Nancy Folbre is professor emerita of economics at the University of Massachusetts, Amherst.
In the world of financial trading, a front-runner is someone who gains an unfair advantage with inside information, including access to a high-speed transaction network revealing specific trades other people are trying to make.
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Like the public bailout of major banks during the last financial crisis, tolerance of front-running challenges the faith that competition always guarantees efficient outcomes and the creed that market value accurately measures real contributions.
The book itself sticks to a heroic narrative driven by likable good guys who patiently decipher and partially remedy illegal practices. More bluntly, Mr. Lewis announced on “60 Minutes” last week that the stock market is rigged.
Some titans of the financial world, including Charles Schwab,
founder of a well-known discount brokerage house, agree. Mr. Schwab describes the form of front-running practiced by high-speed frequency traders as a cancer undermining confidence in the free-enterprise system.
Others, including Vanguard’s founder, John Bogle, insist that few investors
have actually been hurt by front-running and that high-frequency trading has redeeming features,
such as lowering transaction costs.
But in merit-based competition, a violation of the rules undermines the larger game regardless of how many individuals are directly harmed by it.
As the Naked Capitalism blog points out, front-running doesn’t rank very high on the scale of harm done by recent financial travesties. But this doesn’t imply that the “victimless crime” defense can fly.
A recent Bloomberg Businessweek article notes, “ High-frequency trading doesn’t prey on small mom-and-pop investors.” True, but plenty of ordinary people have invested in large pension funds whose trades have been affected.
Imagine a similar defense of Lance Armstrong’s illegal use of performance-enhancing drugs in the Tour de France, which, after all, didn’t hurt a very large percentage of cyclists.
The same article protests, “High frequency traders aren’t Wall Street insiders.” Why should this matter? In any case, the real shocker in “Flash Boys” is not that a few naughty players game the system, but that the New York Stock Exchange and major investment banks help them do it.
Some assert that front-running is not taking place in high-frequency trading. Tell that to the Federal Bureau of Investigation, which opened an investigation of the practice a year ago.
Another jaded defense of front-running simply claims it was ever thus: “History shows that those trying to gain an advantage are simply good at adapting.” Since when is insider trading simply another form of adaptation?
With his adept efforts to market his book, Mr. Lewis has set off a debate over a theoretical point he never explicitly confronts: Intense competition doesn’t automatically elicit greater effort or excellent performance. In the absence of firm principles and strict rule enforcement, it elicits criminal behavior and lame rationalization.
In what the economists Robert Frank and Philip J. Cook call “The Winner Take-All Society,” honest losers are left behind.
The market is not an impersonal arbiter of economic value, and financial markets, in particular, sometimes reward malfeasance rather than merit.
Most of the approximately 165,200 employees in the securities industry in New York City are honest, hard-working individuals whose reputation has been tainted by the culture of Wall Street. It’s worth remembering, however, that last year they took home bonuses amounting to about $26.7 billion.
The Institute for Policy Studies estimates that this sum is more than enough to double the pay for all 1,085,000 Americans who work full time at the current federal minimum wage of $7.25 per hour. Most of them are honest, hard-working individuals whose ability to earn a living has been hampered by the decline of Main Street.
Yet Republicans in Congress continue to oppose a proposed increase to $10.10 an hour, which they consider undue interference in the labor market. They don’t like interference in financial markets, either. What they seem to like is races without rules.