Investment management magnate Cliff Asness has a problem with a Bloomberg View piece on High Frequency Trading (HFT) with particular focus on issues brought up by Michael Lewis in the book Flash Boys. While he makes good points, the real mastery of the HFT debate is how the key issues remain undiscussed.
Cliff Asness notes trading costs have significantly declined
In his rebuttal article, Why I Love High Speed Trading, Cliff Asness correctly notes that trading costs have significantly declined in the era of high frequency trading and he points out the primary issue that neutral observers close to market making and HFT have with the Lewis book.
“HFTs shouldn’t be judged against an unattainable nirvana of zero bid-ask spreads and infinite liquidity,” Cliff Asness writes. This is accurate. In Flash Boys Lewis says that ideally markets would match buyers and sellers at the exact time with the exact pricing without middlemen. This is a false notion that hasn’t been proven inaccurate throughout the history of modern markets. In order to provide an investor the ability to buy or sell a stock or commodity at any given moment in time there has always been a market maker providing a higher price to buy (bid) and a lower price to sell (ask). These market makers are key to liquid markets and likely can’t be replaced without damaging the immediacy of being able to buy and sell at any given moment in time.
It’s what Cliff Asness didn’t address that deserves consideration.
Cliff Asness: The most dangerous aspect of HFT is the flash crash
The most dangerous (and unreported) aspect of HFT is the flash crash – and it is a national security concern. The problem is that since the Flash Crash of May 6, 2010, the damaging impact of future flash crashes has only multiplied. HFT researcher Eric Hunsader, one of the practices leading critics, says there are as many as 4 to 8 flash crashes per week, if you use his more conservative numbers. The problem is these flash crashes remain unidentified and unmonitored. The only person monitoring the problem is Hunsader, which needs to change.
Ever since the discredited regulatory flash crash report failed to identify the real cause of the flash crash, the problem has grown worse and worse. Sweeping Wall Street’s real issues under the rug seldom causes positive change to occur. By not publically addressing the real issues, the flash crash being the most significant, the problem is likely not to be corrected.
While flash crashes are an issue, so is some of the core legality of HFT mechanics, another issue not addressed. If any mid-level executive at AQR, Cliff Asness’ investment management firm, were to pay a broker for retail customer asset order flow they would land in significant regulatory problems. This practice has been questioned by the massive stock firm Vanguard Group, who, we learned in recent Senate testimony, turned down nearly $200 million in HFT cash to purchase their order flow because they considered the practice likely illegal.
As the HFT debate progresses, its more interesting to watch what isn’t mentioned. That’s where the story is.