The epistemology of high frequency trading.

Craig Pirrong on efficiency and incentives to information gathering:

Pooling equilibria hurt the uninformed: separating equilibria help them. The opposite is true of informed traders. Market makers that can evaluate more accurately the informativeness of order flow induce more separation and less pooling. Ultimately, then, the driver of this dynamic is the informed traders. They may well be the true predators, and the uninformed (or lesser informed) and the market makers are their prey. The prey attempt to take measures to protect themselves, and ironically are often condemned for it: informed traders’ anger at market makers that anticipate their orders is no different that the anger of a cat that sees the mouse flee before it can pounce. The criticisms of both dark pools and HFT (and particularly HFT strategies that attempt to uncover information about trading interest and impending order flow) are prominent examples.

Noah Smith on strategies:

But a lot of HFTs simply don't know what their strategy really is. They hunt for patterns in prices or orders, find a pattern that seems to work, and trade on it until it stops making money. They don't have any idea why the pattern exists. Sometimes it only exists for a few seconds. In fact, if they stop to gather enough information about the pattern to figure out why it's there, it often disappears! Actually, there are deep mathematical (information-theoretical) reasons to suspect that lots of HFT opportunities can only be exploited by those who are willing to remain forever ignorant about the reason those opportunities exist. It's mind-bending (and incredibly interesting).

Matt Hurd on IEX:

OK. You are lucky enough know the price is going to be always delayed and thus stale at match point. The stale pricing is guaranteed by many miles of fibre in a shoebox. Great! Try to use all your inputs to deduce an impression of a better price in real time. Throw it at them. Send in limits or IOCs at your biased price and see if you land a trade in their time warp. Better information exists on the outside of the delayed world. Use it. It's still a race. Slower exchanges are always problematic as the world knows better. IEX is no different. You can be played by better information or decisions. You don't eliminate the speed race.

Also here is an interesting discussion of high-frequency-trading on Reuters Insider. And here is Zero Hedge on VWAP algorithms. And "Why not read a fun book on a fun and understudied topic?"

More thoughts about bank capital.

The New York Fed is not short of interesting ideas on bank capital. Here's another one, the "special capital account":

A second feature is that the SCA accrues to shareholders as long as the bank is solvent, but it accrues to the regulator—rather than the bank’s creditors—in case the bank is insolvent and there isn’t an industrywide rescue of banks. That is, in case of idiosyncratic failures, bank creditors are forced to take losses. The fact that creditors don’t benefit from the SCA in that case means that creditors have enough skin in the game to discipline banks.

Dual sovereigns.

Should Credit Suisse be investigated over and over again for helping Americans evade U.S. taxes? Think about all the laws that tax evasion violated or, better, all the regulators' turf that it trod on. The IRS, obviously, but the SEC got in on the action too, and now New York financial regulator Benjamin Lawsky "will examine whether Credit Suisse lied to New York authorities about engineering tax shelters," because the main crime in the world is lying to authorities. (I guess some New York state taxes were probably evaded too?) What is your model for this? I think it starts with the idea that many, though not all, regulators are ambitious to expand their profiles, and so will compete with each other to bring bigger and faster and noisier investigations of high-profile, intuitively unappealing behavior, whether or not it is actually related to their core regulatory mandate. This is good if you think there should be more investigations, and particularly if you think that the most obvious agency to investigate, here probably the IRS, is not so ambitious and needs prodding from the Lawskys of the world. On the other hand it's probably exhausting if you are Credit Suisse, and it does not exactly contribute much to the clarity or certainty of the law.

Asset quality reviewing isn't free.

"It’s an economic stimulus package for auditors," complains a banker about the European Central Bank's asset quality review, and you probably need a better model than that. Every regulation imposes compliance costs on the regulated, and "compliance costs" means in part (though not exclusively) "paying money to people who help you comply." But that is socially beneficial spending, one hopes. Anyway, the auditors and for some reason BlackRock are making out like socially beneficial bandits, or, at least, they "stand to reap about 400 million euros." Meanwhile BlackRock is conducting "its most sweeping managerial overhaul in years," so far without any stories of hilarious Pimco-style dysfunction.

Bonds are contracts.

"Sears is getting rid of all the good stuff and leaving bondholders with the underperforming assets," says an analyst about Sears Holdings's spinoff of Lands' End and other businesses. The classical theory says that Sears has fiduciary duties to its shareholders to maximize their returns, but has no such duties to its bondholders and so should take as much value from them as it can, to give it to the shareholders. This is constrained by the contractual provisions of the bonds, and by the desire to avoid alienating bondholders so as to maintain access to the capital markets, but in some sense if your bondholders aren't complaining you're doing it wrong. Meanwhile, any 30-year bond is a leap of faith but, sure, a 30-year bond sold by a private equity firm that is still run by its original founders is especially faith-based.

Things happen.

Is Jérôme Kerviel the poorest person in the world? How do you board a train? Brian Moynihan is underpaid, and before you snicker, ask yourself how much you'd want to take his job. Gerald Hassell is overpaid, though, apparently. Hedge funds still aren't advertising. A previous Michael Lewis character is back in the news. "The plant also produces babies you can repot for underlings."

To contact the writer of this article: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.