Regulators have various ideas of how to regulate against spoofing, front-running (where flash traders get information on trades milliseconds before the public), and other such high-frequency fun and games; I’ve written about them before. They generally work by creating speed bumps in the trading process, say by moving from continuous trading to “batch trading,” thereby taking away the millisecond advantages of the flashers.
That might work, but it might not. You ask me, an arms race against quants who live to write regulation-beating algorithms is a recipe for more of the same. For example, suppose batch trades across different exchanges are not perfectly synchronized. That’s an opportunity for high-frequency arbitrage.
A better, simpler way—and one with numerous positive externalities—is a financial transaction tax, a small excise tax on the security trades, typically a few basis points (hundredths of a percent) on the value of the trade. A three basis points FTT is scored as raising over $300 billion over 10 years, a score that includes its dampening impact on trades.
Of course, that last bit is a feature, not a bug. We’d have to try it to find out, but it is widely believed that an FTT, even one of the tiny magnitude just noted, would wipe out most high-frequency trading. Though the flash boys can generate huge payouts, the volume of trades they must execute to do so quickly becomes too costly once they’re taxed.
In that regard, the FTT is a Pigouvian tax: a tax that offsets the significant, external costs imposed on the larger society by activities like smoking or polluting. And it does so while generating much needed revenue.
There are, of course, arguments against the FTT—by reducing trading, it dampens liquidity; it pushes traders to other exchanges to escape the tax. I deal with some of these concerns here, as does Dean Baker here. I take these concerns seriously, but my strongly held belief is that the likely benefits outweigh potential costs.…
Jared' makes one of the more convincing arguments for a FTT.
ReplyDeleteBut there is also something to be said for regulating, rather than taxing, whatever "bad" activity we are trying to reduce, like high frequency trading.
For example, you could require that assets must be held for a certain length of time before selling.
The behavioral effect of regulations is more generally more predictable than the behavioral effect of a tax.