In a recent talk at the Federal Reserve Bank of Atlanta, Nobel Prize-winning economist Joseph Stiglitz suggested taxing high frequency trading as a way to effectively stop the practice without an outright ban. Joseph Stiglitz has rejected the notion that HFT benefits the market, or society, and argued that it actually destroys value, reports Pedro Nicolaci da Costa at The Wall Street Journal.

Joseph Stiglitz

HFT has been in the news recently as Michael Lewis’s Flash Boys has accused the practice of rigging the market to take advantage of normal investors while the Federal Bureau of Investigation (FBI) has launched an investigation into whether or not high-frequency traders are breaking the law. The debate has mostly been over what the net effect on other investors really is. HFT defenders say that the practice increases price efficiency and lowers trading costs, while critics say that these benefits are mostly a result of electron trading platforms that could exist without HFT pushing itself in between buyers and sellers.

HFT a negative sum game: Joseph Stiglitz

Joseph Stiglitz takes this criticism a step further, pointing out that HFT acts as a drag on the market as a whole. “Gains to one party come at the expense of money that would have gone to others,” said Stiglitz, but the effort that goes into being the fastest trader or to hiding the nature of your trades to prevent HFT front-running are additional costs on market participants without creating any additional value. This is, in Joseph Stiglitz’s words, a “negative sum game.”

He also makes the interesting point that as HFT becomes more important, markets may become less attached to financial information, because it’s possible to turn a profit through better algorithms that are agnostic about the quality of the underlying stocks. HFT proponents say they help the market price in new information more quickly, but the flash crash in May 2010 shows how prices driven by algorithms may not correspond to what’s really happening.

Joseph Stiglitz mentions that taxes can be used, but doesn’t elaborate

Instead of arguing for an outright ban on HFT, Joseph Stiglitz mentioned that taxation could be used to discourage the practice, without getting into details. It would be interesting to hear a more detailed proposal, because tacking a surcharge on all trades might bring HFT to a halt but it would also hurt the entire market. A tax that has a strong impact on HFT and little or no impact on other traders could be difficult to hammer out.