Third Way’s Wrong Way on HFT
Have you ever heard of a Washington DC based group called Third Way? They are a “think tank” that has been around DC for a while and describes themselves as:
“Unlike traditional think tanks, we do not house scholars who work in silos on academic research. Instead, we are built around policy teams that create high-impact written products and innovative trainings to influence today’s debates.”
Third Way is active in various policy discussions including education, gun rights, energy and religion. We at Themis Trading do not like to make our morning notes political and we really do not care which way Third Way leans politically but we do care about financial markets. And when a group likes Third Way writes a paper filled will misleading statements about the market then we feel it is our responsibility to call attention to it.
Third Way just published a piece titled “The Need For Speed” which is sure to be circulated all around the Senate and House office buildings. The piece could best be described as the Schoolhouse Rock of HFT (with a very pro-HFT bias). We are not sure about Third Way’s motivations for writing this piece. Maybe they are free market folks who fear any sort of government regulation or maybe they are just paid-for mercenaries for the HFT industry. Either way, we take issue with many statements in their paper. Specifically, we have two main problems with it:
1) Third Way confuses HFT with electronic trading. This statement from their paper is an example of what we are referring to: “Electronic trading and HFT has relegated the 25 cent bid-ask spread to the dustbin of history. The savings from a tighter bid-ask spread is now in the hands of pensioners, 401(k) holders, and other investors”. As we have noted many times before, spreads in the most active stocks have plummeted since the early 2000’s but this reduction was caused by electronic trading and decimalization not HFT.
2) Third Way confuses volume with liquidity. As we all know, volume and liquidity are two totally separate items. But Third Way wants their readers to think they are the same and that if volume were to contract then so would liquidity. Read this example that they included in their paper:
U.S. Markets: Answering the Call for Liquidity
The U.S. equity markets are the most liquid in the world. But what does market liquidity mean in practice? Consider this example which compares the liquidity profiles of Deutsche Telekom, Germany’s largest telecommunications company, with its smaller U.S. subsidiary, T Mobile. Deutsche Telekom’s market capitalization, or “market cap”, is $35 billion; T Mobile’s market cap is $4.4 billion. On average, 5 million shares of T Mobile change hands each day in the U.S. markets. That means, on average, $120 million, or 2.7% of T Mobile’s $4.4 billion market cap turns over each day. By contrast, only $115 million, or about .3% of Deutsche Telekom’s $35 billion market cap turns over each day. In short, the shares of the German company—which is 8 times larger than its U.S. subsidiary by market cap—are 10 times less liquid. Which shares would you rather own? If you trade in the more active U.S. markets you will benefit from having many more opportunities to sell your shares. And your trades will have less market impact. HFT adds to the market’s liquidity by standing ready to buy your shares of T Mobile.
The Third Way piece is typical of the “research” coming from the pro-HFT industry. Their goal is to throw sand in the wheels of market structure reform to keep the HFT cash machine going for as long as possible. Most likely the Third Way staff is running around the Hill right now making sure the decision makers in DC read their piece. It’s up to all of us to make sure those same decision makers understand the other side of the story