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Op-Ed Wed Jul 15 2015

Financial Transaction Tax Could Save the State -- and Clean Up the Exchanges

trading screenBy Curtis Black

A lot of taxes are being proposed — sales taxes, property taxes, income taxes — as the state's budget stalemate grinds on and the city's financial crisis metastasizes.

But the powers that be have taken one tax off the table, and it's one that would target the very wealthy — the only ones benefiting from economic growth in recent decades: a financial transaction tax.

A small tax on trades on Chicago's futures exchanges [PDF] could raise billions of dollars, and traditional traders wouldn't even notice it, proponents say in a new report.

"Is a farmer or a pension fund manager going to walk away from a $50,000 contract because of a fee that's the price of a cup of coffee?" asks Ron Baiman of the Chicago Political Economy Group, which has advocated for an FTT for several years.

The group that would feel the pain would be high-frequency traders, who use computer algorithms to do hundreds of trades in a fraction of a second, inserting themselves between buyer and seller in order to extract a tiny profit, sometimes using fake orders to drive prices up or down to their advantage. They often make less than $1 on a deal, but they make up for it with massive volume.

Some use the term "high-frequency trading" as a synonym for computerized trading, but CPEG is talking about a significant subset of traders, which they characterize as "rogue gamblers who are engaged in rigged and illegal trading strategies to enrich themselves at the expense of non-HFT traders."

"On balance HFT firms take rather than provide liquidity" (which is the ability of an investor to buy or sell in a market at a desired price) and their activity "is fundamentally detrimental to the broader economy," according to the CPEG report.

As a paper from business professors at the University of Chicago puts it, high-frequency trading produces "arbitrage rents" that "harm liquidity provision." [PDF]

And, Baiman says, if a financial transaction tax ended up suppressing high-frequency trading, regular traders could well come out ahead. The small fee would be more than offset by eliminating the losses they now experience to high-frequency traders, which amount to many billions of dollars.

But the exchanges seem to be committed to protecting the high-speed guys — and the exchanges' own profits from the transaction and high-speed data access fees the traders pay — at the expense of their traditional customers.

CPEG has proposed a fee of $1 on agricultural futures contracts (which average about $73,000 in value) and $2 on other contracts (which average $335,000) at the Chicago Mercantile Exchange, Chicago Board of Trade, and Chicago Board of Options Exchange. CME Group owns the Merc and CBOT.

That's about a 0.00038 percent levy on the $937 trillion traded every year on the exchanges, and it would be paid by traders, not the exchanges. Compare that to the 6.25 percent sales tax the state charges for other kinds of purchases.

Levying this minimal fee on the millions of contracts executed in Chicago exchanges every year would raise $10 billion to $12 billion for the state, the group says. (They've also proposed that a portion be set aside for the city's budget.)

That's nearly twice as much as the state's sales tax brings in. "This is an emergency situation for the state and city," said Baiman. "And this is the answer."

Mayor Emanuel, a former CME board member, has rejected the idea, and the Sun-Times has called it a "fairy tale," saying it could drive trading out of Chicago exchanges, and perhaps even drive Chicago exchanges themselves to leave town.

There's a test case for the first supposed danger. In 2009 an upstart exchange called Electronic Liquidity Exchange attempted to compete with CME on interest-rate futures. Their selling point: they charged $1.25 to $2 less in transaction fees for each deal than CME did. That's just what CPEG's tax would cost.

ELX "never got traction," according to Crain's. According to Michael Gorham, director of the Stuart Center for Financial Markets at IIT, that's because traders need liquidity, and that requires lots of buyers and sellers and a high volume of trades. ELX didn't have it, and CME did. [PDF]

There's another possible explanation: The price difference was insignificant to traditional investors, and the high-speed traders who leech off them had to remain where the action was.

In any case, it's pretty good evidence that a $2 fee is not going to drive trading elsewhere.

Would the exchanges move? For CME, that would probably mean dismantling and reconstructing the 428,000-square-foot data center it opened in Aurora just three years ago, where its contracts are executed — and where space is rented out to high-speed traders so they can shave milliseconds off the time they find out about bids and offers, the better to manipulate and exploit them.

This would be a huge expense — and it could be politically costly for the exchanges as well, since the only purpose for the move would be to protect high-speed traders and the exchanges' profits from high-speed transactions which hurt traditional investors.

High-speed trading has come under increasing scrutiny in the past year, with the FBI and federal regulators opening a wide-ranging investigation into the industry — and whether its privileged access to information about prices and orders violates insider-trading laws. In Chicago the U.S. Attorney's office has launched a Securities and Commodities Fraud Section, and since last October two high-speed traders have been indicted for manipulating prices — a practice the Commodity Futures Trading Commission says is the subject of frequent complaints.

There are signs that traditional investors are concerned too, judging by a lawsuit filed by three investors last year charging CME with fraud for promising "real-time price data" to investors while allowing high-speed traders much faster access to price and order information. By letting high-speed traders use inside information to manipulate prices, CME failed in its legal duty to ensure a fair marketplace, according to the lawsuit.

CME has said the lawsuit is without merit. But the larger question is whether the exchanges are doing enough to protect investors from market manipulation by high-frequency traders.

CME's federal regulator, the Commodity Futures Trading Commission, has said CME lacks sufficient enforcement staff. In the case of a high-frequency trader indicted this spring, CME had flagged the trader for questionable activity years ago but failed to take action against him when he ignored warnings. He is charged with taking $40 million in illegal profits over six years.

Earlier this year a major trading firm went to court, complaining that CME had failed to take action in 7,000 instances of price manipulation by high-speed traders that had cost the firm a half-million dollars.

"The self-regulating model that worked back when the exchanges were owned by the traders should be called into question," said R. Tamara de Silva, an attorney representing the investors suing CME for fraud. "Policing against the biggest offenders doing wash trades and spoofing [two common, illegal price-manipulation strategies] -- how can they do it themselves when it's going to affect their bottom line?"

A financial transaction tax could accomplish what regulators can't, said Baiman. "These exchanges are really rotten, they're not cleaning up their act, they have no incentive to do so as long as they're making all this money," he said. "The FTT is a way for the public to come in and say, you've got to have an honest exchange."

But if that's too large a goal for our political leaders (many of whom have gotten large contributions from the state's leading high-frequency trader), he offers a compromise. The tax could be tiered based on holding time. For example, traders holding a contract for less than one minute could be charged 10 cents, with the rate rising as the holding period increases. That would still raise well over $6 billion at a minimum, he estimates. And the exchanges would still have their megaprofits, though at some point down the line, they're still going to have to do a better job of running the markets.

Our public budgets are imploding because our revenue system doesn't keep up with inflation. That's because we disproportionately tax folks at the lower end, whose earnings have fallen behind.

The financial services industry is the most profitable sector of the state's economy. It's not pulling its weight. It's got to share the sacrifice.

And it ought to stop hiding behind high-sounding rhetoric while its raking in profits from unscrupulous activity.


Curtis Black is a Chicago journalist and former editor of Haymarket and Community Media Workshop's Newstips.

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