Archives: 04/2014

Reflections on High Frequency Trading

Here are a few thoughts on high frequency trading [HFT] – not a thorough analysis of the problems and solutions, but rather a brief outline to encourage further discussion.

What is HFT?

The modern version of HFT, as described by Malkiel and Leavitt in an April 11 Wall Street Journal op-ed, “involves the placement of high-speed computers in close proximity to stock-market servers to give some participants the ability to buy and sell stocks faster than the blink of an eye.”  The favored participant purchases early access to information from either a public exchange or a so-called dark pool, which is essentially a private exchange established by investment banks.  With privileged access, the HF trader can learn of a pending order before it is executed, and then earn a small profit by buying or selling ahead of the order.  For example, a sell order exists at $100.00; an HF trader learns of a pending buy order at $100.02, which allows the HF trader to earn $.02 by first buying at $100.00 then selling at $100.02.

What are the pluses and minuses of HFT?

Benefits of HFT can include market efficiency, increased liquidity, and lower transactions costs.  To illustrate: Assume orders have been placed to sell 5,000 shares of XYZ at $15.02 and 5,000 shares at $14.94.  Assume further, a pending buy order for a minimum of 10,000 shares at $15.00.  The HF trader, acting as market-maker, might buy 10,000 shares from the two sellers at an average price of $14.98 and re-sell the shares to the buyer for $15.00.  The result would be a narrowed bid-asked spread, reduced trading costs, increased volume, and enhanced liquidity.

On the other hand, as Malkiel and Leavitt point out, HFT is a form of insider trading known as front-running whereby “optimally positioned traders can see trade orders from other investors before they are executed.  They can execute a purchase just ahead of those orders and run the price up just a bit, pocketing the difference.”  In addition, HFT has been blamed for increased market volatility.

Hey GOP: Just Because It’s Choice Doesn’t Make It Right

It is increasingly clear that the congressional GOP will be using school choice – especially charter schools – as an election-year weapon [$]. And certainly Republicans, Democrats, Independents, Greens – whatever – should support school choice because educationally, socially, and financially it is the right thing to do. But that doesn’t mean Republicans should ignore that the Constitution gives Washington no authority to meddle in education outside of controlling the District of Columbia, federal installations, and ensuring that states and districts don’t discriminate when they provide schooling.

Congressional Republicans’ primary vehicle for showing how much they care about choice is a bill – the Success and Opportunity through Quality Charter Schools Act (H.R. 10) – that would use $300,000,000 annually to expand charter schooling. Charters, recall, are schools authorized to function by public entities such as school districts or states, but that are run by ostensibly private entities.

The biggest threat that typically comes from federal funding, of course, is that regulation will follow. That said, as public schools, charters already have to follow federal laws such as No Child Left Behind, so regulation isn’t the primary threat from charter aid. No, it’s another major threat: unintended consequences. And the most dangerous – and real – of those consequences is the damage charter schooling does to private schooling, by far the truest form of school choice.

As a 2012 Cato analysis revealed, between 8 and 11 percent of all charter students, depending on the level of schooling, came from private schools. In urban areas the numbers are much more stark, with nearly a third of elementary charter students having been likely private schoolers. As a new Friedman Foundation report describes, the problem for private schools is a clear one: It is very hard to compete when parents think they are getting a private education at public school prices: $0.

It’s great if congressional Republicans, or anyone else, wants to talk up school choice. But the Constitution exists for a reason: to keep federal politicians from inflicting harm, even when they think they’re doing good.  

Minimum Wage Increase Not the Answer in Hawaii

According to reports, lawmakers in Hawaii agreed to a four-step increase in the minimum wage from its current level of $7.25, rising to $10.10 by 2018. This increase would make them just the third state to impose a double digit minimum wage, along with Connecticut and Maryland. Proponents of the increase point to the high cost of living on the island, and say that, without this increase, low-wage workers will be consigned to living in poverty. They also point to the low unemployment rate in the state as a sign that the labor markets could absorb the increased minimum wage without significant job loss. These arguments fail to look at who the proposed increases would actually affect and do not properly account for the adverse effects this legislation could have on some segments of the population.

Despite claims to the contrary, relatively few Hawaiians would benefit from the increase. For one, the median wage for many sectors that are targeted by minimum wage legislation is already above the $10.10 goal: the median wage for bellhops in 2012 was $10.12, for cashiers it was $10.41 and for amusement and recreation attendants it was $11.87. Older, more experienced workers more likely to support a family are more likely to earn above the median wage, and thus be unaffected by the minimum wage hike.  According to testimony before the state legislature, only around 14,000 people worked at the current minimum wage or less in 2012, but even this might overstate how many people would benefit from the increase; many of these workers were teenagers or secondary earners, after accounting for this, the number of full-time workers who are also the head of household falls to 3,700. Depending on which poverty measure you look at, there are between 173,000 and 231,000 people in poverty in Hawaii, so the tiny proportion of families that could benefit from the increase is little more than a drop in the bucket when looking at their broader poverty problems. The plight of these people is not trivial, but introducing broad ineffective policy that introduces distortions into the entire labor market is not the answer.

While it is true that topline unemployment rate (4.7 percent over the past four quarters) is significantly lower than the national average (7.1 percent), as is often the case, looking solely at a headline statistic leaves out many of the nuances needed to understand the context. When people not attached to the labor force or involuntary working part time for economic reasons are accounted for, their unemployment rate rises to 11.3 percent, closer to the national average, so claims that the labor market is strong enough to absorb the distortions of the minimum wage increase are not true.

The Common Core Walks into a Bar…

Defenders of the Common Core national curriculum standards have long employed ridiculing Core opponents as a primary tactic to keep their effort from crumbling. Unlike, say, a circus, the pro-Core assault hasn’t been very entertaining or funny, but it’s been there. Now, though, the humor tide may be turning, with actual funny people – professional comedians – taking on the Common Core.

A first big laugh attack was launched a few weeks ago, when David-Letterman-in-waiting Stephen Colbert ripped into bizarre math questions stemming from the Common Core:

Yesterday, another comedian went after the Core. Louis C.K., of the show Louie, tweeted what actually sounded like a kinda serious distress call about his children:

Now, nobody should make policy based on the jibes of comedians, professional or otherwise. But that pop culture is starting to mock the Core is yet another bad sign for the national standards effort, an effort proponents once thought in the bag when, under federal pressure, 45 states quietly signed on to the Core.

Funny thing is, Core stalwarts don’t seem to be laughing anymore.

Let’s See What DATA Can Do

The New York Times reported at the top of page one yesterday on the $4.1 million in payments that a single physical therapist in Brooklyn got from Medicare in 2012. It’s a shocking sum, and Medicare fraud is common in both physical therapy and the Brooklyn area. The therapist who received the money says that the billings are for his large, multi-office practice.

The point is broader: Reporters, medical trade association figures, investigators and researchers are poring over newly released data about Medicare spending. They’re strengthening public oversight and the public’s capacity to question this government program. It’s data that the American Medical Association and other industry groups fought against releasing. There is risk that the numbers will lead some to unfair conclusions, perhaps even in the case of this Brooklyn physical therapist, but the public oversight it brings to the Medicare program and the circumspection it brings to fraudsters and others will be more than worth it. Data is a powerful oversight tool.

That’s why I think it’s good news that the House of Representatives passed the DATA Act yesterday. The Digital Accountability and Transparency Act, introduced by Mark Warner (D-VA) in the Senate and Darrell Issa (R-CA) in the House, requires the federal government to adopt data standards for all federal spending and publish all of it online. This will permit the public to gather insights like the ones in that New York Times story across the vastness of the federal spending enterprise. It will make the diffuse cost of government a little more acute in the minds of many, positioning Americans to say specifically which spending should stop.

Change will not come instantly, and the legislation is not self-executing, but groups like the Data Transparency Coalition, a prime mover behind the legislation, appear poised to insist on full execution of the law. Implementation should not have the cost that the Congressional Budget Office estimated for it, and if it does, the billions saved thanks to availability of information to the public should justify the costs. If another “cost” of transparency is improvement of federal programs that should be eliminated, I think that beats the today’s status quo of having them on the books and failing.

The DATA Act is not a direct response to a 2008 Cato event asking the Obama administration to “Just Give Us the Data.” Indeed, the administration has been conspicuously unsupportive of transparency in this area, though transparency was a key campaign theme in President Obama’s first election. Cato studies in this area since then include “Publication Practices for Transparent Government” and “Grading the Government’s Data Publication Practices.” We’ll be repeating the grading study during the summer, though it’s doubtful the administration’s grades will improve by that time. We will use the data structures that the DATA Act requires in our Deepbills project, which shines light on Congress’s proposals, including its plans for spending.

When “Conservative” Means “Alarmist”

Global Science Report is a feature from the Center for the Study of Science, where we highlight one or two important new items in the scientific literature or the popular media. For broader and more technical perspectives, consult our monthly “Current Wisdom.”

There is a new study out that purports to make a “conservative” estimate of the social cost of carbon and in doing so arrives at a figure nearly four times larger than the central estimate currently used by the U.S. government—the latter a figure which we and others have voluminously argued is itself several times too high. Perhaps the authors of the new report ought to look up the definition of the word “conservative.”

Recall that the social cost of carbon is supposed to represent the total value of future damages from climate change resulting from the current emission of a ton of carbon dioxide. As you may imagine, coming up with the SCC involves more imagination than actual science.

The primary “tools” used for determining the SCC are “integrated assessment models,” or IAMs, which incorporate a very simple climate model into an economics model. Writing in the journal Nature Climate Change, Jeroen van den Bergh and Wouter Botzen review elements (economic and climatic) that are poorly incorporated or missing entirely from the IAMs.

A prominent characteristic of the IAMs is that they are notoriously malleable and able produce virtually any value for the SCC that the modeler or end-user desires.

Judging from the introductory sentence of their paper

Climate change has been called “the biggest market failure the world has seen” and “the mother of all externalities.”

you can pretty much guess what kind of SCC value van den Bergh and Botzen prefer.

To support their apparent preference for a high SCC, they spend the bulk of their paper imagining bad climate outcomes—with high monetary damages—and are generally dismissive of positive climate impacts. For example:

Nevertheless, our summary of the main effects provides a clear insight, namely that unquantified negative effects of climate change tend to domi­nate unquantified positive effects. The negative effects comprise large biodiversity losses, political instability, violent conflicts, large-scale migration, extreme weather events, natural disasters and the effect on long-term economic growth. Accounting for the latter is likely to increase the SCC because large impacts of cli­mate change are expected to reduce the rate of GDP growth, partly because of negative effects on labour and capital productivity.

Unsurprisingly, when you include a lot of negative impacts along with a low discount rate, the IAMs produce very high estimates of the SCC.

In fact, van den Bergh and Botzen arrive at a “conservative” SCC value of $125. For comparison, value used by the Obama Administration for cost/benefit analyses of new regulations is $36.

Interestingly, in their “conservative” analysis, they never once mention the growing body of new and prominent scientific literature that produce updated estimates of the earth’s climate sensitivity—a measure of how much climate change we expect from carbon dioxide emissions—that are much lower and much more tightly constrained than the ones used in all of the studies reviewed by van den Bergh and Botzen.

The lower climate sensitivity estimates not only reduce the overall impacts from expected climate changes, but they do so primarily by reducing the chances of unexpected and catastrophic changes—the biggest drivers of the high SCC values in the IAMs. It has been repeatedly shown (see here, here, and here for example) that incorporating the new, lower climate sensitivity estimates reduce the IAMs’ SCC determinations by some 40 percent.

And there are lots of other things, which, if better incorporated in the IAM’s, would lead to lower SCC values.

If the positive benefits from carbon dioxide emissions on the planet’s crop production were better included in the IAM’s, the SCC value drops further.  And if arguments for the use of a higher discount rate, rather than the very low one espoused by van den Bergh and Botzen win the day, the SCC drops further still.

Add to the mix a more reasoned view of future climate extremes, and before you know it, it is an easy argument to make that the SCC value should fall significantly below the Administration’s $36 rather than some three to four times higher.

It is bad enough that van den Bergh and Botzen present a rather one-sided view of the science of climate change/climate extremes and the economics concerning the choice of discount rate, but for them to term their analysis “conservative” is really taking things too far. “Alarmist” would be a more apt description.

Our hope would have been that the reviewers for Nature Climate Change would have caught the glaring oversight of the current climate sensitivity literature (with one of the most persuasive articles appearing in the sister journal Nature Geosciences), but that didn’t happen. We’ll withhold speculation as to why that was the case.


Van den Bergh, J.C.J.M., and W.J.W. Botzen, 2014. A lower bound to the social cost of CO2 emissions. Nature Climate Change, 4, 253-258, doi:10.1038/NCLIMATE2135.

South Korea’s Success, America’s Failure: Still Dependent on the U.S. After All These Years

Last week President Barack Obama embarked on his great reassurance tour of Asia.  America’s allies need not fear.  No matter how wealthy, influential, or powerful, they can count on Washington’s continuing protection.

So it is with the Republic of Korea (ROK).  Behind America’s shield the South prospered, developing an economy now around 40 times the size of North Korea’s.  The ROK also has twice the population, an overwhelming technological advantage, access to global markets, and numerous important international friends.

Yet when President Obama arrived in Seoul he announced:  “The commitment that the United States of America has made to the security of the Republic of Korea only grows stronger.”  The U.S. is rather busy in the world.  Why must Washington promise even greater support for a country well able to defend itself?