Slowing down Wall Street

Wall Street, lately, has been using high-speed trading to allow insiders to front-run trades by ordinary investors. So, for example, when an outfit like TIAA-CREF (pension funds for teachers) tries to place an order to buy shares of a company they like, other investors’ computers can detect the trade before it happens, buy the shares, and then instantly resell them at a higher price.

If you did that an hour before somebody bought shares, you’d be guilty of insider trading, and you’d go to prison. For example, suppose you went through TIAA’s trash and found a memo saying, “Let’s buy lots of Starbucks shares on Tuesday afternoon.” You could buy a lot of Starbucks shares at noon Tuesday, and then resell them for a higher price when TIAA’s orders to buy the shares hit the market later. You’d make an illegal profit.

(The people at TIAA are savvy enough to shred their memos; this particular scam won’t work. But it’s still a valid example.)

People on Wall Street can do this in tiny fractions of a second. The blink of an eye takes about a tenth of a second. These Wall Street computers can make as many as a thousand trades in that time.  So, it goes almost unnoticed.

Does this seem fair to people investing their retirement savings in companies they (or their pension managers) trust? Does this seem fair to those companies?  It isn’t. The companies don’t get all the money the pension fund wants to invest in them. The pension fund doesn’t enjoy that return on the money that’s siphoned off by the high-speed traders. That means you and I don’t get that money when we need it.

There’s a writeup on this in the New York Times of March 29, 2014, by finance writer Michael Lewis. He describes, among other things, the story of a new stock exchange business called IEX (Investors’ Exchange) designed to thwart this kind of front-running trading.  They’re doing that by simplifying and slowing down the trading process. Pension funds, ordinary investors, and companies like this exchange.

Lewis’s article has an interesting photograph in it. This is a box the size of a small microwave oven that contains 38 miles (about 61km) of fiber optic cable. It takes light three hundred microseconds (1/333 of a second) to travel through that fiber optic. That tiny amount of time is enough to thwart the front-running traders. They use boxes like this at IEX to slow Wall Street down just a little bit, and make trading just a little more fair.

Stefan Ruiz, New York Times
Thirty-eight miles of fiber optic. This is what 300 microseconds looks like. Photo by Stefan Ruiz for the New York Times

Leave a Comment