Studies: Mishkin, Angel, Brogaard…

Frederick Mishkin is a former Fed Governor, and a Bernanke ally, who has a mixed legacy as an economist. Why?

Let us start with the good. He often made sage comments and exhibited sage perspective as he talked about the Great Depression. He injected trickle-down economic theory with anecdotes of his grandfather’s clothing shop during the depression (after the 1929 stock market crash, his grandfather, Meyer exclaimed, “serves those greedy rich scoundrels right!” A year later, as Wall Street’s woes spread to the general economy, Meyer Mishkin’s store went out of business).

What was the bad? Iceland. Frederic Mishkin was paid $124,000 by the Icelandic Chamber of Commerce to write a report, Financial Stability in Iceland, which the Chamber commissioned after many critics were sounding warning alarms on Iceland’s economy. We all know what happened in Iceland, and while nobody likes Monday morning quarterbacking, the dude was paid serious coin to write a study, one in which his customers clearly insisted on a specific outcome.

Where am I going with this? Studies are paid for. They are paid for as Mr. Mishkin’s study was paid for. They are also paid for in different less direct ways, such as board seats on corporations, jobs for family and friends, we could go on. We should all question the veracity of studies that are not independent. No matter how intelligent the author, the outcome of “bought studies” will never be contrary to the wishes of those who commissioned (paid for) the study. Cigarette companies paid huge bucks for studies that “proved” that there was no link between smoking and cancer. Automobile companies commissioned studies to counter claims that certain models were unsafe. We can go on (and we will in the next paragraph, re HFT), but please look at any study that you hear touted on ANY subject relevant to your lives, and ask first and foremost who paid for it. 90% of the time you can stop right there. And examination of dumb assumptions in the rest of the studies gets you all the way there.

By now you have heard Professor Angel of Georgetown repeatedly cited for his work on how beneficial high frequency trading is for the markets. By now you also know that Professor Angel sits on Direct Edge’s board (the only stock exchange supposedly still engaging in flash order practices). By now you have also heard Jonathon Brogaard repeatedly cited for his paper, High Frequency Trading and its Impact on Market Quality: (read it here). They are both cited frequently by large firms who ENGAGE in high frequency trading, or who cater to firms that do. As a matter of fact, just yesterday, Deutsche Bank released a “Research Briefing” titled High Frequency Trading, Better than Its Reputation? Without even delving into their bland six-page briefing, we advise you to go right to the references at the end, where you will find the works of Irene Aldridge referenced (yes this is the gal who got into a smack-down with Joe 18 months ago on CNBC and called him a turtle: ThrillerInManilla), as well as J. Brogaard’s study.

Why is the Brogaard study backwash? Here is our critique from October, 2010: Critique.

1)      It under-estimates HFT profits grossly: the study’s author weighted the 120 stocks by market cap to approximate the amount of profits HFT earns in the industry. More important, however,  is extrapolating results by actual trading volume. Doing that, the estimate of profits jump to $6 billion, and not $3 billion.

2)      The source of the data, and what is included in it. It is provided by an Exchange (NASDAQ), and they pick 26 firms that they believe engage in HFT strategies. They exclude any firm that also gives DMA to customers, or does prop trading as part of more diverse strategies: ie they exclude all the large investment banks and brokers, who are among the largest HFT players in the world.

3)      The study also is based on 120 stocks provided by NASDAQ (table 1 of the Brogaard Study), and does not include any ETF’s. I guess HFT firms do not make money in ETF’s. Or in stocks outside those 120 names.

4)      Finally, as with another study that was pro-HFT recently,  it calls any HFT originating order that is a limit order Passive, and any HFT order that takes the other side Aggressive. I guess HFT does not exist in wide-spread mid and small cap stocks. If I place a bid in one of those stocks, and an automated HFT strategy places a limit order ahead of mine, because it is a limit order it is Passive, and not Aggressive, and predatory.

Please, take a moment to view studies with an eye towards who paid for them, and how they are staked. Accepting simplistic, faulty, paid-for studies that demonstrate how HFT “narrows spreads and increases liquidity” may be good for politicians like Bachus and Hensarling (Bachus and Hensarling Letter to Schapiro lobbying FOR FLASH ORDERS), who receive money from the industry, but as grownups we all hold ourselves to a higher standard.