The 5th annual TradeTech Liquidity conference in London, held on November 29, was a top-shelf collection of participants in and experts on Europe’s equities markets. They discussed matters of liquidity, technology, and regulation in the present unsettled environment. This is the first of a two-part meditation on the conference.
Alasdair Haynes delivered the opening remarks. Haynes, the former CEO of Chi-X Europe and at present CEO of Aquis Exchange, a developer of exchange software, told a story about “the humble onion.”
In 1955, the onion futures contract traded more heavily than any other product at the Chicago Merc. That autumn, Sam Siegel and Vincent Kosuga cornered this market, buying enough onions and onion futures to require the shipment to Chicago of millions of pounds of the tear-inducing vegetables.
A Tawdry Tale
Further tears may have been induced when Siegel and Kosuga started using their immense supply of onions as a means of extortion. They demanded onion farmers buy crops from them or they would flood the market and render those farmers’ products worthless.
The extortion demand worked. They did sell to those farmers, and they double-crossed the farmers with whom they had made that deal by continuing to sell, to the market at large, driving prices down effectively into negative value: a bag of onions was, by early 1956, worth somewhat less than the empty bag.
Siegel and Kosuga had a short position on onion futures and profited marvelously. As historian Emily Lambert has written, this isn’t the sort of story that grows “more tawdry with every telling.” The words “genuinely seedy” fit this one from the start.
Haynes told the story at the TradeTech conference because of what happened next. The devastated onion farmers demanded action. A Congressman from the onion and onion-farm endowed state of Michigan, and a future President, Gerald Ford, introduced a bill to ban trading on onion futures. President Eisenhower signed this bill into law in August 1958 and, as Haynes noted, onion futures are “still banned today.”
So: what is the consequence? The banning of onion futures hasn’t prevented continuing volatility swings in the price of onions. Indeed (as standard market analyses would predict) the ban appears to have enhanced volatility. Physical onions are a good deal more price volatile today than is crude oil or its physical or financial derivatives. And the latter are hardly ever considered boringly constant themselves.
The lesson Haynes draws from this: that knees jerk reflexively whenever things go poorly, with an insistence that government just do something. Politicians respond to this demand by passing it along to regulators, and regulators respond by prohibiting previously legal transactions in ways that quite predictably do more harm than good.
No More Rent Extraction
His remarks set the stage for the first panel of the day, on market structure. Haynes was joined for this by Per Lovén, Mark Helmsley, Christopher Gregory, Danielle Ballardie, and Michael Krogmann. They are affiliated respectively with Liquidnet, BATS Chi-X Europe, Squawker, NYSE Euronext, and the Deutsche Börse.
The members of this panel joined on the stage two reporters charged with keeping the pot stirred: Michelle Price of Dow Jones, and Philip Stafford, of the Financial Times.
Ballardie, of NYSE Euronext, said that running a traditional exchange was largely a matter of extracting rents, and that with changes in technology and the economic environment it will be difficult going forward for exchanges to continue without changes in their model.
This is where high-frequency trading entered the day’s discussions. For Price, following up on this, asked, “Have the exchanges supported high frequency trading to a fault?”
“I don’t think,” Ballardie replied, “that the exchanges have courted high frequency traders in some of the ways that people presume.” What has happened, she says, is that the public believes exchanges have a “magic liquidity machine.” When things get illiquid, the public wants the magic. If the magic can’t be turned on, then the public wants someone to blame, and the combination of two targets (the exchanges and their presumed BFFs in the HFT firms) becomes politically quite tempting.
She was saying (although no one drew the analogy explicitly) that parties who believe they have been harmed by HFT are in the same position as were the onion farmers of the mid-1950s. They have created a clamor that could do harm by inspiring counter-production regulation. That was also the consensus opinion of these panelists.
With all due respect, though, I have to respond: that is only a half truth. Yes, politicians look for quick-and-easy solutions. Yes, these do more harm than good. I have no difficulty believing that this is the case with onion futures in the U.S. and that this will be the case with any European Parliament decree that might put limits on the speed of transactions.
On the other hand … the onion farmers in the 1950s still had a real grievance. They had not lost out to real-world fluctuations of supply and demand. They had been taken in by liars.
Likewise, those who have been hurt by HFT and the phony nature of the ‘liquidity’ it offers have a real grievance. Institutions and people who can’t compete with the high-speed arms race and whose costs of participation in the capital markets rise when they drop out of the race are really hurt as a consequence.
The best resolution of the problems posed by HFT – the only genuine resolution – will come in time from within the private sector. But the road to resolution begins (as they say in twelve-step programs) by admitting that there is a problem.