More crony capitalism

Dialogue with the Alter Ego on co-located servers for high-frequency trading

Here’s how firms capitalize on one aspect of high-frequency trading known as co-location: after paying a fee to an exchange, firms are allowed to co-locate, i.e., rent server space within or near the NYSE or another exchange’s computer servers to get access to trading statistics faster — just milliseconds faster — than competing investors. – Kristi Oloffson and Stephen Gandel: High-Frequency Trading Grows, Shrouded in Secrecy, in Time Online, Aug. 05, 2009,8599,1914724,00.html

Question by Alter Ego of Noah denkt™ (AE): Supposedly, Noah denkt™ is aware of the practice of high frequency trading that some Wall Street firms apply to generate profits in their financial speculation?

Answer by Noah denkt™ (Nd): Yes, we are.

AE:  Is Noah denkt™ equally aware that stock exchanges all over the world rent out server space within or near their own computer servers to those flash traders in order to provide them with faster access to the exchanges’ trading data?

Nd: To be honest, we have only learned about this recently due to an article in Pam and Russ Martens’s Wall Street on Parade – Blog. (see: )

AE: Should this project not have been aware of this practice way earlier than this? After all, it can’t be denied that the issue has been widely reported on by insiders such as Michael Lewis (Flash Boys), Sal Arnuk and Joe Saluzzi (Broken Markets) and others.

Nd: Yes, we should have taken note of this way earlier. But we initially considered this flash trading hype as just another gimmick in the market. Perhaps, that is the reason why we didn’t pay enough attention to it.

AE: So, now that you have finally gotten aware of the special access aspect of flash trading, what do you make of it?

Nd: Obviously, we are quite appalled that stock exchanges who are expected to work as co-regulators in conjunction with the Securities and Exchange Commission in order to ensure the sound functioning of financial markets would engage in such frivolous practices. After all, it can’t be denied that this co-location offer violates the spirit of equal access to the market for all market participants.

AE: Well, the exchanges justify this practice by arguing that anyone willing to pay the co-location rent can get access if they want to. Hence, in their mind, the fair access clause isn’t being rigged?

Nd: That argument is clearly a joke since the NYSE itself markets the co-location service by assuring future clients that the new found “proximity to the market can give [their] business model a competitive edge.” In other words, the NYSE itself doesn’t believe its own equal access protestations.

AE: And what do you make of the argument that the co-location service to some isn’t infringing on the fair access clause for all since it is by no means clear whether the algorithms employed by the few co-locating flash traders are indeed good enough to keep them ahead of the crowd?

Nd: This is equally ridiculous since it shouldn’t be the duty of the crowd to evaluate the potential for non-compliance with the equal access rule but the onus should be on the regulator to make sure that the equal access idea isn’t being undermined. Look, regulations make sense only if they are sufficiently clear and evident to all parties concerned. Any uncertainty, any doubt, any lack of clarity and transparency generates a dysfunctional regulatory environment and thereby damages the solidity of the entire market. Co-regulators and regulators, therefore, don’t do their job adequately if they engage in or allow for questionable practices within their own operation.

AE: How then do you explain that such practices continue to exist without major political opposition to them?

Nd: Well, it is probably due to the fact that all systems have a tendency to favor their established players that crony capitalism can develop so easily.

AE: If it is true however, that all systems have a natural tendency to grant preferential treatment to their powerful and well established how does that then impact your own preference for a free market approach over interventionist policies?

Nd: Well, if the government is already giving preference to the established players when it acts as a regulatory umpire then it is only natural to presume that its actions will be even more tilted towards the powerful when it intervenes in a more aggressive fashion in that marketplace. And evidence, such as the bank rescue or the auto industry rescue support that theory.

AE: The government spending on social security isn’t biased in favor of the strong and established players, is it?

Nd: In a way, it is since it is coming with the same patronizing, status-quo and system preserving attitude that the established players employ when dealing with newcomers and no-names on their own turf.

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