Taxing High Frequency Trading

A "click tax" on high frequency trading would be a very good idea, if for no other reason than being a controlled experiment.  The Wall Street Journal has a convoluted story about the idea, where it gives space to the conflicted, self-interested apologists for HFT, who are laughable in their special pleading.

The market for large capitalization stocks is very efficient.  If you follow the activities of the Yale University endowment, you can read this opinion in their annual reports on the fund, so I don't think this is a controversial position.  Small capitalization stocks would seem to have less market efficiency, which accounts for the approach of Dimensional Fund Advisors and many other funds who argue for persistent excess returns from small cap investing.

Even here, the question is "How inefficient?"  Also, what's the gain to society versus the cost of narrowing the efficiency, and by how much?  As Lord Adair Turner has pointed out in his writings on lessons from the global meltdown, the whole notion of equilibrium models and mechanistically efficient markets was adopted as a cult religion by market participants, regulators, the Fed, politicians and journalists.  Concepts like VaR and credit default spreads proved to be inadequate and misleading running up to the crisis and beyond.  Efficiency as as a be all and end all is also cultish.

An owner of an HFT firm is quoted in the journal as saying that a transactions tax of 0.01% on high frequency trading would wipe out the business.  There we have it: that's all the value that's being added.  It's not worth it.  The Journal then suggests that HFT is part of the constellation that has made it easier for individuals to trade stocks.  Huh?  How so? It's a ridiculous notion. 

HFT significantly adds to volatility, and volatility is what scares investors and encourages them to "buy high and sell low."  Individual investors are now being told by their brokers that trades are justified by movements in VIX, itself a flawed, circular indicator of market health. 

Let's try the experiment.  Implement the tax.  If the industry goes away, let's see what happens.  Will markets freeze up?  Will spreads widen like the Grand Canyon?  I'll bet that nobody will notice except for the folks pocketing lots of money for an activity that doesn't help investors or our capital markets.