Compliance

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Greg MacSweeney
Greg MacSweeney
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The Industry Must Educate the Public and Lawmakers About the Markets

Without a true understanding of how the markets work, each time something out of the ordinary happens on Wall Street, the industry will be called down to Washington to testify in front of senators who know nothing of what they speak.

I'm not sure which has lower latency: trading in the electronic markets, or the time it takes for politicians to concoct inane theories on something they know nothing about, then go on national TV and make fools of themselves.

Almost as soon as the markets closed on May 6 -- the day the Dow Jones Industrial Average dropped nearly 1,000 points in a few minutes, only to rebound just as quickly -- Senator Ted Kaufman (D-Del.) was on the cable talk shows ranting about how high-frequency trading had caused the meltdown and how HFT hurts investors. Sen. Kaufman, along with a number of other talking heads, demonized HFT without knowing any of the facts.

Even a full week after the 1,000-point drop and recovery, regulators, exchanges and financial firms had little new evidence as to what caused the crash. (The fact that the regulators and the market can't figure out what went wrong is, frankly, embarrassing. But that's the subject of another column.) The "fat finger" theory -- that a clumsy trader misentered an order -- seems to have been ruled out. And regulators have not uncovered any scheme to game the market either, ruling out another theory.

But just because high-frequency trading is fast and not well understood, it should not automatically be branded the culprit. In fact, many experts credit high-frequency traders for helping with the sudden recovery on May 6, noting that as automated trading systems recognized good buys, they pounced and the markets recovered as liquidity quickly returned.

Yet HFT is feeling the heat from Washington -- again. As it was pointed out during Wall Street & Technology's recent Accelerating Wall Street conference, high-frequency trading has done more to help the markets and investors than most realize. In the opening keynote presentation, Arzhang Kamarei, managing partner at Tradeworx, a quantitative investment management firm with expertise in high-frequency market strategy, outlined the benefits that HFT brings to the electronic markets. For instance, he said, the extra liquidity that HFT provides reduces spreads for long-term investors (PDF) and ultimately gets them better prices.

But Sen. Kaufman -- despite his embarrassing lack of knowledge -- is speaking for his constituents, most of whom do not understand, nor should they be required to understand, HFT. Hence Wall Street's problem. For too long, Wall Street has collectively acted as if it were above the masses (see Goldman Sachs' recent condescending Congressional testimony), telling Congress and the public that finance is "complex," "let the experts handle it," and allow the financial industry to self-regulate. And despite the populist sentiment sweeping the nation and the tough talk from Congress, the industry mostly sticks to its holier-than-thou position.

If the industry wants to continue to have the most liquid and efficient markets in the world, it had better start to educate the public and Congress about how today's markets work, what HFT really is and how it actually benefits investors. Without a true understanding of how the markets work, each time something out of the ordinary happens on Wall Street, the industry will be called down to Washington to testify in front of a bunch of red-faced senators who know nothing of what they speak.

Greg MacSweeney is editorial director of InformationWeek Financial Services, whose brands include Wall Street & Technology, Bank Systems & Technology, Advanced Trading, and Insurance & Technology. View Full Bio
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