Apr 4, 2012

Wall Street Arms Race Makes for a Shoddy Infrastructure Plan

Felix Salmon finds an interesting fact:
File under “unexpected societal benefits of high frequency trading”: it’s doing wonders for building IT infrastructure. Sebastian Anthony and Jeff Hecht both have good overviews of the three — count ‘em — fiber-optic cables being laid deep below the arctic sea floor, all in a $1.5 billion attempt to shave 60 milliseconds, or less, off the amount of time it takes to get digital information from London to Tokyo.
Ok, fair enough, that's pretty cool. But one wonders if this is really the best way to go about this. To clarify, if a trader hears a bit of public information about a stock, and executes a quick trade or two before it's widely known, then she can make a quick buck. That's been true since the dawn of stock markets. But now that we have computers, people have been writing programs that do this automatically, and buying big servers to run the programs as fast as possible. The obvious result of this is that Wall Street and its equivalents across the world now involved in a massive IT arms race to win at this "high-frequency trading."

The thing about this is that it's zero-sum. There's only so much information out there, and every bit of increased money derived (groan) from increased trading speed on one side necessarily comes out of the profits of the other firms. It's a market failure, in that everyone would rationally prefer if someone could put a hard limit on this practice because it's pointless, but will never stop absent some kind of outside force coming in.

In addition, there are enormous opportunity costs here. Not only is the financial sector sucking up huge gobs of IT equipment, they're sucking up huge gobs of the smartest engineers and programmers, who are doing the social equivalent of trying to beat each other at Tetris. (Not to mention the fact that these programs, which do most of the trading these days, can create near-instantaneous stock market crashes before the traders can even reach the off switches.) If that gets some cables built between continents, that's a nice benefit, but it seems to me the optimal policy would be to clamp down on this market, like with a financial transactions tax, and use the proceeds to just build the cables ourselves.

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