Though Wall Street is an easy target, senators are attacking the financial industry for the wrong reasons. Last week, Senators John McCain and Carl Levin led the charge against high-frequency trading in a hearing in the Senate Subcommittee on Investigations. The senators are hoping to use the Securities and Exchange Commission (SEC) to curtail this trading.
High-frequency trading uses advanced computing to rapidly trade securities based on market changes. These trades can occur nearly instantaneously within a fraction of second. Trades done in this manner account for half of the entire equity trading volume in the United States as of 2012 and have been gaining media attention.
Over the last several years, the supposed volatility caused by high-frequency trading has raised some eyebrows. Because these traders can react so quickly, securities prices can change dramatically, sometimes without much explanation. In May of 2010, the DJIA fell by over 1,000 points and recovered in a matter of minutes. Many attribute this “fluke” to the large level of high-frequency trading while others have argued that this kind of trading actually corrected it.
Regardless, the senators and some members of the financial community consider high-frequency trading to be unfair. Those trading via computer systems supposedly have a leg up on traders who do not have access to this information and they benefit from the “maker-taker” pricing scheme. By discouraging traditional investors, critics argue that high-frequency trading is unfair and that investors are losing trust in the financial system. If the SEC worked to put all traders on equal footing, then trust would be restored.
In reality, high-frequency trading demonstrates the efficiency and effectiveness of financial markets for everyone involved. Financial markets are trades in claims to assets. Traders respond to changes in the underlying assets and investors then know where to move resources. Efficient financial markets allow investors to best survey the market and are the means by which capital develops according to the preferences of consumers. Financial markets are crucial to the operation of an advanced and complex economy like ours.
High-frequency trading makes financial markets even more efficient with benefits for the average investor. If traders can respond almost instantaneously to market changes, then financial markets conform even more with the changing conditions of the economy. High-frequency trading allows markets to work even faster at a low cost. What the Senators don’t tell you is that this has strongly increased the volume of trades on Wall Street, decreasing the spread between buyers and sellers which actually benefits the traditional traders more than the high-tech ones. High frequency trading is a win for everyone.
It’s actually quite ironic that Senators Levin and McCain are attacking Wall Street. Both of them voted to make certain financial institutions “too big to fail” and bailed them out through T.A.R.P. Levin voted to reauthorize the crony-capitalist Export-Import Bank in 2012, and voted for the Dodd-Frank Wall Street reforms which encouraged risky lending and opened the door for further bailouts.
Sure, there are plenty of problems on Wall Street. Institutions are growing huge and they seem to be immune from economic forces. But this is only because the government is closer to Wall Street than it ever has been. The prices of securities have been quite volatile due to quantitative easing and record low interest rates at the Federal Reserve. Critics of high-frequency trading despise real competition and management within the financial sector. They prefer government management and financial manipulation through the Federal Reserve.