Archive for May, 2014

Flash Trading the Common Good

The last month has seen the launch of Michael Lewis’s new book Flash Boys on 60 Minutes, detailing how financial markets are rigged against the public by high frequency trading. Enough hornets were stirred in the nest of public opinion that the IPO of high speed trading firm Virtu, Inc., was put on hold.

At Front Seat, we think a lot about the intersection of for-profit business models with social good – good in the sense of the improved functioning of groups. Digital market-making is a frequent topic when we ponder “tech for good” and we have an insight to share that’s very relevant to reforming financial markets.

Principle: when private good conflicts with public good, public good should win.

The increased liquidity, lower trading spreads, and faster trade execution provided by the virtual market-making of high-frequency traders is a private good captured by the participants in a specific trade. On the other hand, price discovery in a market is a public good – a critical mechanism for distributed coordination of group behavior that is used throughout society, not just in stock trades. Regulators are tangled in knots over HFT. On the one hand trade spreads have declined. On the other hand price discovery is inhibited by market segmentation and fracture due to flash trades, front-running, and dark markets developed in response to HFT. What’s a regulator to do?

The answer isn’t found in the technical complexity of our digital markets. Regulators will always be behind the constant innovation of market participants. That’s natural. The issue isn’t lack of understanding, it’s the desire to make decisions based on understanding (which is constantly changing) rather than make decisions based on enduring principles. If we have clarity as a society around a moral hierarchy that the common good, when it sometimes comes into conflict with private good, should win over private good, then the job of the SEC becomes much easier. And we can replace fear of unintended consequences with an understanding of the price of our enduring values.