Having been responsible for the biggest flash crashes in recent years, it is no surprise that when it comes to the market's growing structural vulnerabilities, high frequency traders have emerged as the primary authority on how to crash the market in the blink of an eye. Which is perhaps why none other than the Pentagon is seeking advice from HFTs on how hackers could "unleash chaos" in the US financial system.
According to the Wall Street Journal, the Department of Defense’s research arm, the Defense Advanced Research Projects Agency, better known as DARPA, has been consulting with executives at HFT firms and quant hedge funds as well as people from exchanges and other financial companies, over the past year and a half. Officials described the effort as an early-stage pilot project aimed at "identifying market vulnerabilities." The WSJ notes that meeting participants described meetings as informal sessions in which attendees brainstorm about "how hackers might try to bring down U.S. markets, then rank the ideas by feasibility."
Why approach HFTs? Because of all market participants, it is the "high freaks" who, better than anyone, know how to force a market crash at will. The WSJ was a bit more diplomatic:
High-speed traders and quant-fund managers, who use sophisticated computer programs to buy and sell stocks, sometimes in fractions of a second, form the core of the group. Such traders tend to have deep expertise in the inner workings of financial markets and the automated systems that account for huge swaths of trading activity today.
Among the potential scenarios probed by the Pentagon: Hackers could cripple a widely used payroll system; they could inject false information into stock-data feeds, sending trading algorithms out of whack; or they could flood the stock market with fake sell orders and trigger a market crash.
The name of the DOD initiative is the Financial Markets Vulnerabilities Project. Speaking to the WSJ, Darpa officials confirmed the effort, which while unclassified had not been previously reported.
“We started thinking a couple years ago what it would be like if a malicious actor wanted to cause havoc on our financial markets,” said Wade Shen, who researched artificial intelligence at the Massachusetts Institute of Technology before joining Darpa as a program manager in 2014.
The report is the first tangible evidence of what we proposed back in January 2015, when we asked rhetorically if the US is preparing to blame the next market crash on "Russian Spies" and HFTs. We can now add the generalized "hacker" category to this. For those who may not recall, this is one of the exchanges that was contained in the DOJ complaint:
IGOR SPORYSHEV, the defendant, called EVGENY BURYAKOV, a/k/a "Zhenya,"the defendant, and the following conversation, which was intercepted by the FBI, occurred:
EB: Well, I thought about it. I don' t know whether it will work for you but you can ask about ETF. . . . E-T-F. E, exchange.
IS: Yes, got it.
EB: How they are used, the mechanisms of use for destabilization of the markets.
IS: Mechanism - of - use - for - market - stabilization in modern conditions.
EB: For destabilization.
EB: Then you can ask them what they think about limiting the use of trading robots. . . . You can also ask about the potential interest of the participants of the exchange to the products tied to the Russian Federation.
There was more but the general gist was clear: the US was setting the stage for putting the blame for an upcoming market crash on not only Russians but Russian spies who were looking to ETFs and HFTs as a mechanism of market "destabilization."
Fast forward to today when the WSJ reports that as part of its "Financial Markets Vulnerabilities Project", DARPA has met with some of the most prominent names in the high-speed trading business, especially those who have been implicated in the shadier aspects of HFT. They include Jamil Nazarali, senior adviser to Citadel which is responsible for around 20% of daily volume in U.S. stock markets. Additionally, another former Citadelite, Misha Malyshev, and CEO of trading firm Teza Technologies, has “advised Darpa on vulnerabilities within the U.S. financial markets,” Teza’s website said. Manoj Narang, CEO of quant hedge fund Mana Partners - and one of the most vocal defenders of HFT practices - said he had advised Darpa, too.
So what will Russian hackers focus on?
Among potential targets that participants have worried could appeal to hackers given their broad reach are credit-card companies, payment processors and payroll companies such as Automatic Data Processing , Inc., or ADP, which handles the paychecks for one in six U.S. workers, participants said.
Adding a sense of theatrical urgency to the DARPA project, the WSJ artistically notes that Manoj Narang, whom we have written about previously on numerous occasions, said he began taking part in the Darpa meetings as a skeptic, thinking the U.S. stock market was resilient and it was unlikely for attackers to cause anything more than temporary damage. But since then, he has gotten more worried. What has the biggest advocate of HFTs most concerned?
One scenario he fears: a hack of a U.S. exchange in which the attacker sends a wave of fake sell orders to every firm offering to buy shares. That could potentially erase hundreds of billions of dollars of market value as prices drop and firms try to cover losses by selling on other exchanges, Mr. Narang said.
What he really means is a "wave of fake sell orders" that isn't launched by HFTs, but by some "unknown" entity sabotaging an equity market whose structure is broken beyond repair thanks to, drumdoll, HFTs.
It gets better: "Project participants have also debated the impact of attackers transmitting false data via the electronic feeds that traders use to monitor stock prices, or publishing “fake news” to shake investor confidence."
Ah yes, because the "non-fake" market, which rewards news of a possible ICBM launch by North Korea by sending stocks surging, will crash following "fake news" which "shake investor confidence." Perhaps the only confusion here is who came up with this idiotic script: the US government or the HFTs, who are and will be desperate to shift blame to "someone else" after the next crash.
Finally, what is the logic behind DARPA's project? According to the WSJ, "the goal is to develop a simulation of U.S. markets, which could be used to test scenarios, Mr. Shen said. Such software would need to model complex, interrelated markets—not just stocks but also markets such as futures—as well as the behavior of automated trading systems operating within them."
Many quantitative trading firms already do something similar, Mr. Narang said. His company won a small contract from Darpa this year to test whether its simulation tool could be used by the agency, according to Mr. Narang and a Darpa spokeswoman.
The project isn’t the first time the Pentagon has studied such risks. In 2009, military experts took part in a two-day war game exploring a “global financial war” involving China and Russia, according to “Currency Wars: The Making of the Next Global Crisis,” a 2011 book by James Rickards. The Applied Physics Laboratory at Johns Hopkins University hosted the event, a spokesman there confirmed. Such scenarios might seem far-fetched, but Mr. Shen said it is Darpa’s job to think about futuristic attacks that haven’t happened yet.
For those who are still confused, here is what is going on: HFTs are preparing to scapegoat some other, potentially "Russia government controlled" actor for the upcoming market crash, and Darpa has been brought in to provide credibility and validation to the upcoming charge.
“Our charge at Darpa is to think far out,” Wade Shen, the Darpa program manager said. “It’s not ‘What is the attack today?’ but ‘What are the vectors of attack 20 years from now?’”
In retrospect, the only thing we find surprising about today's WSJ report is that the Fed is not involved (at least not yet) in these Darpa-HFT level talks: after all, in addition to HFTs, whose domination of markets has resulted in market structure that is brittle and fragile and susceptible to fracture and flash crash without warning, and thus responsible for crashes at the micro level, it is none other than the Federal Reserve whose actions over the past decade (and really 104 years) that has led to the biggest macro level asset mispricing, i.e., bubble, in history. As for today's trial balloon that preparations for the scapegoating process are already taking palce, and that it likely will be some "Russian hacker" blamed for the upcoming crash, the fact that the top echelons of the US government are already contemplating "next steps" is the clearest indication yet that the current market bubble is approaching its terminal phase.
Until then, we leave readers with this prophetic observation made by Bank of America this past May: