Technology and Markets: Is Flash Front Running Insider Trading?

April 23rd, 2014 at 11:20 am

If a machine engages in something that looks a lot like insider trading, is it illegal?  Should it be?

I was talking about this with CNBC’s Eamon Javers, who broke some of the early stories about millisecond trading advantages on market-moving data releases.  As he put it, if you were a broker representing a client who just ordered a large volume trade, and based on the assumption that the big trade would boost that stock’s price, you yourself traded on that information before the trade took place, you’d clearly be guilty of an insider move.

But what if it’s a machine that’s doing much the same thing?  That is, it takes a few milliseconds for computer systems to coordinate a big trade over numerous exchanges.  Flash traders have developed algorithms to pick up that information in even fewer milliseconds and get in on the trade before it goes through.  They’re running in front of the big trade, buying shares at the presumably lower, pre-trade price.

New York State Attorney General Eric Schneiderman, a guy with both a great nose for ways in which well-placed elites game the system, and the position and energy to do something about it, has been on this case for a while now (full disclosure: he’s a friend).

Here’s how he summed this up recently:

When blinding speed is coupled with early access to data, it gives small groups of traders the power to manipulate market movements in their own favor before anyone else knows what’s happening.  They suck the value out of market-moving information before it even goes public. That’s ‘Insider Trading 2.0,’ and it should be a huge concern to anyone who cares about the markets and the free flow of capital on which our economy depends.

I know Michael Lewis’s new book, Flash Boys, deals with this and I look forward to reading it (it’s staring at me across the room); I’ll be interested in what he thinks should be done about this problem.  I suspect Schneiderman will prosecute the case and at least to me, it’s no reach at all to see the analogy between the clear-cut human case of using insider info and the digital case.

But wherever this lands, it provides another rationale for a financial transaction tax.  In this case, the tax would internalize a negative externality—whether you view digital front-running as legal or not, it seems entirely unrelated, if not antithetical, to efficient capital allocation and wholly related to rent-seeking.


The Upshot Is…

April 22nd, 2014 at 9:32 am

…a new feature over at the NYT—the brainchild of long-time economics writer David Leonhardt—covering all kinds of interesting stuff in the intersection of econ, politics, and life.  I’ll be writing for it, as it absorbs the Economix blog.

In the first issue (not the right word in digital world, I guess), Leonhardt and Kevin Quealy team up for a fascinating look at the progress of real income growth across countries and across the income scale, adjusted to be in comparable dollars.

The US problem relative to others is clearly seen in the table below: our real median income has been flat where other middle-incomes in other advanced economies rose from slightly in Germany to fairly strongly in Canada and the UK (the latter result is partly driven by stopping at 2010—since then the real UK median is down significantly—see this from the Resolution Foundation).


Source: NYT, Upshot

The other figures, including one that looks exactly like a bunch of games of pickup sticks, show that thanks to this post-2000 stagnation, the US is losing its lead, except of course, at the very top of the income scale, where we’re pulling away from the rest.

By way of explanation, the authors note our loss of relative ground in educational attainment—a key theme of Leonhardt’s—along with higher inequality, less collective bargaining and lower minimum wages compared to the other countries in the study.  My readers are hopefully wondering about slacker labor markets in the 2000s, and that’s part of the problem too, though not uniformly across all of these countries (Ireland, UK, pretty strong; Germany, Canada, less so).

On the inequality point, I’ve lately seen some writing, partly in response to Piketty, that higher inequality is benign in terms of the income growth of lower-income households.  Such a claim is far from obvious and justly counterintuitive.  Clearly, the same amount of growth will reach fewer households amidst rising inequality.  One could argue that progressive taxes and transfers and greater redistribution offset the tilted growth dynamic, but that is to be seen—these data apparently capture direct government benefits.  And of course, amidst persistently rising inequality, that after-tax offset implies a constant increase of the redistribution function, something US politics at least will not abide.

At any rate, that’s the Upshot, and I’ll see you up there myself later this week with a scintillating look at the “rents” versus merit debate.

Wage Theft Must Not Be Ignored

April 22nd, 2014 at 8:36 am

Here’s an important editorial on something I haven’t written enough about: wage theft, i.e., situations wherein “employees are forced to work off the clock, paid subminimum wages, cheated out of overtime pay or denied their tips.”  Sometimes this meshes with misclassification, another violation of labor law, wherein regular employers are classified as self-employed.  According to one study, misclassification of port truckers resulted in over $800 million in wage theft in CA alone.

The editorial interestingly points out that this doesn’t just hit low-income workers, citing the Silicon Valley case where employers of top tech firms were allegedly colluding to suppress wage competition.

My strong sense is that one way to deal with this is to mete out a spate of significant punishments to violators as a signal that we’re serious about cracking down on wage theft.  As I understand it, too often, the current penalties for being caught stealing workers’ wages are a slap on the wrist (though I think this is improving a bit in the misclassification space).

Also, as the NYT piece points out, wage theft is seriously under-policed, as the number of wage and hour inspectors at the Labor Dept has declined while the workforce has grown.  Ross Eisenbrey provides an excellent analysis of the broader issues for our full employment project.  He notes, for example, that “when Congress enacted the FLSA in 1938, it funded one Wage and Hour Division (WHD) investigator for every 11,000 workers. By 2007, when there were only 731 WHD investigators for the entire nation, the ratio had fallen to 1 inspector for every 164,000 covered employees. Even today, with around 1,000 WHD investigators, the odds of any particular employer being inspected in any given year are trivial.”

This is a rich area of pursuit in the interest of protecting labor standards which are in turn essential to protect the quality of jobs, often jobs held by those with the least bargaining power.

Slack is Whack

April 21st, 2014 at 4:01 pm

Just how much slack remains in the labor market?

It’s a key question for the Fed, of course, which is explicitly gauging many indicators—not just unemployment—for signs of inflationary pressures.  Thus far, such pressures have been noticeably absent from their favored measure: the core PCE, which if anything, has decelerated of late.  Chair Janet Yellen has been particularly explicit on these points, stressing these dynamics as her rationale for continuing to up-weight the full employment side of their mandate.

Which indicators do Yellen&Co. watch?  Ylan Mui goes through some of that here, citing some nice research by Cornerstone Macro.  But their work just made me want to get out the big pasta pot and boil up a bunch of the labor market statistics into a principal components analysis (here’s a pretty simple explanation, but it’s really just a way a reducing a large number of variable down to a few factors that summarize much of their variance).

I used unemployment and employment rates, labor force participation, long-term unemployment (as share of labor force), initial claims, payroll and wage growth (yr/yr; production, non-supervisory wage), and involuntary part-timers (as share of employment, adjustment for big measurement change in 1994). I left out some of the JOLTs measures—vacancy and quit rates—because even though the Fed watches them, they don’t go back very far and I wanted to look at this mix over a few cycles (I start in 1979).

The first figure below just plots the summary slack measure (the first principal component, which explains 60% of the total variance of the eight variables) against the actual unemployment rate.  They’re very similar, of course, but not the same in some interesting ways (don’t worry about the scale of the summary measure). For example, even though unemployment rate looks almost as low at the end of the 2000s cycle as the 1990s one, such that a bunch of folks think of them as similar episodes of full employment, the summary measure shows that there was considerably less slack in the late 1990s (compared to the unemployment series, the ‘pc1’ series late 90s trough is lower than its late 2000 trough).


Source: BLS, my analysis

But it’s the next figure that bears on the current dynamics.  Here, I’ve indexed both series to 0 at the peak of the last cycle, Dec07.  Both unemployment and the 8-variable-summary-measure have fallen about the same amount, but the summary measure went up further and is thus still more highly elevated.


Source: BLS, my analysis

Anyway, you don’t have to look much further than the low and decelerating core PCE price index to understand where Chair Yellen and others are coming from on this, but my little data compression exercise shows that if the eye is trained solely on the unemployment rate, there’s more slack than meets the eye.

Hey, What’d I Miss? OTE Summary 4/11 – 4/21

April 21st, 2014 at 11:21 am
  • Over at NYT Economix blog: sifting through the various meanings of tax fairness (and presenting one pretty intuitive measure from the Citizens for Tax Justice).
  • On Tax Day: Jotting down some random thoughts on Tax Day Eve regarding tax fairness, examining our general perceptions of the question, and rounding up a few articles to wrap up this year’s Tax Day.
  • A brief comment, with more to come, on Thomas Pikkety’s great new book, “Capital in the 21st Century”.
  • Pointing out that it’s hard to tell a story about top earnings that doesn’t involve a hefty dose of rent seeking.
  • Listing some observations regarding Fed Chair Janet Yellen’s speech on the health of the labor market.
  • Pointing to two things to watch and one to listen to regarding income inequality, tax policy and fiscal policy.
  • Evaluating income inequality in the United States and questioning whether capital or labor income are to blame for its growth.
  • Analyzing the correlation between high salaries in finance and deregulation of the industry.
  • Highlighting an op-ed by former Treasury Secretary Larry Summers on infrastructure investment and listing a few key points of my own on the topic.

Music: Another taste of Elvin Bishop in this week’s musical interlude.