February 25, 2015

Taint Natural

In 1884, British comedian Arthur Roberts invented a card game of trickery and nonsense for which he coined the name “Spoof.”  In 2015, spoofing is a decidedly unfunny and ostensibly illegal trading technique in securities markets. But the joke may be on us.

Mr. Roberts made a living on the Briton public-house and music-hall circuit offering bawdy cabaret like “Tain’t Natural,” a vaudeville version of Robinson Crusoe. Today as a result we call satirizing parodies “spoofs.”

Nobody is laughing about spoofing in securities markets.  Wall Street Journal writer Bradley Hope, that paper’s new Robin to the caped-crusader Scott Patterson (IR folks should read Patterson’s “The Quants” and “Dark Pools,” available at Amazon), portrayed as “illegal bluffing” the frenetic keyboard-clicking of a derivatives trader dubbed “The Russian” in a Feb 23 front-page piece. Dodd-Frank, the Roman Coliseum of regulation, banned these fake trades.

Yet stock prices depend on fakery.  Rules mandate trading at the best national price even if you’re moved by something else.  Stock pickers may like the story at a lesser or greater price but can’t so choose. Traders with horizons of milliseconds following rules have the price gun. In order to post best prices, stock exchanges pay high-speed firms for trades (nobody cares more about price than those who exist to set it). Those then price all the rest.  Then exchanges sell the data, perpetuating a market version of robo-signing.

Like a mutating hospital supergene, this price-setting matrix replicated globally. We have two million global index products and options and futures on those and on the ETFs that track them and the components comprising them and the currencies for the countries in which they reside and on the bonds from the debtors and the governments and the commodities driving industry from milk to corn to futures on Norwegian krone – and most of this stuff trades electronically at speed.

Take a breath.

In the WSJ piece on spoofing, the Chicago proprietary-trading firm behind them, 3Red Group LLC (if the firm has three Russian founders they’ve got a sense of humor) says if it clicks fastest, that’s skill not spoofing. Melodramatic?  If only Arthur Roberts could say.

But it’s a point. If we created a marketplace around fakery, is it fraudulent to be a better faker than others?

Blackrock yesterday decried phantom liquidity in currency trading, called “forex” or FX, short for foreign exchange, a $5 trillion daily market dwarfing US equities.  Said Blackrock in a statement reported by Bloomberg: “Our preference in the FX market would be to a view on the liquidity in which we can deal, even if this comes at a higher cost compared to the phantom liquidity.”

We’ll rephrase for the jury.  Real orders are better than fake ones even if they cost more. Like real Twitter followers beat drones, and real restaurant reviews beat paid ones and real interest rates trump manufactured ease.

Jocularity aside, Blackrock proffers a profundity not to be missed by public companies, regulators, central bankers or members of Congress. They’d prefer to pay up for actual trades than down for fake ones.  That ought to be both on a bumper sticker and in handbooks for fresh-faced congresspersons and new central bankers.

The joke here is that spoofing is consequential, not causal.  There’s ad-selling prurience in stories about spoofing but focusing there skips over the root problem. The moment regulators decided to help people figure out the best price (suggesting regular humans are less able than regulatory humans), market gravitas transmogrified into Arthur Roberts slapstick on a collision course with spoofing.

Regulators have long trumpeted the virtue of low spreads and the right of little orders to price the whole market.  Turns out low spreads don’t help real people. A lot of prices doth not liquidity make. And if you want to buy a hundred of something, you don’t get the same price as she who buys a thousand. Tain’t natural – and that’s probably in Hammurabi’s code somewhere.

The next time you check your stock price, consider what’s setting it and why you, your executives or CNBC conclude it’s natural. Until we fix the original mess – which will require collective demand for more real stuff and less fake stuff – the best thing going for the IR chair is that you can measure it all and sort out the trick cards.

And we’re not spoofing you.

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