After the U.S. government saved Wall Street’s skin last fall, one would expect more gratitude. But these days, all we hear from the Street are demands to level the playing field, keep the government’s nose out of our business, and let those who know how to play the game make sure the markets remain “fair and efficient,” that is, as fair and as efficient as they want it to be. This is Wall Street’s old song and dance, for sure. What is worrying market watchers and ordinary investors alike is just how little Wall Street has learned from the financial and credit debacles of 2008.
Case in point — something called “flash trading.” As of late, flash trading has created massive profits for big Wall Street players, such as Goldman Sachs and J.P Morgan, while ordinary investors feel again left out of the loop, and rightfully so. This is particularly rubbing it in, since it was ordinary investors’ hard earned tax dollars that had pulled Wall Street from the brink of the abyss. Yet again, Wall Street fails to return the favor. To add insult to injury, U.S. policymakers and regulators remain clueless as ever.
What is flash trading? It is super-fast order execution, like flash flooding, hence the name. To successfully flash trade, two things are needed. The first is enormous computing power (not to be equated with the ability to trade electronically), and the second is ease of access to stock exchanges and alternative trading systems that permit flash trading. Mind you, you cannot flash trade just anywhere; there are gatekeepers, too, but what is so annoying is that Wall Street’s biggest firms seem to have VIP access nearly everywhere. Once these two factors are put together, flash traders with enough computing power have the ability to see, for literally a flash — a split-second — other traders’ orders, giving flash traders’ computers enough time to calculate a way to profit ahead of everyone else.
Front running is illegal, but flash trading is not, because it is not defined as front running. In fact, flash trading is not defined as anything yet, other than as another example of how technology is running ahead of the law. In Wall Street’s typical style, it is a dubious, yet highly profitable practice. To put things into perspective, so far in 2009, flash trading represented 2.4% of all business done on U.S. exchanges. It does not sound like much percentage-wise, but in dollar terms, flash trading hauled in $8.0 billion in profits. When the going was tough in the past 12 months — particularly last fall and in the first part of 2009 — $8.0 billion is nothing to sneeze at and it certainly explains how the supposedly ailing Wall Street was able to pull off such a profitable second quarter.
Of course, Wall Street is now up in arms against the negative publicity flash trading is receiving. Who wouldn’t be, with that kind of money at stake? Flash traders say this is innovation at its best and, for the sake of progress; it must not be stifled with regulations. Unfortunately, this reasoning sounds eerily similar to what hedge funds used to say about derivative trading being the future of investing. We all know how that prediction unraveled.
If history is of any guidance, flash trading is likely going to end up as another Wall Street debacle. If for no other reason, it threatens to shatter whatever little public faith in Wall Street remains. Ordinary investors already feel that investing is worse than gambling, because the game is inherently rigged and those best at the game are usually crooks. All they need now is to think that every little trade made in online brokerage accounts is going to serve as a premise to some flash trader with a supercomputer for making even more money off our backs.
Regulators claim they are working hard on closing the oophole on flash trading. Under the current Quote Rule, trade orders that remain open for less than a second are not under scrutiny, and that is the realm where flash trading exists. The Securities Exchange Commission has promised the public that it will find a way to close this loophole. Again, if we were to learn from history, regulators and business operate through a two-way door. What is good for business is often condoned until it is not anymore, at which point the pot has already melted and all anyone can do is clean up the mess.