Monday, November 16, 2015
Why is This So Urgent and Important?
Recently I ran across a book defending the financial system, Smart Money, by Andrew Palmer. The author says that since the recent financial crisis and bailouts, the system as a whole has been demonized to an extent that people no longer appreciate its benefits to society. There was mismanagement and criminal activity, but that is no reason to give up on new innovations or demand regulations that turn the clock back to simpler times.
One particular example is high-frequency trading that took off in the mid-2000s. This use of high-speed computing to execute trades in the market has led to a number of bad practices, where those traders are able to take advantage of price swings and manipulate the market in various ways. He asserts that the publicity received by instances of manipulation exaggerate the real size of the problems (understandable when I consider similar reporting of rare airline crashes). He claims that the advantage of speed merely replaces the former advantage of monopolistic privileges of having a place on the trading floor, where similar manipulation was known to have happened. HFT leads to more efficiency and lower transaction costs, and the “HFT era arose...in part because of concerns about how the old system worked.”
So what’s the big deal and what does this have to do with behavior? The biggest problem with HFT is “that the unchecked logic of competition has increased the risk and potential severity of sudden market crashes.” [Emphasis added.] A company can go out of business in a matter of minutes. The economy, the one we depend on for our livelihood and the goods and services we need, could receive a major shock in a matter of hours! The speed of these automatic transactions, faster than the ability of humans to intervene when things go out of control, is very dangerous. It calls for regulation and responsibility.
Now see the parallel with behavior. The types of innovations that drive the financial industry are not unlike those that affect our daily lives. Many people have smart phones; most have cell phones. The Internet is a common platform for personal financial transactions and simple shopping. A billion people on Facebook, and how do they make their money? – Advertising and selling consumer information gleaned from the massive amounts of stored data.
We go on line to see news, which now at 24 hours is filled with fluff and repetition. We gather information on fashions, hobbies and view the latest postings of cute babies or clever animals. (On average teens spend more time on their devices than sleeping.) While we do, we are exposed to hundreds of times the advertising compared to a generation ago and hundreds of times the misinformation, some of it harmless enough, but much of it full of bad health advice, unproven nutritional advice, advocacy of feel-good but illogical policies featuring skewed economic understanding, along with the usual divisive political partisanship depending on accusations and name-calling (rather than facts or logic) to promote positions. Social media is filled with opinions: those we agree with we take as fact; those we disagree with are seen as insults. Among all this chatter, we must deal with threats like identity theft and phishing that were unheard of a generation ago.
Here we sit, with the same critical thinking (some would argue worse based on America’s educational decline), the same economic understanding, perspective, sense of responsibility (some would argue worse based on the current trends in narcissism and victimhood), and discipline (some would argue much worse based on the obesity epidemic and personal savings crisis). Here we sit, expecting to get by and strive in the high-tech, high-speed twenty-first century clinging to the belief that the behavior and skill levels of the past will see us through. Instead of getting more demanding, we have in fact become more tolerant of lax behaviors in many of these areas, defending weaknesses instead of motivating for change, defending failed government programs that make people more dependent, squandering our money on luxuries and expecting someone else to bail us out at retirement.
The potential dangers of high-speeds in finance offer an important lesson about the real potential dangers of the high-speed society we live in. The regulation to avoid disaster in the first instance comes from government and everyone will cry out for it. Regulation to avoid disaster in the second can only come internally and there is nary a peep.