TOPICS > Economy

Fictional Thriller Tackles Dangers of High-Frequency Trading

March 15, 2012 at 12:00 AM EDT
Part of his series on Making $ense of financial news, economics correspondent Paul Solman spoke with author Robert Harris whose fictional take on Wall Street, "The Fear Index," stresses the dangers of algorithm-driven, high-frequency trading.

JEFFREY BROWN: And even as — speaking of markets, we turn to a very different, fictional take on Wall Street in the form of thriller with a plotline drawn from real life.

That’s the subject of NewsHour economic Paul — economics correspondent Paul Solman’s conversation. It’s part of his ongoing reporting Making Sense of financial news.

PAUL SOLMAN: Not every novel gets its own trailer, especially not novels about the world economy. But, then again, few novelists have a track record like Robert Harris’.

ROBERT HARRIS, author, “The Fear Index”: This is what it’s like being on the campaign trail with a prime minister in 1983.

PAUL SOLMAN: After years as a British journalist, Robert Harris turned to speculative thrillers, so popular they have consistently reached a mass audience, “Fatherland,” an HBO movie, “Archangel,” a BBC miniseries, and “The Ghost,” renamed “The Ghost Writer” when filmed by Roman Polanski.

But Harris latest book, “The Fear Index,” stars a hedge fund driven by an algorithm run wild. And the more Harris researched its plot, the more plausible it seemed to become.

ROBERT HARRIS: I’d never heard of algorithmic trading. I went to see a hedge fund in London. They showed me a room full of computers. And in the course of the 20 minutes that I watched, this machine made $1.5 million without any human intervention.

PAUL SOLMAN: What did you come to understand that these machines were doing?

ROBERT HARRIS: What the machines essentially do is take millions of pairs of data. You know, if the price of copper is here and the German Stock Exchange is there, and the price of oil is here, and IBM is there, then, tomorrow, the price of tin will be here. It’s not always right by any means, but they only have to be right 55 percent of the time, and then they’re going to make an awful lot of money.

PAUL SOLMAN: Now, computer trading has been around for years, and stock exchanges have instituted various safeguards to keep it from getting out of hand.

But the new game in town is high-frequency trading, with computers and their algorithms moving in and out of stocks as many as tens of thousands of times a day.

ROBERT HARRIS: And what they’ve done, in my book, is they have developed an algorithm that can predict the markets by analyzing the incidence of fear-related words on the Internet, trends on Facebook, Twitter, the sense of a mood.

I thought I was making this all up, but, of course, I then discover that this is yesterday’s news. They’ve been doing this for years. There’s nothing you can invent that these guys, very clever, haven’t thought of before you. Bloomberg News feeds are digitalized and go straight into the machine, and buzzwords are picked out, “panic, rumor, fear, slump.”

And, you know, you just get a few milliseconds’, maybe, advantage if the machine can work out what this news story is going to do to the markets in the next few minutes.

PAUL SOLMAN: And that’s what your novel gets at, the ability of an algorithm to exploit that anxiety.

ROBERT HARRIS: That we are the victims of some sort of gigantic H.G. Wells-like science fiction creation, which is the markets, so huge in the — in the numbers of shares and the vast values of transactions every day, so fast with the speed, that it has somehow slipped the control of human beings, and almost is itself a kind of Frankenstein’s monster run amok in the world.

MAN: Suddenly, it’s down 300 more from when I sat down here.

PAUL SOLMAN: On the afternoon of May 6, 2010, reality overtook the fiction Harris had just begun. The Dow, already down 300 points for the day on Greek debt jitters, plunged another 600 points within five minutes.

MAN: When I ask them what the heck is going on down here, I don’t know — there is fear. This is classic capitulation, really. It is classic capitulation. There is fear in this market.

ROBERT HARRIS: And I remember watching that happening live. And it was that uncanny feeling that your fiction was coming true in front of your eyes, because it was very much algorithmic trading that caused that flash crash.

PAUL SOLMAN: In the U.S., high-frequency firms represent only 2 percent of the 20,000 or so trading firms operating today. But they now account for nearly three-quarters of all trades.

And the average time a stock investment is held these days is 22 seconds. If time is money, microseconds are now millions. In a recent so-called TED talk on cutting-edge technology, tech whiz Kevin Slavin wowed the audience by describing buildings now being hollowed out in Lower Manhattan. Why? So that high-frequency trading firms can move in and get as close as possible to New York’s point of entry for the Internet at a so-called carrier hotel in Tribeca.

KEVIN SLAVIN, technology consultant: And this is really where the wires come right up into the city. And the further away you are from that, you’re a few microseconds behind every time. These guys down on Wall Street, they’re eight microseconds behind all these guys going into the empty buildings being hollowed out up around the carrier hotel.

Just to give you a sense of what microseconds are, it takes you 500,000 microseconds just to click a mouse. But if you’re a Wall Street algorithm and you’re five microseconds behind, you’re a loser.

PAUL SOLMAN: Who are these people?

ROBERT HARRIS: They don’t hire anyone to work who has less than a Ph.D. in the natural sciences or mathematics and that weren’t peer-reviewed in the top 15 percent. They don’t even want someone to come and work for them who’s got a degree in economics. It’s too soft.

PAUL SOLMAN: The algorithms are actually the brainchildren of top-flight physicists, forced to migrate to Wall Street in the early ’90s, when Congress killed the 54-mile-in-circumference supercollider, for which land outside Dallas was already excavated.

ROBERT HARRIS: There were going to be 2,000 scientific posts at this — the Desertron, as they called it. And this coincided — we’re talking here of 1993 — with the rise in Wall Street of computers and of pricing risk and bringing in mathematicians. And hundreds moved into Wall Street.

We’re talking about the influence of physicists and mathematicians. And the speed and power of computers and of the Internet and the Web have utterly changed everything.

PAUL SOLMAN: Now, the traditional argument for high-frequency trading is that it promotes liquidity, making it easier for the normal investor, because there are so many more big buyers and sellers willing to make trades quickly and cheaply.

But many market observers are skeptical. Count Robert Harris among them.

ROBERT HARRIS: We live in an age of great jitteriness in the financial markets. And there’s no doubt at all, I think, that the volume of computer-traded stocks has helped contribute to that.

One of the great moments for me in researching the novel was to listen to the audio commentary that was broadcast live from the pit of the Chicago market as the whole market started to collapse. And you can hear people screaming in the background. And the guy’s voice, it is as if he’s seen the monster coming towards him. It’s the most extraordinary piece of soundtrack.

WOMAN: I think that we have had the most exciting 15 minutes in “Street Signs” history.

PAUL SOLMAN: By the end of the day, the market had recouped the 600 points it lost during the flash crash. But nobody can guarantee that it won’t happen again.

ROBERT HARRIS: And that is what is worrying, I think, about this high-frequency trading. We won’t know it’s disastrous until the disaster has occurred.

PAUL SOLMAN: A disaster like the one imagined in Harris’ book or in real life.