nickles

> So your business collapses when you have to temporarily pay $236 for something that normally costs $27?

No, think of it as paying $236,000 for something that normally costs $27,000.

You can think of this business as providing banking services to large corporations, who aren't able to simply put money in a savings account at their local credit union.

It's doesn't collapse in the short run, but it can harm the ability of these corporations to access their funds. Short term financing disruptions can have major impacts across all markets.

Show me a business where a sudden 10x increase in costs isn't painful...

> Discount rate is, by design, quite a bit higher than the fed funds rate, and is only tapped for credit in emergencies.

That's right. Open market operations were traditionally used to target the fed funds rate. The discount window does serve as the upper bound though in extreme cases. Typically, reserves would be loaned overnight between banks on the fed funds market. This market has been decimated by the floor system.

> IOER, by design, provides just a floor.

In theory, yes. It has also acted as a ceiling. Not all institutions with access to Fed's balance sheet are able to receive IOER (e.g. GSE's). These entities loan the money to banks overnight at a rate below IOER. The banks then earn IOER on that money. This arbitrage can lead to an effective fed funds rate below IOER.

> Well, I guess it would be high on a typical loan. On an overnight loan, the difference between 9% APR and 1% APR is the difference between paying 0.0236% in interest for the loan and paying and 0.00273%

As a rates trader, your positions are denominated in the millions of dollars. Some back of the envelope math:

1mm of 10y treasuries (repo'd at EOD) is roughly $1k of risk (dv01 -- if rates move by 1bp, your pnl fluctuates by $1k). To finance that position, you're paying $236 at 9% vs $27 at 1%.

Now say you've got 1mm of 2y treasuries. That's roughly $0.2k dv01. Unless 2y rates move 1.25bp overnight, you're losing money just financing the position.

In short, there's a massive difference between paying 2.3bps and paying 0.27bps.

> I mean how else the current 2.00-2.25% rate is forced onto the financial system?

Traditionally, Fed used open market operations to target the fed funds rate. This entailed either buying/selling treasuries or conducting repo operations (as was done here). This was a corridor system, as banks could earn no less than 0% interest keeping reserves on the Fed's balance sheet (no negative interest) and could finance at a cost no higher than the discount rate in which banks borrowed directly from the Fed's discount window (this, however, sent a very negative signal to the market).

For the past decade, the Fed has relied on interest on excess reserves (IOER) to target the fed funds rate, a policy known as a floor system. Here, banks earn a given interest rate on reserves kept on the fed's balance sheet. The floor system theoretically ensures short term rates do not drop below the IOER rate (although it is not always the case). This does not entail engaging in open market operations.

> Why else would anyone even care about what the FED rate is?

All dollar interest rates are impacted in one way or another by the fed funds rate. The strength of the dollar is also impacted by the fed funds rate, as it may become more or less attractive to keep balances in the US. The floor system currently employed makes it less attractive for banks to use excess reserves to make loans, as the risk free rate (on the fed balance sheet) is greater. This diminishes the money multiplier effect that banks have.

Additionally, some foreign institutions are able to keep money on the fed's balance sheet, helping them avoid negative interest rates. Again, this disincentivizes them from making loans and also undermines monetary policy implemented by their local central banks. Finally, some currencies have a USD peg (e.g. HKD). These pegs effectively import Federal Reserve monetary policy (to help mitigate the risk of currency crises) which affects the local economies.

> considerably less sensationalized

To be clear, a GC repo at 7% to 9% is outrageously high. Lack of short term financing can have severe repercussions that ripple throughout the financial system.

> When you send a letter it does not belong to the post office while in transit.

You only have an expectation of privacy of the contents of the letter. You have no such expectation of anything on the envelope itself (e.g. sender/receiver address). The government contends that it only collects analogous metadata in transit, not the contents of the communication itself (although this is debatable).

The constitution does not explicitly enumerate a right to privacy.

Griswold v. Connecticut (1965) explicitly established the right to privacy. Justice Douglas’ opinion states that such a right exists within the “penumbras” and “emanations” of the constitution. As there is no explicitly enumerated right, strict constructionists may oppose this interpretation.

Katz v. United States (1967) established a two part test to determine whether an individual has a reasonable expectation of privacy in a given circumstance:

"first that a person have exhibited an actual (subjective) expectation of privacy and, second, that the expectation be one that society is prepared to recognize as 'reasonable.'"

Smith v. Maryland (1979) established the basis for the government’s claim that the data collection program is permitted. The case focuses on whether an individual has an expectation of privacy for metadata they willingly give up to a third party. The court found that a warrant is not required to collect such information.

My understanding of your comments is influenced strongly by this statement:

> Thus, any analysis that averages across market participants' P&L will conclude that futures trading is unprofitable[0], except for the market makers. This is true regardless of the savvy of market participants.

By virtue of offering various services to market participants, savvy market operators can consistently generate profit. In the context of this article, I took your statement to mean that any given participant cannot consistently do so.

At the same time, the end users entering into these transactions understand they will be paying these fees, just as a firm expects to pay a fee to borrow money from a bank. If we describe this process as a zero-sum game, it gives the impression that trading is a speculative casino, reallocating money to participants at random (the misconception). If we describe it instead as negative-sum, where participants are paying/paid for services, it better reflects the economic value of the transactions.

> ignoring/averaging across trades with non-daytraders

I didn't see this bit for some reason when originally responding to your comment. Had I, my comment would have been stated differently.

> Isn't that example nearly zero-sum (ignoring the spread)?

But ignoring the spread is incorrect, and nearly zero sum is not the same as zero-sum. The spread is the fee that market makers earn for a service they provide. You're also not considering other participants. The price changes you're talking about could be driven entirely by end users, or they could be driven by speculators, arbitrageurs, and others who are providing separate services (price discovery, liquidity, balance sheet, arbitrage, etc.) and are also capturing some of the value.

> futures trading is unprofitable[0], except for the market makers

If you are explicitly excluding participants who profit by providing financial services to markets, then you are begging the question.

> Obviously, it doesn't capture non-cash considerations. Starbucks and the farmer both might be thrilled with reduced risk.

Transferring risk can definitely provide economic value (insurance policies exist for this reason), but it should be noted that there are other advantages as well. These futures transactions can help Starbucks manage inventory without needing to maintain large stockpiles of perishable or reduce the volatility of prices charged to consumers.

Suppose a farmer wants to lock in the price of milk produced the farmer's dairy. The farmer wants to sell futures and sees a market of 18.30 / 18.50. These prices are probably being shown by a market maker. The farmer sells the futures to the market maker at 18.30. A few minutes later, Starbucks would like to buy the same contracts, to lock in its costs for the next month. Starbucks buys at 18.50.

These two participants have paid the market maker, in total, 0.20 in spread. Here, the spread is the fee the market maker charges for facilitating liquidity. At this point, the net sum between the three participants is still 0. However, we also need to factor in the fees charged by the exchange, any taxes that may be charged on the transaction (for example the SEC fee in equities), clearing fees, and funding costs.

On the whole, the transaction between the three participants was negative sum. However, the market maker is running a business by reflecting those costs, and the risk premium, in the spread. Even though this transaction is negative sum, it, presumably, still provides economic value to the farmer and Starbucks.

> So for an outsider, I say it's pure speculation.

And you assert this on what basis? There's enough that's been published to get some broad idea of what happens within the firm.

> And I speculate that their outsized gains are due to market manipulation, front running, or other insider activities (as in, illegal/unfair).

If they were engaging in illegal activities, it's very likely the firm, which is undoubtedly scrutinized by regulators, any such activities would have been discovered.

> No one is smart enough; no algorithm or model is future-proof; nobody gets returns like this unless they define the scenarios themselves.

RenTech constantly updates its algorithms. Alpha decay is a well known phenomenon. The firm utilizes sophisticated risk management techniques in order to avoid drawdowns, in all likelihood. Assuming this is the case, they're able to more effectively compound returns while simultaneously levering positions. Here's an example of a risk parity strategy [0], which may help explain how risk management works.

[0] https://towardsdatascience.com/ray-dalio-etf-900edfe64b05?_b...

> Renaissance Technologies did not use algorithms to beat the market...

This is false. RenTec generated outsized returns for a decade prior to entering into the derivatives with Barclays and DB beginning in 2000.

> the bulk of their profits beyond what would have been made just investing in an index fund

This is also false. For example, RenTec generated 99% return in 2000 net of fees, while the S&P 500 lost ~8%.

This is a common misconception. Futures contracts are very often used for nonspeculative purposes (e.g. Starbucks locking in prices for buying milk or farmers locking in prices to sell wheat). This is a form of insurance. While the end users are ultimately may net with each other, the intermediaries who take risk matching these parties charge a fee (the spread) for doing so.

Why can't the end users trade with each other directly and avoid such fees then? Often they are not in the market at the same time or want to trade different quantities, relying on the intermediaries to resolve these problems.

> An illiquid asset cannot be liquidated without slippage - that's why there's a liquidity premium.

We agree here.

> Those are the same thing.

We disagree here.

"In economics, a liquidity premium is the explanation for a difference between two types of financial securities (e.g. stocks), that have all the same qualities except liquidity." [0]

"With regard to futures contracts as well as other financial instruments, slippage is the difference between where the computer signaled the entry and exit for a trade and where actual clients, with actual money, entered and exited the market using the computer’s signals."

The concepts are related, but not identical.

[0] https://en.wikipedia.org/wiki/Liquidity_premium

[1] https://en.wikipedia.org/wiki/Slippage_%28finance%29

> As the manager of the ETF you could allow it to float freely in which case it could trade at a premium or discount to NAV.

ETFs are securities that trade freely. They may be open ended or closed ended, but the price of both is determined independent of NAV.

> But it wouldn't move too far because this would attract arbitrageurs who would trade the ETF against the individual stocks and bring it back in line.

This is the creation/redemption mechanism and is actually responsible for keeping the market cap of open ended ETFs in line with the NAV. Closed ended funds don't have such a mechanism, so the cap may diverge from the NAV.

> Another way you could do this is hold a pile of units in reserve and actively sell into the market when the ETF trades at a premium and buy when it trades at a discount. This approach would not result in any volume in the individual stocks (except for re-balancing from time to time).

This defeats the tax advantages of the ETF structure. Instead of having the manager buy and sell names, APs (authorized particpants) do the trading, hedging with units of the ETF. They then do an in-kind exchange with the fund manager at the end of the day. If the AP has net purchased the underlying basket, they will exchange the basket for shares of the ETF (creation). If the AP is net short the basket, they will exchange their offsetting ETFs for the underlying basket (redemption). This should affect the volume of the constituents.

Some ETFs do not require creation and redemption to be done with the full basket of index members. These tend to be based on names that trade less frequently. In this case the manager allows a subset of the index to be exchanged. In this case, the creation/redemption mechanism will not necessarily affect the volumes of all members of the index. Note that this can could cause tracking error.

Managers will rebalance when the index the fund is based on changes. For example, bond ETFs generally rebalance once a month. Market cap weighted ETFs (as opposed to, for example, equal weighted ETFs) are easier for managers as well, because the fund doesn't need active rebalancing.

> Any reasonably competent quant can calculate a liquidity premium and factor it into their ETF arbitrage strategy

Liquidity premium isn't relevant here. The concept of the liquidity premium explains the differences in prices of otherwise identical securities as a function of their liquidity. What you're thinking of is called slippage, the difference between your target price and realized price for a trade.

When running an ETF arbitrage strategy, your concern is not explaining the price of the relevant securities. However, you do care whether you can enter and exit positions profitably. Slippage models are highly nontrivial.

> ETFs that trade illiquid assets should simply trade at a discount relative to their "last traded price" NAV

Many closed ended funds do in fact trade at a discount to their NAV.

> A second concern is the collateral effects of a bubble bursting: the inflated assets are tied into many other assets/instruments, and untangling the mess caused by a rapid bubble burst may cause a financial crisis.

This is really the main concern. The indexes these funds are based on include names that don't have any liquidity. This means 1) the price of the security is less likely to reflect its intrinsic value; 2) attempting to unwind any position may cause substantial issues.

Let's expand on 2) by examining an ETF (say SPY). This ETF is a fund that is meant to track the value of the S&P 500 (a weighted basket of securities). The value doesn't drift too far from the value of the underlying securities thanks to the creation and redemption mechanism, which allows for arbitraging the ETF against the underlying basket of securities. If constituents are illiquid, it becomes more difficult to perform this arbitrage, and the NAV of the ETF diverges from the market cap of the ETF.

This is a bigger issue with instruments like HYG or JNK, which track high yield (AKA junk) bonds. Many of these bonds are highly illiquid, and trading them directly could significantly impact their prices. Instead, many funds trade the ETFs, relying on the basket of high yield bonds as a proxy. These ETFs may then have greater liquidity than the entire underlying basket. This situation clearly undermines price discovery of the underlyings, as the implication is that investors don't particularly care about which names they have exposure to within the basket.

These concerns aren't merely theoretical. In August, 2015 there was a flash crash in which the values of a number of ETFs significantly diverged from their NAVs.

> red light cameras however, they were shown to actually cause more accidents

Adding to this, the issue was not directly with the cameras themselves but with the length of the yellow light. In order to increase revenue from traffic cameras, municipalities were reducing the amount of time the traffic light was yellow. However, reducing the length of the yellow light also leads to an increase in car crashes.

[0] https://www.motorists.org/blog/6-cities-that-were-caught-sho...

[1] https://phys.org/news/2012-09-length-yellow-caution-traffic-...

> As I have told my patients and medical students, a surgical infection is a life altering event. There is a good chance that you will never be the same after experiencing it.

What is it that makes such an infection is so impactful? Is there physical damage that persists, psychological trauma due to the experience, or some other factor?

Edit: Read the comments prior to reading the article.

> When Harrison awoke from that surgery, he imagined his nightmare was over. But in reality, it had just begun. Since then, what began as a simple operation has turned into a lengthy struggle that left him for months at a time dependent on hired nurses, unable to dress himself, take a shower, or work, and afraid for his life.

> I just wonder where they get the cash in the meantime. >$1B/year burn rate

They're raising up to $6B in a debt offering.

> They "loaned" out $700B to a select few companies, many who were former employers of cabinet and treasury members. Only $4 out of $700 billion ended up going to help home owners directly, the other $696B went to Wall St

This is false. As of Feb 2019, the government earned $107 billion in profit on TARP. Your source is 6 years old and out of date.

Additionally, funds were not loaned exclusively to financial companies. Automobile companies received ~$60B in TARP, which has netted a loss of approximately $12B for taxpayers.

[0] https://projects.propublica.org/bailout

[1] https://projects.propublica.org/bailout/list/index

> Derivative contracts like perpetual futures are inherently better than old-school futures.

Can you elaborate on this? Physically settled futures are important to producers and consumers of commodities. I can imagine that replacing these with a cash settled contract might increase spot volatility.

> The first point violates your explicit 'ceteris paribus' assumption.

Not necessarily. The decision of individuals to allocate in a particular manner can be thought of as a continuous function (IIRC this is called an indifference curve). In this case, the individual’s preferences (given by this curve) remain constant. As the relative prices of goods (currency being one) adjust, the composition of the preferred basket also adjusts. This is consistent with ceteris paribus. If an individual’s preferences were assumed to change, then the assumption would be violated.

> A devaluation today doesn't on its own provide information about future moves.

In general terms, people cite ‘momentum’ as a trading factor. A change in price today may continue tomorrow. If you consider the feedback loops that occur as something appreciates or depreciates, it may explain why momentum can be observed.

In more concrete terms, China has very deliberately kept its currency from devaluing below this level against the dollar for quite some time. The country has attempted to undermine short positions against the currency by doing things like adjusting fixings and overnight rates massively against the shorts for a brief period. Given that China is now allowing this devaluation to occur, it signals that the nation has a new exchange target in mind, presumably lower than the previous one.

> They are taxed as capital gains for recipients.

No, ordinary dividends are taxed as income.

This is where the analogy certainly gets stretched. The network and the registers are really both the exchange here.

Equity trading only happens at a small number of venues (inclusive of OTC, dark pools, and internalizers probably not more than in the hundreds, potentially low thousands). These would be the registers. In order to buy a stock, either you choose to ‘cut the line’ by paying the price someone tells you they are willing to sell at, or you wait for someone to sell at the price you announce you’re willing to pay. These transactions are processed serially (albeit quickly) at the exchange.

Allowing trades only once a minute (or some other period) is akin to allowing the credit card network to clear once a minute. Trades cannot occur more frequently, so the ability to enter and exit positions on demand is diminished. Obviously someone who wants to trade immediately for one reason or another is harmed by having to wait. Additionally, everyone (even those not trading) is harmed by not having up to date valuations for the positions they hold.

> I don’t think I ever had to do two transactions in a minute.

If the network only clears once a minute, you need to wait at least a minute for each person ahead of you in line at the store. Alternatively, you need to be willing to pay more to cut them in line.

> Pretty much everything at sub-second resolution is pointless.

Should your credit card network only allow transactions once a minute? Price data comes from transactions (trades) as they occur. There’s more utility derived from a market where people can transact on demand.

> yet the largest markets in the world are closed 2/3rd of the day

Not correct. Equity markets are far from the largest in the world, yet it’s possible to trade 24 hours a day, 5 days a week (actually thanks to HFT). Currency markets operate around the clock. Rates markets operate ~22-23 hours a day, 5 days a week.

> The fact that most markets are closed on all weekends plus over 10 holidays per year

Markets exist for their participants. Corporations looking to hedge commodities exposure, trade currencies, manage interest rate risk, or buy/sell stock have employees who work during business hours. That doesn’t diminish the need for real-time pricing. And most holidays are domestic, so major markets still operate internationally.

> That is a pointless comparison.

I was highlighting the difference between online advertising and financial markets. They operate at different scales.

> That $107b was all revenue for somebody (Google, Facebook, etc), while the $145b was just the nominal value of shares traded.

These are cash instruments, not derivatives, so that is indeed $145b of cash changing hands each day.

Adding to this, HFT is a product of rule 612 of Reg NMS (the sub-penny rule). Markets are not allowed to show quotes in increments of less than $0.01 for most names. Since traders cannot compete on price, they have been forced to compete exclusively on speed.

The impact of such regulation was tested by the SEC recently with the 'tick size' program. Instead of reducing the minimum increment, some names saw it increased to $0.05. The hope was to increase liquidity while decreasing volatility in these names. In fact, those names experienced decreased liquidity with no decrease in volatility.

HFT is a result of regulation.

[0] https://www.sec.gov/divisions/marketreg/subpenny612faq.htm

[1] https://www.benzinga.com/general/education/18/04/11517027/th...

> Nanosecond pricing updates might be a little more than anybody needs

That may be the case, but the 'problem' is caused because market makers aren't legally allowed to offer better prices than they might otherwise desire. It doesn't seem prudent to layer flawed regulation on top of flawed regulation when there's a simpler solution.

> Remember the market is ultimately about allocating capital between businesses and governments

Equity markets have many purposes. Companies indeed raise money by issuing equity (IPOs and secondaries), and there are cases where governments participate for monetary purposes (BoJ & SNB's equity purchases). But markets also allow:

* employees to sell equity compensation they've received whenever they want

* retail investors to diversify their asset allocations

* sovereign wealth funds, pension funds, endowments, and other real money sources return on their portfolios

* for hedging financial risks

* companies to return money to shareholders in the form of buy backs

> for economic purposes it doesn't need to run any faster than they can

All the previously mentioned functions happen all the time, and the marks (prices) generated from this activity helps inform many other economic functions. Everything from central bank policy to insurance pricing depends on well functioning markets. In light of this, why should we make things less efficient by slowing things down and driving the cost up?