14 April 2012
Andy Haldane, the Bank of England’s executive director for financial stability, last year warned that high frequency trading has become an “arms race” that imperils the whole financial system. In a speech in Beijing in July 2011, Haldane said:-
“Arms races rarely have a winner. This one may be no exception. In the trading sphere, there is a risk the individually optimising actions of participants generate an outcome for the system which benefits no-one – a latter-day “tragedy of the commons” How so? Because speed increases the risk of feasts and famines in market liquidity. HFT contribute to the feast through lower bid-ask spreads. But they also contribute to the famine if their liquidity provision is fickle in situations of stress.
“In these situations, backstop sources of longer-term liquidity ought to ride to the rescue. But HFT has also affected this outside option. LFT market-making has been squeezed-out by competitive pressures from HFT. And those low frequency trader market makers that remain are at an acute informational disadvantage in situations of stress. The result is a potentially double liquidity void.”
Well Haldane has once again criticised high-frequency trading and rubbished recent claims by its apologists that it boosts liquidity in the market.
In a speech at the Institute for New Economic Thinking’s Berlin conference today [Paradigm Lost – Rethinking Economics + Politics, April 14th 2012] (full video above), whose main theme was the social utility of finance, Haldane said that at best high speed trading creates a “mirage of liquidity”:
“One reason [high frequency traders] dominate volumes is because they submit huge volumes of quotes in the market, the vast majority of which are never exercised. The firms cancel them before they are ever exercised… So at present [in the US equity market] for every order executed, 60 are cancelled. So what’s going on here?
“One thing that’s going is that, although there are loads of quotes on the screen, if you try and hit them, they’ve disappeared before you can ever transact as you would wish. There is a mirage of liquidity …
“Some have said that this ‘quote stuffing’ is imposing an externality, in terms of bandwidth, on slow traders… the 6 May 2010 ‘flash crash’, when the mirage of liquidity disappeared before our eyes, was no one-off. In the period since, although less publicised, there have been hundreds of mini ‘flash crashes’, the sources of which have been this speed race in financial markets, that brings with it the externality of fragile liquidity, which brings with it the externality of order cancellation.”
Haldane opened his speech to the INET conference, in which he attempted to answer the question “How Can We Create a Financial System That Is Socially Useful?”, by saying that the classic arms race does deliver “socially inefficient equilibria”… “The desire for individual safety results in equilibria where everyone is collectively less safe – I want to talk about some examples where similar sorts of dynamics are at play in the financial sector, where competition can in fat be a public bad.”
He also make a rather good joke a 6,000 lb elephant seal!
I’m writing a longer post on HFT which will be published on QFINANCE soon. The full text of Andy Haldane’s April 14th, 2012 speech to the INET conference in Berlin is available from the Bank of England website.