Should capital markets slow down?

I've been following the recent Knight Capital algorithm debacle for some time, and am a bit puzzled: what's the advantage of allowing all these algorithms to run amok in the capital markets? In particular, those algorithms that make hundreds of trades per second.

Brokerages and exchanges will want these algorithms in the market, since algos will allow them to earn commissions. With a global trend of declining commissions, most brokerages and exchanges need to increase the volumes to make up for the declining commission rates. Prop firms (including hedge funds and proprietary desks of investment banks) will want these "algos", since the algos supposedly give an "edge" (i.e. competitive advantage over the rest of the market). As my previous trading boss used to say, "no edge, no profit". 

However, if you look at the capital markets on the whole, it's hard to see how the advantages outweigh the risks involved. A rogue algorithm running amok in the market can react much more quickly than any human, causing markets to crash without any underlying economic basis: besides this Knight Capital incident, the Flash Crash of 2010 also comes to mind. This can spread fear through a market faster than you can swear "F----"... and fear (as an emotion) is a dangerous emotion to have spreading throughout a market. Worse, once a "situation" occurs, it's next to impossible to stop it without disrupting the entire market's function. High frequency trading basically raises the possibility of more negative black swans, without any real economic benefit.

It's also arguable if allowing milli- and micro-second trades helps in the price discovery process: is it really meaningful price discovery between a willing buyer and seller who can cognize the price and economic benefit/cost, or is it just "noise" between one algo and another? Can it really be meaningful price discovery if a human watching the exchange (even an experienced floor trader) won't be able to cognize the price, as it just happens far too quickly?

Perhaps as a policy, exchanges globally should consider limiting the speed of transactions, s.t. an algorithm cannot be faster than, say, the typical human reaction time on an electronic trading desk. Otherwise, we run a real risk that the Machines will overtake the markets, and leave us wondering what happened in the aftermath. 

Review on article in the Economist about bank stocks and employees

Sorry to my non-existent readership for not updating this in a while, as I have been busy being funemployed.

My favourite magazine in the world, The Economist, just published a brillant article over the weekend about bank employee compensation and their returns to shareholders (over the same holding period). The most striking thing about this article was the diagram that they used to illustrate the investment-turkey-payoff vs. the employee compensation for Lehman Brothers (see below, from the Economist website). From this, it is fairly obvious that (a) it sucks to be a shareholder of an investment bank that is going bankrupt, and (b) it's great being an investment bank employee, as you get all upside and absolutely no downside whatsoever.

The second thing that was striking about this article was the last paragraph, which is much the same said by Nassim Taleb, phrased in a different way:

Banks pay low dividends, and when they get into trouble the capital that shareholders have retained in the firm typically gets wiped out. Employees have taken money out of their firms each year. It may be time for the owners of banks to mutiny over the bounty.

Read the article, and then think for yourself whether speculation in bank stocks really is worth the risks involved: you might be better off trying to get into a bank as an employee than playing with their stocks.

As I'd previously highlighted in this blog, we Singaporeans hardly have a choice in the matter, given Temasek's huge investments in banks as a proportion of its portfolio. But I do hope that the powers-that-be are looking closely into their portfolio, and demanding more "bounty".

And in response to Temasek's repeated exhortation that they are investing in stocks "for the long run", it is worth considering what ex-Morgan Stanley Asia chief economist Andy Xie (who apparently got into trouble for his candid remarks about Singapore, ball-carrying Westerners and PM Lee) has to say about stocks in the long-run:

It's a widely accepted notion that long term stock investors make money. Actually, this is not true. Most companies don't last for more than 20 years...In the long run, all companies go bankrupt.

(from the English 财经 magazine, link here)