
Firms in the flash game make money using the oldest trick on Wall Street: grabbing an information edge over everybody else, and finding a crack in the regulations to take advantage of it. It’s the digital, lightfast equivalent of a stock tip from your barber. The way flash trading works is complicated, but it boils down to this: Traders with enough computing power can get a split-second, advance look at other people’s orders. That’s just enough time for their computers to race into action, taking advantage of the sneak peek to move ahead of the original traders and profit ahead of them.
So if, say, you knew a large investor was about to spend $10 a share on a stock currently trading at $9, you could swoop in and buy up a wad of the $9 shares without the bidder ever knowing you had snuck in ahead of his purchase. (The actual spread is generally in the neighbourhood of only two or three cents.)
It’s dodgy, but profitable. At a time when most of Wall Street’s business lines are badly flailing, flash trading is a rare bright spot. Such trading now represents 2.4% of the total business transacted on American exchanges this year, generating profits of at least $8 billion (U.S.).
With that kind of money at play, Wall Street is eager to defend the practice. Players in the game say it helps the markets keep their edge, rewarding the swift and innovative, which is what capitalism is supposed to do. One recent op-ed article in The Wall Street Journal portrayed the debate over flash trading as one of innovation versus the stodgy status quo, much as hedge funds once described derivatives trading as the future of investment.
This is likely to end equally badly. If anything, flash trading represents the opposite of innovation. At a time when public confidence in Wall Street is at an all-time low, the smartest people in finance are coming up with yet another way of gaming the system. It feeds the perception that the market is a sucker’s game, that every trade we make in our own online account is just grist for someone with a supercomputer to exploit.
Regulators say they’re on top of the issue. There already is a law against “peeking” at other people’s trades, except that a fat loophole keeps the flash traders in business. The so-called Quote Rule is supposed to expose trading to the fresh air of public disclosure, but does not apply to orders lasting under half a second, which is where flash trading mainly lives. Securities Exchange Commission chairperson Mary Schapiro has asked her staff to quickly find a way to close the loophole. Don’t expect much. If we’ve learned anything from the past year, it is that regulators often share the moral myopia of the banks they regulate. The revolving door from business to government, and back again, continues to spin and, every day, investors continue to wonder whether they can ever trust Wall Street again. Whatever confidence we might have gained in the past year of regulatory reform is now gone, just like that, in a flash. |
