The Ball Player and the Dark Pool

It’s October!  Baseball playoff season!  Which means that in Cashland, it’s time to harvest a fresh crop of those old chestnuts of a complaint: Why is it okay for baseball players to make outrageous salaries, but not okay for the Streeties?  People love this one. Remember my friend who thought 287 = 300?  He said it to me once, and I heard it again this very morning from a radio show caller responding to whether or not it was okay for the government to institute a cap on the top executive salaries at the seven companies which received bailouts (they didn’t think so).

The difference is dark pools. 

Dark pools started getting popular with traders a couple of years ago. As the name suggests, they are trading venues that exist outside traditional exchanges.  They operate via crossing networks, systems that troll around electronically looking for matches between buyers and sellers and then execute those trades, all without ever seeing the light of a public trading floor.  Some, for instance, are set up to automatically execute a trade at the midpoint between the bid and the ask – in other words, if you have a pair of shoes you want to sell for $100 bucks and I’m willing to buy them for $50, the crossing network would execute the trade automatically at $75.  (I would like them to be these shoes, by the way; if I could get these shoes for 75 bucks I’d move into the dark pool like it was Atlantis.)

Dark pools are popular because they allow investors to buy large amounts of stock without letting anyone know they’re doing it, and therefore without impacting stock price.  One way the buy and sell sides find each other – and there are probably more ways than this – is by “indication of interest” messages (remember, these are all electronic and automatic).  Here’s a quotation from a May 2009 post on the awesome Zero Hedge about co-acting director of the SEC's Division of Trading and Markets James Brigagliano announcing that IOI’s were becoming a “concern.”  (Zero Hedge is quoting an article from TradersMagazine.com, which has since been cached.)

"...these automated IOI messages, which usually are executable and for small size, are sent to seek liquidity from other dark pools to increase the original pool's executions. The widespread use of these 'actionable order messages could create the potential for significant private markets to develop that exclude public investors,' Brigagliano said."

In other words, while you and I and other average investors are shopping in the light and doing our best to play by the rules, crossing networks are running around in the shadows waving their IOIs at each other and making below-the-radar trades in dark pools in pretty much the same way black marketeers troll back alleys whispering “Hey buddy, wanna buy a watch?” and opening their coats to flash a slew of hot Rolexes.  The streeters can split descriptive hairs all they want, but from over here the dark pool is nothing more than a black market with a good lawyer.

Which is why the comparison to baseball salaries is completely off base. Yes, star ball players make tons of money.  I’m not even arguing that they deserve that money. But Derek Jeter doesn’t take his money – and he definitely doesn’t take your money -- and disappear behind closed doors writing algorithms designed to disguise how he’s going to play the game.  He stands in the middle of a brightly lit field in full view of tens of thousands of people and does – or doesn’t do – exactly what he is paid for.  When he succeeds we know it, and when he fails we know that too.  There is not a single hidden thing about how baseball players do what they do, unless they’re using performance-enhancing drugs.  And when they get busted doing that they are vilified, their records are stripped, and they are threatened with jail time.  And after all, if that's okay for ball players, why isn't it okay for Wall Street? 


If things go well, maybe it soon will be.