Stock image: the New York Stock Exchange reopens after the Easter holiday, 21 April. Photo: Getty
Show Hide image

HFT: the latest scam devised by Wall Street and the City

Felix Martin discusses Flash Boys by the American financial writer Michael Lewis, which examines high-frequency trading (HFT).

Flash Boys, the new book by Michael Lewis, America’s explainer- in-chief of all things financial, is an account of “high-frequency trading” (HFT) – a technique developed by financial firms that deploys vast computing power to trade electronically on the world’s stock exchanges at extreme speed.

That may sound pretty esoteric. However, the book is generating an enormous amount of attention because it argues that HFT is the latest in the litany of scams that Wall Street and the City have devised to relieve unwitting investors of their money.

Whenever you hit Enter to buy shares through an online brokerage, Lewis shows, your order does not go straight to the stock exchange as you might think. Instead, HFT firms get a look-in first – and they use their superior speed to “front-run” your order by buying the shares ahead of time and then offloading them into the market at a marginally higher price. The resulting profits are tiny on any individual order but they run into the billions when you add them up. And they are made at your expense. Given how many people have a stake in the stock market these days with their Isas and their Sipps, this is certainly a disturbing revelation. Lewis deserves all the praise he is getting for exposing it.

Yet, to my mind, Flash Boys is even more important than this. For it exposes HFT as a prime example of one of the major problems of our age: the unintended consequences of technological innovation. Technologists, regardless of their political bent, tend to be idealists – it probably requires a healthy dose of idealism to take the risks required to innovate. But all too often, idealism can slip into naivety. The unstated assumption is that if new technology can be used to better the lot of the individual, it will. Everything will be OK so long as you “don’t be evil”.

Unfortunately, it doesn’t always work like that in the real world. The new technologies developed by well-intentioned young geeks in Silicon Valley and Old Street get grafted on to an economy that is still dominated by big, profit-seeking corporations run by shrewd old-economy dinosaurs. Innovation is driven by the admirable belief that new technology is a tool for the emancipation of human creativity and self-fulfilment. Less thought is given to what might happen after, say, News International buys your app.

The point is more general than just the compromises that come with commercialisation by big business. What the technologists are missing is the crucial importance of the social context in which new technology is deployed and, above all, the role of that most reliable of social scientific regularities, the law of unintended consequences.

The canonical problem is that we design some new technology to solve a problem but in doing so we make a crucial assumption: that everything else will remain unchanged and in particular the way that people interact, the social context, will be unaltered. What happens is that behaviour adapts. The technology succeeds – the old problem is eliminated – but new problems arise.

An example that is almost guaranteed to have infuriated anyone reading this at some time or other is the computerisation of personal credit scoring. Companies such as Experian or Equifax apply information technology to the problem of deciding who should and should not get loans.

In an economy where mortgages and mobile-phone contracts are considered essentials, the decisions that their computers churn out are important. Their claim is that their algorithms are not just cheaper than the Captain Mainwaring-style bank manager of old but also more objective and therefore fairer.

If it were true that people’s behaviour had remained constant after the introduction of computerised credit scoring systems, that might be the case. But in reality, people game the system. Personal finance articles and chatrooms warn them that cappuccinos and city breaks flag them for a downgrade, so they take a breather for three months before applying for a mortgage – and then they start up again as soon as the ink on the contract is dry.

It is no different from the snag that the Soviet Union discovered with a planned economy. You could solve the problem of low productivity – at least as the bean-counters captured it – with more demanding targets. The underlying disease of demotivation proved more resilient, however. As an aphorism of the period had it: “They pretend to pay us and we pretend to work.”

The story that Lewis tells of HFT is a perfect example of the law of unintended consequences at work in the technological transformation of the stock market, one of the most basic institutions of our capitalist economies. The computerisation of stock exchanges that began in 1986 promised to make them simpler and more efficient. The world of barrow-boy traders bellowing at one another in the pit and the old-boys network of City stockbrokers was abolished in favour of anonymous electronic trading on a virtual exchange.

The intention was to stop investors being ripped off by an uncompetitive industry. However, this assumed that behaviour would not adapt. The stockbrokers and pit traders did hang up their red braces and garish blazers but a new generation of rent-seekers emerged in their place. As Flash Boys documents, the fixed commissions levied by the stockbrokers of yesterday were replaced by the cuts taken by the HFT firms of today.

So, what is the lesson to be learned from Lewis’s latest blockbuster? Well: this past week, the government’s ambassador for digital industries announced that schoolchildren should learn less French and more code. Maybe. But the lesson of the burgeoning HFT scandal is that the naive application of technology can be a uniquely dangerous force. We should be teaching our budding technologists not just code – but the law of unintended consequences.

Macroeconomist, bond trader and author of Money

This article first appeared in the 14 April 2014 issue of the New Statesman, Easter Double

Getty
Show Hide image

The World Cup you’ve never heard of, where the teams have no state

At the Conifa world cup – this year hosted by the Autonomous Republic of Abkhazia – ethnic groups, diaspora communities and disputed territories will battle for footballing glory.

Football's European Championship and the Olympics are set to dominate the back pages over the next few months. How will Team GB fare in Rio? Will the zika virus stop the tournament even going ahead? Will the WAGS prove to be a distraction for the Three Lions? And can Roy Hodgson guide England to a long-awaited trophy?

But before the sprinters are in their blocks or a ball has been kicked, there's a world cup taking place.

Only this world cup is, well, a bit different. There's no Brazil, no damaged metatarsals to speak of, and no Germany to break hearts in a penalty shootout.  There’s been no sign of football’s rotten underbelly rearing its head at this world cup either. No murmurs of the ugly corruption which has plagued Fifa in recent years. Nor any suggestion that handbags have been exchanged for hosting rights.

This biennial, unsung world cup is not being overseen by Fifa however, but rather by Conifa (Confederation of Independent Football Associations), the governing body for those nations discredited by Fifa. Among its member nations are ethnic groups, diaspora communities or disputed territories with varying degrees of autonomy. Due to their contested status, many of the nations are unable to gain recognition from Fifa. As a consequence they cannot compete in tournaments sanctioned by the best-known footballing governing body, and that’s where Conifa provides a raison d’être.

“We give a voice to the unheard”, says Conifa’s General Secretary, Sascha Düerkop, whose world cup kicks off in the Autonomous Republic of Abkhazia at the end of this week.

“We are proud to give our members a forum where they can put themselves on the map.

“From that we hope to give back in the long run and invest in the football infrastructure in our member nations to help them grow.”

The two week footballing celebration starts with an opening ceremony before Kurdistan and Székely Land kick off the tournament. It follows on from 2014’s maiden competition which saw The County of Nice avenging a group stage defeat to Ellan Vannin from the Isle of Man, to take the spoils in the final via a penalty shoot-out.  There were some blowout scores of note however, with South Ossetia smashing Darfur 20-0 and Kurdistan beating the Tamils 9-0 at the event which took place in Östersund, Sweden. Neither of the finalists will be returning to the tournament – throwing down the gauntlet to another twelve teams. 

This, the second Conifa world cup, is testament to the ever-expanding global footprint of the tournament. Abkhazia will welcome sides from four continents – including Western Armenia, the Chagos Islands, United Koreans in Japan and Somaliland.

Despite the “minor” status of the countries taking part, a smattering of professional talent lends credibility to the event. Panjab can call on the experience of ex-Accrington Stanley man Rikki Bains at the heart of their defence, and the coaching savoir-faire of former Tranmere star Reuben Hazell from the dugout. Morten Gamst Pedersen, who turned out for Blackburn Rovers over 300 times and was once a Norwegian international, will lead the Sapmi people. The hosts complete the list of teams to aiming to get their hands on silverware along with Padania, Northern Cyprus, and Raetia.

A quick glance down said list, and it’s hard to ignore the fact that most of the nations competing have strong political associations – be that through war, genocide, displacement or discrimination. The Chagos Islands is one such example. An archipelago in the Indian Ocean, Chagos’ indigenous population was uprooted by the British government in the 1960s to make way for one of the United States' most strategically important military bases – Diego Garcia.

Ever since, they've been campaigning for the right to return. Their side, based in Crawley, has crowdfunded the trip to the tournament. Yet most of its members have never stepped foot on the islands they call home, and which they will now represent. Kurdistan’s efforts to establish an independent state have been well-highlighted, even more so given the last few years of conflict in the Middle East. The hosts too, broke away from Georgia in the 1990s and depend on the financial clout of Russia to prop up their government.

Despite that, Düerkop insists that the event is one which focuses on action on the pitch rather than off it. 

“Many of the nations are politically interested, but we are non-political,” he says. 

“Some of our members are less well-known in the modern world. They have been forgotten, excluded from the global community or simply are ‘unpopular’ for their political positions.

“We are humanitarians and the sides play football to show their existence – nothing more, nothing less.”

The unknown and almost novel status of the tournament flatters to deceive as Conifa’s world cup boasts a broadcast deal, two large stadiums and a plush opening ceremony. Its aim in the long run, however, is to develop into a global competition, and one which is content to sit below Fifa.

“We are happy to be the second biggest football organisation,” admits Düerkop.

“In the future we hope to have women’s and youth tournaments as well as futsal and beach soccer.”

“Our aim is to advertise the beauty and uniqueness of each nation.”

“But the most important purpose is to give those nations that are not members of the global football community a home.”

George Weah, the first African winner of Fifa World Player of the Year award remarked how “football gives a suffering people joy”.

And after speaking to Düerkop there’s certainly a feeling that for those on the game’s periphery, Conifa’s world cup has an allure which offers a shared sense of belonging.

It certainly seems light years away from the glitz and glamour of WAGs and corruption scandals. And that's because it is.

But maybe in a small way, this little-known tournament might restore some of beauty lost by the once “beautiful game”.