Financial Phrases to Beware Of, Part LXXII

| Thu Apr. 1, 2010 10:34 AM EDT

Here is Mike Konczal reading my mind today:

Like "providing liquidity," whenever I hear "competitive disadvantage" as the main reason to not do a sensible financial regulatory related thing I think that there's some real shenanigans going on.

Obviously he's right about the "competitive disadvantage" shibboleth, but it's the other one I really have in mind. It's everyone's go-to excuse for why some arcane bit of financial rocket science is really a good thing: because it "provides liquidity" to the market. Whenever I hear that I reach for my wallet.

Example: if you ask Goldman Sachs about the value of high-frequency trading, in which they co-locate their servers near a stock exchange's servers so they can complete trades in 3 milliseconds instead of the pokier 10 milliseconds required by the dinosaur brokers that you and I have to use, they'll tell you that HFT provides needed liquidity. There are, at a minimum, two problems with that. First: does anyone really think that U.S. stock markets have historically suffered from a lack of liquidity? Stop laughing back there. But you're right: the answer isn't just no, it's hell no. In fact, U.S. equity markets are generally used as textbook examples of the most open, liquid markets ever created on planet Earth.

Second: financial rocket science does often provide additional liquidity. Unfortunately, it doesn't always provide additional liquidity. Typically, it provides liquidity when you don't need it and then scurries away and hides in a corner precisely when you do. Unless there's some underlying reason — or, better yet, some regulation — that gives you a reason to believe that a financial innovation will provide liquidity all the time, even when the market panics, it's useless.

End of rant. You may now go back about your business.