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How to lose money - fast!
00:27:41
Last week Knight Capital lost a lot of money very quickly. It was the latest chapter...
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- [00:00]
Tim Harford
Hello and welcome to More or less. While the rest of the world is going faster, higher, stronger, we're double checking the stopwatch. This week we talked to Mark Henderson, the author, who says that the geeks are on the march in politics and in life. We'll take yet another brief statistical tour of the Olympic medal table and I'll be reviewing one of the toughest decisions of my life. Is that Captain Flack?
- [00:25]
Captain Flack
Yes, it is.
- [00:26]
Tim Harford
I'm afraid I have some bad news. Captain Flack, can you please find Dibble?
- [00:30]
Captain Flack
Find the what?
- [00:31]
Tim Harford
Find Dibble. Please find him and tell him he's been made redundant.
- [00:35]
Captain Flack
Oh, dear. Whatever next?
- [00:38]
Tim Harford
But first, let me tell you a story about a strange thing that happened last week. The New York Stock Exchange launched a new electronic trading platform. In preparation for this, a company called Knight Capital had created some software to link up with a new platform in order to trade shares on it. The stock market opened and Knight Capital prepared to launch its new software.
- [01:00]
Felix Salmon
There was some problem with the program. We don't know exactly what this is.
- [01:03]
Tim Harford
Felix Salmon, finance blogger for Reuters, based in New York.
- [01:07]
Felix Salmon
They switched it on and immediately they started losing literally $10 million a minute. It looks like what they were doing was they were buying high and selling low many, many times per second and losing 10 or $15 each time. And this 45 minutes. And at the end of it all, they wound up having lost $440 million.
- [01:33]
Tim Harford
Oops. But how could a company lose so much money so quickly? This is the latest chapter in the story of something called high frequency trading. Investors have always valued being the first with the news, But high frequency trading is something different. Automatic trades conducted by computers, each one racing to be first. Humans still watch the systems, but the computers move far too quickly for us to react to everything they do. And at Knight Capital, the computer glitch meant the company was making trades it didn't intend to make. That's how to lose almost half a billion dollars in less than an hour. To give you a sense of how fast high frequency trading can be, imagine slowing down time so that 10 seconds lasts 30 minutes. In this parallel universe, Usain Bolt ran the hundred metres in just under 29 minutes. It took him 30 seconds just to react to the starter's pistol. And the pistol bang itself lasted two minutes. Let's play you just the B of the bang. Just the beginning of a two minute gunshot sound. And now let me play you some pulses. One pulse for each trade from a high frequency trading computer. Now, that doesn't work. There are still too Many trades in the 1600s of a second. Usain Bolt is understanding that it's time to run an algorithm written into a high frequency trading platform called could complete about 165,000 separate trades. That's pretty fast. So let's slow it down even more. The 10 second 100 meter race now lasts two months. The 160 millisecond reaction time lasts just over a day and the bang of the starter's gone lasts four and a half days. On that incredibly slowed down timescale, here's how quickly the high frequency trades are happening. And it's getting faster all the time.
- [03:45]
Jonathan Portes
Now.
- [03:45]
Tim Harford
This isn't quite as insane as it sounds. These computers all competing with each other are a lot cheaper and more efficient than human traders trying to match bids to buy and offers to sell. So within reason, automated high frequency trading is a good thing. But it's possible to have too much of a good thing. On 6 May 2010, the UK was preoccupied with the general election. But. But on the other side of the Atlantic, a very different story was unfolding.
- [04:13]
Felix Salmon
We were all sitting around in the middle of the afternoon on a relatively slow news day and suddenly the Dow Jones Industrial average was down 600 points in a matter of five minutes. There was this huge crash in the stock market for no reason. And then 10 minutes after that it went back up again and no one knew what had happened.
- [04:37]
Tim Harford
What may have happened was that somebody rather clumsily tried to make a big trade all of a sudden on an electronic exchange called globex. As the price dropped sharply in the process of trying to find willing buyers, the algorithms of the high frequency traders plugged into globex went into overdrive. And the flash crash wasn't just what happened when the algorithms were in a frenzy. It was also what happened when human beings pulled the plug on all of those individual algorithms.
- [05:04]
Felix Salmon
A whole bunch of high frequency traders saw a lot of weird stuff going on in the market which didn't make any sense. And they said, you know what, we don't know how to make money in this. This is outside what our algorithms are used to playing. And there's a lot of unpredictable stuff. We're all just going to hit our off buttons at the same time. And what that did was it meant there was no what's known as liquidity in the market. There was no one in the market buying and selling because the market has become reliant on these high frequency traders to buy and sell stocks whenever anybody wants to trade. And when they all went away, what that meant was you had some crazy trades being done. You had, you know, stocks being sold for literally one penny.
- [05:44]
Tim Harford
What actually stopped the flash crash was absurdly simple. The exchange itself, Globex shut down.
- [05:51]
Donald McKenzie
How it stopped was that Globex has got a program built into it called the Stop Logic functionality. And in this case, it stopped the system trading for just five seconds. But that was in fact, enough time to halt the downward spiral. It gave human traders, for example, the chance to just take a quick glance at the rolling news feeds, discover that nothing catastrophic in the wider world seems to have happened, and then to think, well, here perhaps this plunge of prices is a buying opportunity. So the five second pause was just enough to stop things spiraling completely out of control.
- [06:36]
Tim Harford
That's Donald McKenzie, a sociologist at the University of Edinburgh who studies financial markets. Professor McKenzie has been interviewing dozens and dozens of people in the algorithmic trading industry and he divides the flash traders into categories. First, there are algorithms designed not to lose money while executing a trade that's being placed by a human. Then there are algorithms designed simply to make money by finding buyers and sellers with a small margin between them. Third, there are algorithms which find statistical relationships between different shares or bonds. And when the statistical relationship fails to hold even for a moment, they jump in and make a bet that normal service will soon be resumed. Now, there's nothing immoral about these three approaches, but there are more predatory strategies. One is called algo sniffing. Here a super fast computer tries to find other computers going about their everyday business of buying or selling shares and figures out what they're going to do and when. The algo sniffer can then get ahead of the game and exploit the slower computer. And of course you can have algo sniffer sniffers and algo sniffer sniffer sniffers in a high frequency arms race. No wonder speed can be so important. Andrew Haldane, executive Director for Financial stability at the bank of England, is increasingly interested in how high frequency trading works and what the future might hold.
- [07:58]
Andrew Haldane
What we have out there now is this complex array of multiple mutating interacting machines, algorithms. The half life of an algorithm might be as little as a few weeks. So this is a system that's constantly evolving, that's traveling at ever higher velocities, and it's just difficult to know what will pop out next. And that's not an accident waiting to happen, that's an accident that has been happening with increasing frequency over the last few years. We see, you know, mini flash crashes all over the place. You know, academics have spotted thousands of them. And that is telling us something, that's something to concern us because it's a signal that this is a system that we don't really get, we can't really peer into. It's the blackest of boxes actually. We shouldn't wait for the equivalent of the space shuttle disaster before remedying the situation. We already have enough lights on the dashboard flashing red to want to do something differently.
- [09:07]
Tim Harford
Presumably you're in a position to have a lot of influence. You're in charge of financial stability at the bank of England. What would you recommend?
- [09:14]
Andrew Haldane
There's at least two or three relatively simple things that could be done. I think one of the most straightforward would be on occasions when things are spiraling out of control, we ought to be able to stop the clock. That timeout period will allow prices to be reset, algorithms to be adjusted, perhaps even turned off, and the market to restore some semblance of stability. So circuit breakers, when spiralling is happening, can help prevent a bad situation becoming calamitous.
- [09:44]
Tim Harford
I'm slightly surprised at the idea that
- [09:46]
Andrew Haldane
they don't already have these in the United States. After flash crash they strengthened the circuit breakers they had. The events of the last week have demonstrated that the circuit breakers they have may need to be thought about a little bit more rigorously than they have been. And within Europe we haven't quite got the equivalent of those circuit breakers in most markets at the moment. So I think there's work there still to be done.
- [10:13]
Tim Harford
So what are the other two?
- [10:14]
Andrew Haldane
Another feature of the high frequency trading community is that they send in to the trading systems loads and loads and loads of messages, many of which they subsequently then cancel. This sending of multiple messages can have really negative side effects for the performance of these systems. It clogs them up. So a the equivalent of a congestion charge for financial markets might help lower volumes and make this a freer highway for everyone to trade on. This would be trying to rule out the situations where a high frequency trader sends in a message and then cancels it before they ever execute. This is different than a transactions tap.
- [10:57]
Tim Harford
It's a non transactions tap.
- [10:58]
Andrew Haldane
It's a non transaction tap. Exactly, exactly. And the third thing, in the United States in 2010, during this so called flash crash, high frequency market makers proved to be rather fair weather friends. In other words, they stopped making markets when the going got tough. There's a question about whether we ought not to put stricter obligations on people to make two way markets all of the time. Not just in the fair weather, but in the foul Weather as well.
- [11:29]
Tim Harford
Andy Haldane, Executive Director for Financial Stability at the bank of England. The UK's Olympic success seems to have brought the home nations together. Certainly, as an Englishman, I've been cheering the Northern Irish rower Alan Campbell, the Welsh cyclist Geraint Thomas and Scotland's Andy Murray as loudly as anyone. But while the medal table puts all UK successes together, some people have been tempted to peer under the surface. Scotland has been pronounced superior to England per head of population, while Yorkshire has been hailed as the number one county, beating Australia in the medals table. Well, Wesley Stevenson, proud Yorkshireman, is here. Hello, Wes.
- [12:05]
Captain Flack
Hello.
- [12:06]
Tim Harford
You've been reviewing York County's achievements?
- [12:08]
Wesley Stevenson
Aye, that's right. It was the Yorkshire Post that first drew attention to Yorkshire's successes after Alistair Brownlee won gold in the triathlon on Tuesday. They said that competitors from the county have now won five golds, representing almost a quarter of Team GB's total gold haul.
- [12:24]
Tim Harford
Well done, Yorkshire. But something tells me it's not quite as simple as that. I mean, I was born in Kent, I grew up either side of the Peak District and I live in Oxfordshire, so. So, assuming that board games are finally recognised as an Olympic sport, when I go to Rio in 2016, will I count as representing Oxfordshire, Cheshire, Derbyshire or Kent?
- [12:42]
Wesley Stevenson
This is a problem not just because you won't be going to Rio in 2016, but you're from the UK, so you would, in an imaginary world, be competing for the inaccurately named Team gb. But there isn't a Team Scotland or a Team Yorkshire. Well, not yet, anyway. So this makes things tricky. For example, Scotland were trying to claim Sophie Hoskins as their own.
- [13:04]
Tim Harford
Well, she was born in Edinburgh.
- [13:05]
Wesley Stevenson
Well, yes, but she's not Scottish. She was actually brought up in London. And Royal Mail painted a postbox for her in London.
- [13:12]
Tim Harford
Well, they put one for cyclist Laura Trott in Harlow in Essex, because she was born there. And then she complained, saying she's from Cheshunt in Hertfordshire.
- [13:18]
Wesley Stevenson
Yeah, but they painted one in Cheshunt too, and that's a good example of why this thing is tricky.
- [13:24]
Tim Harford
I suppose the golden post boxes are actually a good measure of where athletes actually reckon they're from, because the athlete gets to express a view on where the post box should go.
- [13:32]
Wesley Stevenson
Yes. So we've used the location of golden post boxes to track gold medals. And using the golden post box method, here's the medal tally as of Friday morning, which is when we're recording this. Scotland has six gold medals to England's 33. Wales has three. The Isle of Man has one and the Channel Islands have one. Northern Ireland so far haven't got any.
- [13:55]
Tim Harford
And Yorkshire, are they really ahead of Australia?
- [13:57]
Wesley Stevenson
Yes, and as of Friday morning, they have seven to Australia's six.
- [14:02]
Tim Harford
Now, this assumes every medal winner is a winner in their own right.
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Wesley Stevenson
Yes. Some of the medals were, of course, won in pairs and teams, so if you weight the totals by the number of people in each winning team. So, for example, in rowing, if you give the men's four a quarter of a medal each, Yorkshire slips down to 4.25 gold medals, which is behind Australia's six. And on this basis, England has 19 and a third gold medals, which is still more than the Aussies. Scotland has three and two thirds. Wales has one and a half gold medals, the Channel Islands have a third and the island man a quarter.
- [14:36]
Tim Harford
But if we're being fair, we've got to weight it by population too. England is home to a lot more people than the other home nations.
- [14:42]
Wesley Stevenson
Well, the number of gold medals for every 10 million people in England stands at 3.6. For Scotland, it's almost double at 6.8. And Wales are also ahead of England with 4.9. But competition between England, Scotland and Wales is insignificant compared to the performance of the Isle of Man, which can claim 3.31.3 gold medals for every 10 million people.
- [15:04]
Tim Harford
Now, before the Olympics got underway, we tried to work out the number of medals we think a country would get based on their population and wealth. Charlotte MacDonald's here. How's that going, Charlotte?
- [15:15]
Charlotte MacDonald
It's ticking along nicely, thanks. Next week, we're going to tell you how those predictions have worked out to see which countries have punched below or above their weight. But we've also had a number of emails asking which countries overachieved if you just factor in population. So, as a little taster for next week, I've had a look at the total number of medals which have been won so far. Everyone knows Team GB has been doing well and the UK's medal tally looks more impressive when you consider that for every 10 million in the population, we've got almost eight and a half medals. France has a similar population to us and they've only got four and a half medals per 10 million. But there are 16 other countries which are doing more impressively per head of population. Top of the list is Grenada, which only has one medal, but it also has a tiny population of just 100,000 people. If it had a population of 10 million, it would have the equivalent of 95 and a half medals.
- [16:10]
Tim Harford
OK, that's fine. Although I feel by allowing countries with these very small populations, we're going to get some very odd results. What if you restrict the medal table to countries with, say, more than a million people?
- [16:20]
Charlotte MacDonald
Well, the top countries which fit that are Jamaica, home of Usain bolt, which has 33 medals per 10 million, while New Zealand has 23 medals per 10 million.
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Tim Harford
And what about the big players?
- [16:31]
Charlotte MacDonald
Well, the US, which has won the most medals of any country, doesn't rank as well. If you look at its population, it has roughly five times as many people as Britain, but it has only three medals for every 10 million people. China does even worse on this scale and gets just over half a medal per 10 million people. But of course, some countries with very large populations don't have any medals. Nigeria and Pakistan included.
- [16:57]
Tim Harford
Thank you, Charlotte and Wes. Is Yorkshire the best county?
- [17:00]
Wesley Stevenson
Well, yes.
- [17:00]
Tim Harford
Why do you say that? Well, because it's Yorkshire. Well, from one great county to another, It's time for an update from Trumpetonshire. You may recall that last year I was proud to be elected Treasurer of Color Trumpetonshire County Council, the county made famous by the BBC's 1970s documentaries about Trumpeton, Camberwit Green and Chigley. With Trumptonshire's budget deficit at completely unsustainable levels, I felt that it was my responsibility to introduce a tough package of austerity measures.
- [17:48]
Captain Flack
Trumpeton Fire Station.
- [17:49]
Tim Harford
Hello, this is the Treasurer of Trumpetonshire County Council. Is that Captain Flack?
- [17:54]
Captain Flack
Yes, it is.
- [17:54]
Tim Harford
I'm afraid I have some bad news. Captain Flack, can you please find Dibble?
- [17:58]
Captain Flack
Find the what?
- [18:00]
Tim Harford
Find Dibble? Please find him and tell him he's been made redundant.
- [18:04]
Captain Flack
Oh, dear. Whatever next?
- [18:06]
Tim Harford
I know it's hard to believe, Captain Flack, but this is a fiscal emergency. Cutbacks must be made. We're all in this together, you know. I'm sorry, but please, will you or one of your team find Dibble and sack him?
- [18:18]
Captain Flack
Yes, of course we will. Right away. Right away.
- [18:21]
Tim Harford
I'm sorry to say that Dibble didn't take the news well.
- [18:24]
Captain Flack
If you will step into my. I will go and plaster your for you now, how's that?
- [18:30]
Tim Harford
As you may recall, I agonised about the decision. Not only the human cost, but the risk that the cutbacks might, in the end, prove self defeating. Well, it's time for us to report back on how austerity is working out for Trumpetonshire. I called up Jonathan Portes, director of the National Institute for Economic and Social Research, and asked him how the economy was doing.
- [18:51]
Jonathan Portes
Very Badly, I'm afraid. Not only have we dipped back into a recession, but perhaps more seriously, the economy of Trondentshire hasn't grown at all for the last couple of years. Although you clearly need to balance your budget over the medium term. You made the cuts at the wrong time. That was the big mistake. We here at the National Institute recently did a bit of analysis on what would have happened if Trump and Shear had postponed the spending cuts and tax rises for three years, still doing exactly the same thing, but just waiting a few years until circumstances were better. And what we found was that that would have led to significantly higher growth and lower unemployment over the medium term.
- [19:32]
Tim Harford
For Trumpetonshire, it's been very disappointing and a lot of people say the buck stops with me. I'm the treasurer, of course, and I introduced the austerity programme. But is it really my fault? I also spoke to Chris Giles, the economics editor of the Financial Times.
- [19:47]
Chris Giles
You, as treasurer, do have to ask quite a lot of questions of yourselves because you did put in some big austerity measures and that was certainly going to slow the Trumpet show economy down. But lots of other things have been happening too. The Eurozone, which we all trade with, has been having a terrible time, and that's our biggest trading partner. And then lots of other things happened in the rest of the world. So commodity prices rose, oil prices rose. All these things we didn't expect, we didn't know were going to happen. And so I don't think, I think very strongly, you cannot say it was your fault. It might have been your fault, but there is no firm evidence to say it was your fault.
- [20:26]
Tim Harford
It's good to know that I have plausible deniability at least. I mean, austerity measures will slow the economy, but they're not the whole story. Those commodity prices that Chris Giles mentioned really do have an impact. Good morning, Windy Miller. It's Tim Harford here. I've just taken a call from Mr. Cresswell.
- [20:46]
Captain Flack
Ah, the biscuit factory. Nothing wrong, I hope.
- [20:49]
Tim Harford
Well, Creswell says your flour prices have gone through the roof and he's had to put his biscuit prices up and now biscuit sales are way down.
- [20:56]
Captain Flack
Oh, dear.
- [20:57]
Tim Harford
I know the price of grain has never been higher, but isn't there something you can do?
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Captain Flack
Any ideas?
- [21:02]
Tim Harford
Well, is there a cheaper farm you could get your grain from?
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Captain Flack
There certainly isn't one in Trumpton.
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Tim Harford
Could you absorb some of the grain costs?
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Captain Flack
There is one way of doing it.
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Tim Harford
Oh, no, Windy, I don't want you to start putting sawdust in the flour sacks again. I guess I'll just have to tell Cresswell to look at his other costs.
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Captain Flack
Good idea. And now, if you'll excuse me, I've got a lot of work to do.
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Tim Harford
I can't deny that the economic picture is challenging, but I think I've been vindicated in at least one way.
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Jonathan Portes
The number of jobs in the public sector has shrunk considerably. The number of jobs in the private sector in Trumpordshire has actually gone up quite considerably over the last two years. So, in terms of the labour market, the private sector has indeed picked up the slack.
- [21:40]
Tim Harford
So there we have it. The one bright spot is that given how badly the economy has been doing, there are more jobs available than we might think. Not all of them are particularly attractive jobs, of course. And speaking of which, I've been putting this off for too long. It's time to give Dibble a call and find out how his career in the private sector has been going. There have been some unsettling rumours.
- [22:05]
Captain Flack
Hello?
- [22:06]
Tim Harford
Hello, Dibble, it's Tim Harford here. Have you got a moment?
- [22:10]
Captain Flack
I'm posing. What? I'm posing.
- [22:13]
Tim Harford
You're not modelling those dirty pictures again, are you?
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Captain Flack
I sell them to anybody who wants them.
- [22:17]
Tim Harford
Dibble, please.
- [22:18]
Captain Flack
Soon. Have it out just in front of my mirror.
- [22:20]
Tim Harford
Can't this wait? Who's helping you? Where did you get the camera?
- [22:22]
Captain Flack
Chippy Minton. He seems to have everything.
- [22:24]
Tim Harford
Well, you should both be ashamed of yourselves. You're listening to More or Less in association with the Open University and I'm Tim Harford, the part time treasurer of Trumpetonshire County Council. Now, Trumpetonshire has at least one geek in a position of power. Me. But it's the same true of the United Kingdom. I spoke to Mark Henderson, former science editor at the Times, about his new book, the Geek Manifesto. It's a book with a mission to promote scientific thinking in public life. And I began by asking Mark what he sees as the problem.
- [22:54]
Mark Henderson
In short, there aren't enough geeks in politics. Science has so much potentially to offer to politics, to public policy making, both through the scientific advice that experts can give, but also I think the scientific approach to problem solving is the most powerful tool for generating reliable knowledge that humanity has yet developed.
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Tim Harford
So you say there aren't enough geeks in politics. Quantify that.
- [23:21]
Mark Henderson
Yeah. So there are 650 MPs. Of those, there are 158 who have a background in business. There are 90 who are what you might call professional politicians. There are 86 lawyers and 38 from the media. There is only one professional PhD level scientist in the whole House of Commons. There are another two who have science PhDs, about 20 or 30 who have a science undergraduate degree. But really, even once you start to draw in non scientists who've got some record of engagement with science, it's very difficult to get beyond about 70 names who've shown that.
- [24:01]
Tim Harford
Now, if we imagine 400 MPs had undergraduate qualifications in science and 100 or so of them had actually gone on to practice science, what difference would it make?
- [24:15]
Mark Henderson
I certainly wouldn't want everybody to be a scientist. But what I think you'd get is a situation where ministers realised what they don't know and turned to the tools of science. Randomised controlled trials, for example, are tools that could be used much more in, for example, education policy. Let's take phonics as an example. Passing stand. We don't really know whether phonics is a more effective method of teaching kids to read, but it would be very easy to find out by setting up a randomised controlled trial.
- [24:47]
Tim Harford
I recently saw David Torgerson of the Trials unit at York University give a talk on this subject and people are very happy to give him half a million pounds to figure out whether Veruca treatments work. They don't seem to have a lot of interest in applying the scientific methods to these more social or policy problems.
- [25:05]
Mark Henderson
That's correct. I think politicians tend to be worried there about two things. First of all, they've got this rather strange idea that it's unethical to experiment with something like, say, children's education. Actually, I would argue that it's unethical not to. And as things stand, we're absolutely experimenting with the way we teach kids because we don't really know what's effective and what isn't. The second thing, of course, is that many politicians and the civil servants who help them out are often, I think, rather reluctant to put their ideological policies to the test because you might discover it didn't work.
- [25:41]
Tim Harford
I was quite struck reading your book, that you have this nice little taxonomy of different ways in which politicians and the political process abuses evidence. I wondered if you could just summarise that for us.
- [25:52]
Mark Henderson
So you've got evidence shopping. This is where evidence perhaps has been considered in the round. But the minister goes in and picks out the bit that his policy looks good in. Doesn't make the policy's bum look big. There's fixing the evidence. That's where you don't like the evidence that you're getting. So you change the people you're getting the evidence from. There's clairvoyant evidence, which is best summed up by an advisor to Patricia Hewitt, who told a newspaper some time ago when she was Health Secretary, that home births are safe and we will commission research to show that they are safe. Really a case of putting the cart before the horse. There's also a secret evidence. Damian Green, the Immigration Minister, went to the House of Commons to claim that there was no queuing crisis at Heathrow airport borders, using statistics that had not been published so nobody could challenge them. And then finally, you've got mishandling the evidence. That's when there is rather good evidence about one thing that's then used to justify something completely different. Just because the research shows one thing in one circumstance doesn't necessarily mean it's going to be applicable to a different but related policy.
- [27:02]
Tim Harford
Mark Henderson, author of the Geek Manifesto. And that's all we've got time for this week. Next week is the last program in the current series, but it's not too late to send in your ideas and perhaps your questions for TVs Yan Wong via more or less@BBC.co.uk our spiffing website is@BBC.co.uk moreorless or perhaps you could just relax and hum a little tune to pass the time until next week. Goodbye.
- [27:28]
Charlotte MacDonald
More or Less was presented by Tim Harford, the Financial Times undercover economist. The producer was Richard Knight and the editor was Richard Varden. More or Less is made in association with the Open University.