Sunday, August 22, 2010

A suggestion for commodity hedging

Problem:  influx of assets into soft commodity derivatives is increasing volatility and imposing costs for producers and food companies.

Solution:  treat commodity hedging as a utility public service. Financial players would state their purpose as hedgers or speculators, with different regulatory regimes applying to each. Regulators could vary the mix and capture rents for the public benefit.

Friday, August 20, 2010

Stock exchanges: stop the robots

Regulators must stop the robots from ruining our stock exchanges, according to democrat Senator Ted Kaufman.

In a 5 August letter to SEC chairman Mary Shapiro, Kaufman warns that some algorithmic trading harms long term investors and dominates the equity markets in a way that brings no social utility. He describes some murky algo practices such as trading on advance information about other people’s orders, collecting unearned liquidity rebates and unnecessary intermediation, to support his case.

The Senator has picked up a useful ally in Gillian Tett, who used her FT column today to back his call for a review of high frequency trading. Tett explains his argument that the benefits of the narrow spreads which high frequency trading supposedly brings may be outweighed by hidden costs, leaving only a “thin crust” of liquidity that evaporates in bad times, as with the flash crash of 6 May.

In an separate but related story, the paper reports that two day-traders in Norway were indicted on charges of market manipulation after they stumbled across – and exploited - a trading pattern that tricked programme trading computers into raising their prices. Despite the breach of market rules, plenty of people cheered the duo for beating the machines: “Robots are designed to push the market but when someone pushes the robots it is suddenly a criminal offence,” was one comment on a Norwegian chat forum, according to the report.

Behind both these stories lies an unease about the growing dominance of robot trading. While not quite an android invasion, the increasing use of computers to arbitrage short-term price anomalies is a sinister development whose effects are not well understood. But it accounts for nearly 70% of US equity trading, making it an important source of revenue for stock exchanges.

Wednesday, August 18, 2010

Appropriating or creating, economists must tell us which is which

John Kay returns to one of his favourite topics in today’s FT: the Robber Barons of the Rhine, who in the 13th century charged illegal tolls on cargo passing their stretch of the river. Old-school baddies like Werner von Bolander and Philip von Hohenfels, who lived in fabulous castles and plundered their neighbours, are a colourful metaphor for modern finance, which Kay uses to make this point:
"The distinction between the creation and the appropriation of wealth – between those who add value to the cargo and those who help themselves to a fraction of it as it sails by – is vital, if not always clear. But our ability to recognise it will determine, not just the fate of individuals, but the future of modern capitalism."
When Adair Turner suggested there might be good finance and pointless finance, he was probably thinking of this. Despite the City's appalled reaction, many people felt they knew exactly what he was on about.

Kay’s distinction between “brigandry and productive business” exists and has been tackled before without resorting to communism, despite the theoretical difficulties.