Source Code and Chicken Indexes

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Regulation AT.

The thing is, high-frequency trading just isn't that important. You just shouldn't trade stocks that much. If you do, "high-frequency trading" probably saves you a bit of money, versus, you know, the absence of high-frequency trading; it probably costs you a bit of money, though, versus an ideal market structure. Either way the numbers are probably small. As a subject matter it is full of intellectual interest and fun little puzzles, but as an important issue in American life it ranks pretty far down there. And yet it is the thing that I write about that gets the most intense emotional response. 

On Friday, the U.S. Commodity Futures Trading Commission held a meeting to re-propose a modified version of Regulation Automated Trading, its proposed rules on the registration and supervision of algorithmic traders. The most controversial rule in Reg AT is the one requiring traders to give the CFTC access to their source code; that has been pared back but not eliminated in the new proposal. It is controversial mostly because trading algorithms are valuable intellectual property and the firms are worried that, if they give the CFTC their code, the CFTC will lose it. (Bart Chilton: "If they can't keep something as simple as their own website up and running, they surely can't protect proprietary source code.") And because it is about high-frequency trading, the controversy is weirdly intense and emotional. CFTC Commissioner J. Christopher Giancarlo opposed the proposal in goofily apocalyptic terms:

Benjamin Franklin is said to have warned that “A people that are willing to give up their liberty for temporary security deserve neither – and will lose both.”

Franklin was right. Reg. AT is a threat to Americans’ liberty AND their security. After twelve score years of ordered freedom, it is a degree turn in the direction of unchecked state authority. If adopted in its present form, it will put out of balance centuries-old rights of the governed against the creeping power of the government.

First they came for the source code, etc.  

But the deeper strangeness is: Why high-frequency trading? Like, ignoring the realities of administrative law and regulatory jurisdiction: If you were The Government, and you wanted access to one set of source code that importantly affects the lives of citizens and where failure could be disastrous, would you really pick the code that trades commodity futures? It's just not that important. Giancarlo again:

If the CFTC adopts the source code provisions of the Supplemental Notice, the Securities and Exchange Commission (SEC) will likely copy it and so will other U.S. and overseas regulators – and not just regulators of financial markets. Regulators like the Federal Communications Commission may demand source code for Apple’s iPhone. The Federal Trade Commission may seek source code used in the matching engines of Google, Facebook and Snapchat. The National Security Agency may demand to see the source code of Cisco’s switches and Oracle’s servers. The Department of Transportation may demand Uber’s auction technology and Tesla’s driverless steering source code.

Yes but I mean all of those are better ideas! If Tesla's code breaks, cars will crash into people and kill them. If an HFT firm's code breaks, you know, there will be a flash crash, and futures will trade at irrational prices for five seconds. No one will die. Google's and Facebook's algorithms order how we perceive the world, our emotions, our politics; they reach into every aspect of our lives and have reshaped our reality in profound ways. And of course they are subject to various sorts of oversight: antitrust law, congressional pestering, etc. But we are not particularly close to giving the government unfettered access to Facebook's source code, despite its importance. Instead it gets the code for trading cattle futures.

Chicken Libor!

There are two basic ways to make a financial index:

  1. You look at some stuff that trades, you observe prices for those trades, and you use them as your index price.
  2. You call up some people who trade the stuff and ask them "hey what should the index price be?"

There are some big advantages to the second approach! Sometimes. That's why it is used, even though it sounds dumb. If the stuff doesn't trade that much, or if the trades aren't publicly reported, or if the trades aren't comparable, or if it is too easy to manipulate the price by trading a little bit of the stuff, then your best shot of getting an accurate representative price might be to call up the experts every day and ask them for the price. On the other hand, that approach is also really easy to manipulate: If one of those experts wants the index price to be higher, when you call her up and ask for the price, she can just tell you a higher price. There is no difficulty or subtlety; she doesn't need to trade millions of contracts to push around the price. She can just say a higher number, and then that number becomes real. 

That was the problem with Libor, as you may have heard, and the solution was to (fine many banks billions of dollars and put several traders in prison and also to) try to find a trade-based index to replace the survey-based Libor. But Libor is not the only index that works on the survey method. There is also the Georgia Dock, which is the Georgia Agriculture Department's index of chicken:

Once a week, Arty Schronce, an employee at the department, calls facility managers, who give him information including how many birds were processed each minute on how many production lines and over what number of shifts, and the average price per pound of poultry sold. Mr. Schronce enters the figures into a formula used to calculate the price of a 2½- to 3½-pound bird, as well as prices for parts of chickens. The price is published once a week on the department’s website.

If you followed the Libor story at all, you know how this one goes. Chicken producers have an incentive not to be entirely honest with Arty Schronce, and "critics say the index does not do enough to verify the data it receives." And the Georgia Dock price -- which is "widely used by grocery stores in America when buying chicken from producers" -- is now significantly higher than other, more trade-based chicken indexes. There's a class-action lawsuit alleging a conspiracy. It is "Chicken Libor." 

Elsewhere: (alleged) wine fraud!

Transcendental meditation.

Here's an article about the craze that is sweeping Wall Street: Transcendental Meditation. (Delightfully, it includes a photograph of a UBS broker practicing TM, that is, sitting in his office chair with his eyes closed.) Ray Dalio, the founder of Bridgewater Associates, LP, is its most famous financial fan, but there are many others. "Trading is a mental game, and anything that gives you even a slight edge is valuable," says Andrew Ross Sorkin, and I wonder how true that is. There is an argument that trading is a computer game, especially at Bridgewater, and that anything that keeps you from touching the computers is valuable. We have talked before about the sometimes absurd lengths that Bridgewater goes to to keep its employees distracted while its computers make all the investing decisions ("Any meeting of at least three people is expected to hold at least one poll"), and telling them to just sit very quietly with their eyes closed seems like a particularly effective approach. Maybe they'll even achieve transcendence.


A few people have asked me my thoughts on Andrew Caspersen's four-year prison sentence for stealing a bunch of money from friends and acquaintances and charity to bet on S&P 500 options. I dunno, seems okay? I don't really think that anyone should go to prison for a non-violent crime. ("No purpose would be served by having him rot in prison for years on end," said Judge Jed Rakoff, before sentencing him to rot in prison for years on end.) But I also think that white-collar criminal law does not do a good job of reckoning with gradations of intent. A lot of people are convicted of white-collar crimes that stop short of conscious intentional theft: Insider traders may not know the illicit source of their information; options backdaters may not think that they are harming anyone; tax evaders may think that they have found a defensible loophole; accounting book-cookers may think that they are doing a good deed by lying to keep their company alive. Many of those people are sent to prison with a lecture about how their crimes weren't victimless and how they were motivated by greed. Maybe? But just directly stealing millions of dollars from people (and from a charitable foundation!) to blow on your gambling habit seems ... much worse? Like, you have to know that that's wrong, even if your addiction to S&P 500 options makes the temptation impossible to resist.

Sorry about your bonus.

I claim no special talent for market timing, either in financial markets or in my personal employment history. If anything, I am exceptionally bad at it, and you could probably make some money betting against me. I entered the workforce a few months after the Nasdaq Composite peaked in March 2000. I went to work at an investment bank in the summer of 2007, a few months after the S&P 500 Financials Index peaked. But I did get one thing right, which is that I left in 2011, and bonuses have been miserable ever since. "The bonus pool for banks has dwindled more than 30% since 2009," and this year's "bonuses are expected to be an average 5% to 10% smaller than last year, according to consulting firm Johnson Associates Inc." I do not want to gloat, but if these trends continue, the day may come when I make more money than I would if I had stayed in banking. It feels good to have made a well-timed move into a stable lucrative profession like internet journalism.

Damodaran on DCFs.

Aswath Damodaran, the NYU professor and valuation expert, published a bunch of posts about discounted cash flows at his blog on Friday. (They are DCF Myths 4.1, 4.2, 4.3, 4.4 and 4.5; he's previously published Myths 1, 2 and 3, and there are plans to go up to 10.) If you are involved professionally in the production of discounted cash flow models, you should probably read these; a sample from Myth 4.2:

There is also a behavioral component at play in the discount rate focus. When faced with significant uncertainty in valuation, it is comforting to turn our attention back to discount rates, where we can draw on established models and data to estimate and fine tune the components (risk premiums, betas, costs of debt). Estimating risk free rates, betas and equity risk premiums to the second, third or even fourth decimal points offers the illusion of control in a world where estimates of revenue growth and operating margins are difficult.

I have previously mentioned that Damodaran's standards for discounted cash flow rigor perhaps differ a bit from those commonly used in investment banks, but that's okay. Even for junior investment bankers who are just cranking out spreadsheets, he provides a pleasant model of aspirational DCFing, of financial modeling as a passionate intellectual calling rather than something that you do at 3 a.m. before passing out in the car service on the way home.

Some politics.

Donald Trump put out an ad blaming America's troubles on an international conspiracy involving Jews in the financial industry, so I guess there's about a 35 percent chance that tomorrow will be the last Money Stuff? (Here's the Anti-Defamation League's condemnation.) It constantly surprises me that people in the financial industry -- like Steven Mnuchin, Anthony Scaramucci and John Paulson -- are funding a campaign like this. (I am not alone; I think sometimes about the Holocaust survivor who called Mnuchin to tell him how upset he is.) I wonder who'll go to the SALT Conference next year.

A lot has been written this year arguing that the Republican Party has been a party of tax cuts and deregulation, while tricking its base into thinking that it was a party of authoritarian white ethnic nationalism. In this telling, Trump exposed the con, made the subtext text, and now leads an actual campaign of authoritarian white ethnic nationalism. But I still feel like we are missing a good explanation of how Trump pulled the opposite con, and convinced some (not all!) of the Republican donor class to think that the party of Trump is still at its heart about tax cuts and deregulation. It has happened -- here's Scaramucci's endorsement of Trump, in which he tries desperately to pretend that Trump doesn't exist ("Elections are never about candidates"!) -- but it is hard to see how. The best effort I have seen is Jessica Pressler's "Secret Trump Theory," which describes donors who seem to really want to be conned. The alternative is too painful to think about.

Elsewhere, I linked to it briefly on Friday, but Katia Porzecanski's reporting on the election and "bro culture" on Wall Street remains disturbing:

A trader at another firm said she’s come to question her boss’s judgment after he dismissed Trump’s caught-on-tape comments about sexual assault. As one of the millions of American women who’ve been sexually assaulted during their lives, she now wonders if her boss would stand by her if she were victimized at work or on a business trip. She’s thinking about quitting.

And here's Megan McArdle at Bloomberg View on Trump and nuclear holocaust. And Trump's staff won't let him tweet anymore. And: "This Election Was About the Issues."


Here is a story that I don't really understand? Apparently a Japanese day trader tweeted that Hiroki Kuroda, a pitcher for the Hiroshima Carp, was retiring, and other people on Japanese day-trading Twitter got excited because they thought he meant Haruhiko Kuroda, the governor of the Bank of Japan, and so they retweeted him a lot. But ... that's it? Like, the yen didn't go into free fall or whatever. I am totally here for stories about one company getting acquired and another company with a similar ticker jumping on the news, because people and algorithms on Twitter are easily confused. That's funny, and tells us something interesting about the short-term efficiency of financial markets. But this isn't a story about financial markets. This is just a story about people on Twitter being wrong. That happens a lot!

People are worried about unicorns.

Google Capital, the growth-equity arm of Google, is now the growth-equity arm of Alphabet Inc., and it's now CapitalG. I wonder how many engineers at Google/Alphabet were told to just take a year off and concentrate on renaming things with letter puns. (On Twitter, I proposed "Hard G" and "Soft G" for the hardware and software divisions; Daniel Olmstead proposed "O.G." for search.) Along with the name change, CapitalG also let slip that it had quietly invested in Snap Inc., because real G's move in silence like lasagna

Elsewhere, Snap will of course have a new class of shares to ensure founder control after it goes public. The schedule for Goldman Sachs's unicorn conference (sorry, "Private Internet Company Conference") is out. And if you live in the U.K., you can make dumb investments in crowdfunded startups

People are worried about bond market liquidity.

The Bank of Canada just "published the results of the 2016 Canadian Fixed-Income Forum (CFIF) survey on market liquidity, transparency and market access," with a nice heat chart of the worries on page 8. Basically people are pretty chill about on-the-run Canadian government bonds, pretty worried about non-government repos.

Elsewhere here is Adam Levitin on "Tinder for CDS":

In short, dealers are really just matchmakers.  So here's the thing:  we've seen how human matchmaking can be entirely replaced by (1) algorithms and (2) apps.  For algorithms, that's just stuff like or eHarmony.  And for apps, well, there's Tinder, etc.  I assume that someone has even combined algorithms with an app, so users don't have to browse for dates, but just log on and are automatically matched.  This model seems entirely applicable to many types of financial contracts.  If I'm a hedge fund looking to go short on some debt obligation, I need to find someone who will sell me CDS.  I could go to a dealer (and pay a nice bit for this), but why not just use an app that will match me with all of the funds that are looking to go long?

This is an idea that you see a lot: that some sort of all-to-all electronic trading platform will solve the liquidity problem in bonds, or credit default swaps, or whatever. The dealers aren't really providing a useful function, so they'll be easy to replace, as soon as we get the technology sorted. Maybe! But one thing to think about here is that the stock exchange is pretty much the best matchmaking app ever, and it is still absolutely rife with dealers. The U.S. stock exchanges are a high-speed, fully automated, integrated system for matching hedge funds who want to buy Microsoft stock with hedge funds who want to sell Microsoft stock -- and yet people constantly complain that too many trades are with electronic market makers, rather than directly between end users. The stock exchange disintermediates the dealers, but intermediation creeps back in. That suggests that it's doing something useful, and that a bond or CDS trading app without dealers might not work so well.

Oh and: "Obama’s Successor Inherits Bond Market at Epic Turning Point."

Things happen.

A profile of Yale endowment manager David Swensen. HSBC Shares Rise on Surprise Profit Jump, Capital Ratio Increase. EU reconsiders financial market access rules. China Weighs Giving Wall Street Investment Banks Greater Mainland Access. There's more money in exchange-traded funds than in hedge funds. Bondholders Scarred by Busted Mergers Push Banks for Change. Tesla Motors' SolarCity deal gets a boost from shareholder advisory firm. Dealpolitik: No Winners in Gannett’s Failed Deal for Tronc. How Wells Fargo’s Problems Flourished in Arizona. Did Wall Street Banks Suddenly Turn Into Better Traders? A Stranded $2 Trillion Overseas Stash Gets Closer to Coming Home. Deutsche Bank Said to Shrink London Office Space After Job Cuts. AT&T Rivals Make Wish Lists as Review of Time Warner Deal Begins. New Discovery Broadens VW Emissions-Cheating Crisis. Earnings Management and Corporate Investment Decisions. "We find that counterparty risk has a modest impact on the pricing of CDS contracts, but a large impact on the choice of counterparties." Anthony Weiner rides through sex addiction rehab on a horse. How I became a time-millionaire. Happy Love Your Lawyer Day (observed). 

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(Corrects unicorn section to reflect that CapitalG is Alphabet's growth-equity arm, not its venture-capital arm, which is called GV.)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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Matt Levine at

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