Hello Aaron,

If you haven't seen it you have to watch http://video.cnbc.com/gallery/?video=3000263252

Brad Katsuyama to William O'Brien (BATS CEO): "I believe the markets are rigged. And I also think that you're a part of the rigging. So if you want to do this, let's do this."

P.

Hello Aaron,

My sense is that a lack of liquidity in 2008 was an effect, rather than a cause, right? The cause, in my estimation, was a combination of poor regulatory oversight and an lack of transparency. And of course home buyers didn't have to accept all of those crazy loans, either.

Grant

My point was merely that lack of liquidity can be detrimental to markets. Those who seek to curtail HFT should be careful what they wish for.

Hello Grant,

To see why the 2008 crash happened I highly recommend "The Trillion Dollar Bet" (http://www.youtube.com/watch?v=tsZRndV5lIc) and "Inside Job" (https://archive.org/details/cpb20120505a).

The US had to bail out LTCM after their Nobel-prize winning quants bet $1 Trillion in 1998 and lost. Instead of reform the US effectively repealed Glass-Stegall with the 1999 Gramm–Leach–Bliley Act, and then deregulated derivatives with the 2000 Commodity Futures Modernization Act. Then Goldman Sachs execs were appointed to the Treasury, the Fed, the SEC and the CFTC.

Investment banks mis-sold CDOs and bet against their own clients. Ratings agencies rated junk as AAA because the banks said they were AAA and they got paid a lot to do it.

2008 - banks are too big too fail. Goldman gets bailed out 100 cents on the $ (http://dailybail.com/home/aig-ceo-on-paying-counterparties-goldman-sachs-100-cents-on.html)
2011 - Wall Street bonuses are at pre-2008 highs
2012 - UK regulator says banks too big to prosecute (http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/9743839/Banks-are-too-big-to-prosecute-says-FSAs-Andrew-Bailey.html)
2013 - US Attorney General says banks too big to prosecute (http://www.youtube.com/watch?v=Z3zwhp5-jXA)

The next crisis will be the big one. Especially if the US$ is no longer the World's Reserve Currency. It could be the end of fiat money and fractional reserve banking.

P.

http://www.zerohedge.com/news/2014-04-03/sick-and-tired-being-frontrun-hfts-interactive-brokers-has-solution

Thanks Aaron. Interesting...I wonder if Quantopian/IB orders can be directed to IEX?

Thanks Peter. I've seen "Inside Job.". I've never seen "The Trillion Dollar Bet" but I do recall when LTCM was in the news. Regarding your comment "The next crisis will be the big one" what occurred to me was the same thing that has been in my mind regarding the 2008-2009 downturn--how can such big problems build up without detection? Or rather, my intuition says that they should be detectable with the right information (e.g. in March 2008, William Berstein pointed out that something was way outta whack--http://www.efficientfrontier.com/ef/0adhoc/darkside.htm)

--Grant

Hi Grant,
Michael Lewis's The Big Short is based on those who saw the 2008 crash coming and took advantage of it. Its a good read. They saw it coming in 2006, took positions in 2007 and were expecting the crash to happen a lot sooner than when it really happened.
Ajay

A few thoughts/questions on the original comment (from Aaron) regarding HFT / cost / risk management:

1. Following a fundamental law of economics, that there are always buyers and sellers, liquidity is of the utmost importance. But, if there is a catastrophic market event, and HFTers pull their orders because they don't want to take risk, then how are they providing "liquidity?"

2. I'm not an expert on market making...are most HFTers actually market makers or predators/scalpers? If market makers, then do they have a "duty" to the market to "be there" when times are tough? Or, is that something that has been lost with HFT market making where there is much more sophisticated/advanced risk management?

3. I wonder how mega large asset managers (like AQR) manage risk in terms of worst case scenarios (like flash crashes)? Do they just assume it will be V-shaped and "stay invested" if they get caught up in a fast crash?

Thank you guys for posting / having this discussion. I'm looking to trade an intraday strategy and am extremely nervious about the risks of HFT frontrunning my orders, so this entire thread made me aware of IEX, and Aaron's link on IB integration is extremely useful.

I've been in Thailand the last 6 years so wasn't aware that HFT visibility is increasing (which is a good thing unless you work at wall street)

A broader view is that Wall Street/City of London and financial regulators have leant nothing since 2008 and it's very much business as usual. RBS in the UK lost £8.24 Billion in 2013 and paid bonuses of £588 Million. (http://www.theguardian.com/business/2014/feb/27/rbs-bonuses-loss-pay-market-rate)

In the US a small part of Dodd-Frank has been implemented as lobbyists continually get the legislation revised until it becomes too complicated to enforce. (http://www.c-spanvideo.org/videoLibrary/mobilevideo.php?progid=298949 from around 28:00 although it's worth watching all of it)

The 2008 crisis was a 'securitization bubble' based on Residential Mortgage-Backed Securities (RMBSs). But just to show nothing has changed Wall Street now wants to sell Rent-Backed Securities (RBSs):

"....securitizations are back, baby, and this time they are scarier and riskier than ever.
It appears that since America's financially innovative elite doesn't have the patience to wait until housing prices regain their previous all time highs in order to usher in the second great RMBS wave, they...came up with a brilliant idea: "Hey, let's just securitize rents."
Sadly, we are not kidding."

See: http://www.zerohedge.com/news/2013-07-30/here-we-go-again-step-aside-rmbs-rent-backed-securities-are-here-and-them-beginning-

"“Times like these are cathartic. Bubbles of overpriced assets collapse along
with the egos of many investors. The wannabe stars in, say, hedge funds and
private equity will go to the wall but the genuinely talented will survive. Some
senior banking heads have rolled – and more will no doubt need to roll – but
the danger is that the banks learn nothing, only to repeat it all in a few years’
time. So when you are having a conversation and some banker tells you that
this time there is a new paradigm, you know it is just moral hazard on the
horizon. And you should run for the hills. You have been warned.”
Ian Morley, Chief Executive of Dawnay, Day Brokers

See: http://www.thecornerhouse.org.uk/sites/thecornerhouse.org.uk/files/WallMoneyOct08.pdf, p.13

P.

Ajay,

Thanks for the tip on "The Big Short" book. I'm getting old enough to have experienced a whole set of ups and downs. The earliest I can recall was Black Monday (1987). I'd have to agree with Peter's sentiment above that there will be more crises. In the context of Quantopian, the question is what data are relevant and how can they be used predicatively (at least in a probabilistic sense)? I figure data beyond what Quantopian provides are needed. Any idea?

Grant

Here is a counter view bashing Lewis and Katsuyama (a bit biased, but some valid points I guess)
http://scottlocklin.wordpress.com/2014/04/04/michael-lewis-shilling-for-the-buyside/

Grant, I need to read the book again to see what data they looked at to predict it. I know they did look at lot of these CDOs and identified them as being junk. They were looking for instruments to short these and none apparently existed. So they went to the financial services firms and asked for those instruments, which the firms readily created and sold, till they wised up and then started buying themselves. The last to know and the one that took all the losses was AIG. It would be funny if not for the losses that everyone suffered.
Ajay

Hello Ajay,

Yeah, it'd be nice to test some ideas out on Quantopian. I've seen plenty of backtests (my own included) that, in one fashion or another, avoid or profit from the big 2008-2009 market downturn. But who knows if they'd work for the next downturn. Thinking about the recent mortgage-backed securities craziness, presently I wonder if there is a huge amount of money (something ending in a T) sloshing around the globe from which one could derive an uber-indicator. Maybe one could sort out the next global financial scheme?

Grant

@Peter my big issue with that counter argument is that observing 100k shares available and attempting to buy it is only "ham fisted" to those who are deeply aware of HFT, which is mostly just those who profit from the front running strategies.

Adding 0.1% per transaction to pay the skimmers makes a lot of otherwise profitable intraday strategies unprofitable.

IEX has appeared today as a destination exchange in TWS.

P.