Wall Street – The Noose Tightens

8/2/2016 - David Buckham CEO of Monocle

Bank executives observing the recent electoral party conventions in the US must have become increasingly concerned. In the run-up to the most divisive elections in living memory – with both Democrat and Republican campaigns making negative slander their number one issue – there is one thing the parties actually agree on. Reining in the banks.  

Since the ravages of the Financial Crisis of 2008, the Democratic Party has for some time been firmly planted on the far left of the political spectrum in terms of their position on Wall Street. The issues have included executive pay, anti-money laundering fines, insider trading convictions, and eye-watering penalties for market manipulation.  

In October of 2015 however, Hillary Clinton turned her attention to a far more technical aspect of the financial markets. She delved into the murky world of high frequency trading (HFT) and recommended the imposition of a financial transaction tax (FTT) on all trading transactions.  

She announced that, as President, she will impose a tax on high-frequency trading. These trades, she explained, have “unnecessarily burdened our markets and enabled unfair and abusive trading strategies.” HFT are the computer-generated trade orders and cancellations that occur in incredibly large volumes and at massively high frequency to make margins off price differentials in exchange markets in different locations.  

A natural arbitrage exists, for example, between the futures price of a stock traded in Chicago and the spot price of that same stock traded in New York. Logically, the prices must converge, so the faster one can exploit the relative value arbitrage, the better. Hence the installation of high quality dedicated fibre-optic cable between the two exchanges, as chronicled by Michael Lewis in his book Flashboys.  

In analysing the Clinton-proposed FTT, the arguments against penalising high frequency trading practice are strong. There are three main points.  

Firstly: how could it possibly be more fair or efficient to go back to a world in which brokers stood on trading floors, signalling and shouting, and side-dealing off information only they had at that moment in time? One recalls here the Eighties classic movie Ferris Bueller’s Day Off  – particularly the scene in which Cameron Frye, Ferris’s friend, apes the motions of the floor traders, ridiculing both himself and inevitably them.  

Secondly, a number of market commentators have claimed that HFT has a stabilising effect on the markets. Directly after prices experience inexplicable spikes, HFT brings the market back into alignment by robotically and immediately exploiting the arbitrage. Computer-generated trades have been blamed however for causing the spikes in the first place.  

Thirdly, there is an argument that a tax on financial transactions would simply create a “cascade effect”. In this argument, the spread between market-maker prices and end-user investor prices would widen. The new tax would simply be passed on and embedded in bid and ask prices quoted to retail investors.  

The Economic Policy Institute, a Washington DC think tank that focuses its efforts entirely on reducing inequality in the US and bringing integrity and fairness back to US jobs, thinks otherwise. In a well-researched paper published on the 28th of July 2016, the authors provide a compelling argument for the introduction of the proposed transaction tax. It will bring in more than a US 110 billion in revenue, they argue. At very little cost to the retail investor.  

Their argument rests on the assumption that high-frequency trades benefit only the hedge funds and investment banks that make use of fibre optic cable trading, rather than the retail investor. The tax then will “crowd out” this nature of profit-taking, the kind of business that adds no value to the US economy. They may well be right. There are no retail investment funds on offer that I can think of in which the average investor can benefit from this kind of “micro-second trading arbitrage”.  

Irrespective of one’s own convictions, it would seem likely that should Clinton be President, Wall Street can look forward to the introduction of financial transaction tax in the US.  

Wall Street, however, will not find solace in the Republican agenda. At the recently held Republican Convention in Cleveland, policies were adopted which effectively re-instate the Glass-Steagall Act. This was the legislation in the early 1930s that split investment banking activities from deposit-taking institutions, and was the result of the 1929 Crash. Many regard Bill Clinton’s repealing of this Act in 1999 as one of the causes of the 2008 Great Recession. Much is said at conventions however, that never see the light of day. And bankers may well be hoping that these proposals follow the same suit.  

If, however, Wall Street had any doubt as to whether there remained any Republican sympathy for them, they were left with a clear message after Ted Cruz’s speech in Cleveland. To much furore at the convention, Cruz refused to endorse Donald Trump during his turn at the microphone. After descending from the stage, he and his wife were ushered out by security guards. They needed protection. Delegates were advancing on them hissing the phrase “Goldman Sachs, Goldman Sachs”. That is the firm Ted Cruz’s wife works for. And it is the same firm that laid those fibre optic cables.

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