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September 9, 2009

Unfair at Any Speed

Why success itself is the true target

By Dan Mathisson

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We are all bad guys. After reading the opinion pages in The New York Times over the past few weeks, I have been forced to confront the sad truth: that trading profitably is a morally questionable enterprise that is damaging to society.

Dan Mathisson

My awakening began when I read a recent Times column by Nobel laureate Paul Krugman, who commented that much of today's trading is a "socially useless" activity, as opposed to a higher calling, like say, writing opinion pieces. He ripped apart traders for the crime of making money "mainly by outsmarting other investors, rather than by directing resources to where they're needed." Dr. Krugman proposed pay restrictions and higher taxes as the solution to curbing trading activities that serve no "useful purpose."

Next up was an opinion piece by Paul Wilmott, the quantitative researcher and hedge fund manager, who launched an attack specifically on high-frequency trading, calling it a "morally suspect financial minefield." The two articles in concert led to a fresh explosion of anti-Wall Street sentiment among the general public, leading to dozens more newspaper articles, CNBC interviews, calls for new regulation from politicians and thousands of angry blogs and chat-room rants demanding trader blood.

In trying to decide whether I should join the angry masses on the march, or maybe turn and run from them, I first needed to understand who they were going after. Did I personally know any of these financial miscreants? Was it possible that I had seemingly mild-mannered clients who were really serial portfolio killers? Was I unknowingly aiding and abetting morally suspect DELL flipping? Fortunately, Professor Krugman outlined a clear definition that differentiates good from bad trading. He defines good and useful speculation as trading based on publicly available information, as opposed to damaging speculation, which is based on information not available to the public at large. So far, so good--who could argue in favor of insider trading? My conscience remained clear.


Menace to Society

But I became a little worried when I realized how low the professor sets the bar for non-public information. He's not talking about Gordon Gekko learning about the impending takeover at Blue Star Airlines. Far from that, Dr. Krugman first cites high-frequency traders, who by processing public information faster than the next trader, are damaging society. The implicit argument is that since not everyone has "superfast" computers, the information that high-frequency traders are reading from the public tape is still essentially non-public until everyone has had time to read and digest it. It's a good point--why should a trader have an advantage over his competition just because his broker splurged on a nitrogen-cooled tungsten-coated nanochip processor? Shouldn't algorithm providers be polite and wait until the old-school broker with the paper ticker tape and the Atari 800 catches up?