The technological revolution that has swept through Wall Street and enabled stock trades to take place in milliseconds has thrust the equity market into a “crisis” that demands a regulatory response, a former high-frequency trader told Congress on Thursday.
David Lauer, who left his job at a high-frequency trading firm in Chicago last year, told a Senate panel that the ultra-fast trades that now dominate the stock market have contributed to frequent market disruptions and alienated retail investors.
“U.S. equity markets are in dire straits,” Lauer said in his written testimony.
The comments came as Washington struggles to figure out how to keep up with the trading practice that firms use to purchase and sell huge volumes of stock in fractions of a second, often to take advantage of market inconsistencies. This so-called high-frequency trading — along with the automated nature of stock markets in general — played a role in alarming technology glitches that policymakers say they’re compelled to address.
The botched public offering of Facebook’s stock, the fiasco linked to Knight Capital Group in August and the so-called “flash crash” more than two years ago are among the events that have caught the attention of Capitol Hill, leading to Thursday’s hearing.
“The capital markets are a public good, much like a highway,” Sen. Jack Reed (D-R.I.) said at the hearing. “We need to have clear rules about the speed limits and who can use the HOV lanes. . . . We need to make it clearer what the rules of the road are.”
Just about every witness who participated in the hearing acknowledged the advantages of automated trading. High-speed computers that crunch millions of quotes a second provide more accurate market prices to retail investors with lower transaction fees.
“Automation is the lubricant that makes this process efficient and seamless,” said Larry Tabb, chief executive of the consulting firm TABB Group.
But many of the witnesses also agreed that automation combined with the high-frequency trading strategies used by many firms has created a chaotic trading atmosphere. Andrew Brooks, a vice president at T. Rowe Price Associates, described it as a “casino-like environment” that long-term retail investors have come to distrust.
“Our sense is that the almost-myopic quest for speed has threatened the very market itself,” said Brooks, whose firm caters to long-term investors. “It also seems many high-frequency trading strategies are designed to initiate an order to simply gauge the market’s reaction and then quickly react and transact faster than other investors can.”
Unlike long-term investors, high-frequency traders are not looking to hold onto a stock. They make money by initiating many small transactions, buying and selling stock in milliseconds, as they react to sometimes miniscule changes in market conditions.
Lauer said technology has added so much complexity that a market that was once well understood by most Americans now baffles even sophisticated investors, who no longer grasp what happens behind the scenes when they buy and sell stock.
The challenge for regulators is to address the speed issues that have contributed to market volatility without erasing the advantages that computer trading has provided.
“We’ve gotten faster than we can possibly handle,” Tabb said. “The challenge is how do you stop it, and what happens if you stop it?”
Chris Concannon, executive vice president of Virtu Financial, an electronic market maker, told the panel that moving faster probably adds no value. But “if we regulate speed, then what speed do we move at?” he asked.
Concannon warned that the “regulatory re-engineering” that has taken place over the past 15 years has added to the complexity that the government is now trying to address because each regulatory change required substantial technological enhancements.