Faster, Knight Capital! Kill! Kill! • Does Anybody Here Have a Tax Plan?

Another high-speed trading debacle

The financial markets in the U.S. are the most sophisticated in the world, yet they can unaccountably spin out of control at a moment’s notice. The latest case involves Knight Capital Group, a securities-trading company laid low by one of its inadequately tested computer-trading programs. In less than an hour on Aug. 1, the program entered incorrect bids for about 150 stocks into the interconnected electronic marketplace. Computer programs at other firms sniffed out the errors and traded against Knight. By the end of the day, the company was out $440 million, forcing it to seek outside financing to survive.

By now, it’s pretty clear that computer-driven trading is a major source of volatility. In the so-called flash crash of May 2010, the Dow Jones industrial average shed almost 1,000 points in less than an hour, only to bounce back just as fast.

In March of this year, Bats Global Markets had to withdraw its initial public offering after its system froze, forcing a halt in shares of Apple. Two months later, Facebook couldn’t trade on time in its first day as a public company because of hang-ups in a Nasdaq computer.

The pursuit of speed is an obsession among trading firms. They can profit by taking advantage of minuscule discrepancies in prices that might exist for a few microseconds or by getting a sneak peek at orders before they are executed. Markets now believe that “if something is faster, then by definition it’s better,” says Duncan Niederauer, chief executive officer of NYSE Euronext, which owns the New York Stock Exchange. “We are understanding that speed is not always better.” Amen.

What we can do, at a minimum, is ensure that monitoring systems keep up with the traders’ algorithms. The Securities and Exchange Commission last month took a half-step by requiring markets to build a $4.1 billion system that can generate audit trails of all transactions. The trouble with this system is that the industry insisted trading data not be available until the next day, which might not help regulators who are called upon the instant a market blows up. Nor is it clear that the system will be able to pinpoint the identity of every party in a transaction.

The SEC might need to consider whether more work is needed on market circuit breakers, a device introduced after the 1987 market crash that temporarily stops trading when an individual stock or an entire market behaves erratically. New rules, scheduled to take full effect next August, set lower thresholds for triggering a trading halt. One idea the SEC might consider is applying circuit breakers to specific firms that issue an excessive number of trade orders.

Market apologists have said Knight’s errant trades caused no harm to anyone other than Knight and its shareholders, who saw the value of their investment shrink by about $600 million in a few hours. Yet who can be so certain the next bug-infested program won’t inflict much more damage?

Two candidates, no tax plan

U.S. presidential elections often produce half-baked proposals. The campaign websites of President Barack Obama and Republican rival Mitt Romney are loaded with 10-point plans to reform everything from education and Social Security to energy policy.

But not their tax plans. Both offer the vaguest of nostrums for the most important issues of our day: What size government do we want? How will we pay for it? And how should the burden be fairly distributed?

Romney says he would reduce or eliminate the taxes most of us currently pay. The 2001 and 2003 tax cuts adopted under President George W. Bush? Extend them all. Individual income-tax rates? Reduce them by one-fifth across the board. Dividends and capital-gains taxes? Eliminate them for most taxpayers and keep the current low rates for those with high incomes. While he’s at it, the former Massachusetts governor would end the estate tax, repeal the alternative minimum tax, and ditch the higher tax rates enacted with Obama’s health-care-reform legislation. Here’s the cherry on top: Romney says he would offset the huge revenue losses dollar-for-dollar and still keep the tax code’s progressivity.

If it sounds too good to be true, that’s because it is. Romney hasn’t said how he would accomplish all of this and not worsen the deficit or make the tax code less progressive — probably because it’s mathematically impossible.

Obama also has a tax plan, and it’s almost as sketchy. It can be summed up as “soak the rich.” In keeping with his pledge not to increase taxes on the middle class, Obama would extend the Bush tax cuts only on income up to $250,000 for married couples. He would increase the top tax rate to 39.6 percent from 35 percent and put an end to tax breaks for hedge fund and private equity managers. Most famously, the president proposes a Buffett Rule, named after investor Warren Buffett, which would require Americans earning more than $1 million to pay an unspecified minimum tax rate.

The millionaire’s tax would affect fewer than 450,000 people. Based on 2009 figures from the Internal Revenue Service, even doubling the tax rate on the richest of the rich would bring in only about $190 billion a year, far short of the $4 trillion over 10 years that most economists conclude is needed to keep the national debt sustainable.

Just as Romney must shed his pie-in-the-sky promises, Obama needs to come clean with middle-class Americans by telling them their taxes, now at record-low rates, will need to be raised.

To read Ezra Klein on Washington’s favorite tax idea and Noah Feldman on badminton and politics, go to: Bloomberg.com/view

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