$22 billion per annum is roughly $200 per year per household in the United States.

If it is someone’s trading revenue it presumably comes out of someone else’s pocket so measuring it per household is appropriate.

The trading revenue of “Wall Street” major investment banks (including Barclays, the trading parts of Citibank and similar entities) peaked at over $500 per household in the Western world.

Revenue like this is usually paid for a service. Ultimately I thought the service was intermediation between savers in China, Japan and the Middle East (who want Treasuries) and dis-savers in the Anglo countries (who want to fund exotic credit card debt and mortgages). That remains the only service that looks large enough to justify that sort of revenue. [The real service having been finding suckers such as municipalities and insurance companies to hold the toxic waste such as CDO squared resecuritisation paper.]

That said, given almost nobody knows how to make $22 billion per annum trading and jealousy is a common trait, conspiracy theories abound. The current conspiracy theory is that this money comes from front-running clients in the market with very rapid trading. The New York Times recently promoted this view.

The idea is that by knowing client orders you can extract profits. Computers fleece clients by forcing clients to pay more when they buy and to receive less when they sell.

And it is clear this happens. We trade electronically at our fund. We were recently trading in a stock with a large spread. I have changed the numbers so as not to identify the stock – but the ratios are about right. The bid was about 129.50, offer was about 131.50. We did not want to cross the spread – so when we bid for the stock we bid $129.55. Within a second a computer (probably at our own broker) bid $129.60 for a few hundred shares. We fiddled for a while changing our bid and watching the bot change theirs. We would have loved to think we were frustrating the computer – but alas it was just a machine – and we were people up late at night

Actually obtaining the stock required that we paid up – and when we did so it was probably a computer that sold the stock to us.

Inevitably we cross spreads and the computer earns spreads.

The computers make even more consistent profits with high volume low spread stocks. If you are buying or selling Citigroup it is almost certain that when you buy you will pay the offer price and when you sell you will receive the bid price. They are only 1 cent different – but in almost all cases it will be a computer that traded with you – and the computer will – through owning the “order flow” be getting the better end of that deal.

That said – these profits can’t add up to sufficient to explain Goldman’s trading profit.Interactive Brokers is (by far) the most electronic and lowest cost broking platform in the world.We use it extensively as do many others. Interactive Brokers has a 12 percent market share in option market making globally and probably a 10 percent share in all market making. Trading revenue was about 220 million. Moreover in the conference call the CEO/Founder (Thomas Peterffy) thought the influx of competition in the area had reduced market maker margins very substantially.

Anyway if 10 percent of global stock volume provides 220 million dollars revenue per quarter then there is no way that a substantial proportion of Goldman’s trading profit can come from high frequency trading. The numbers do not work.

When the New York Times quotes William Donaldson (a former CEO of the New York Stock Exchange) as that high frequency trading “is where all the money is getting made” they are quoting bunk – and they should know it.

This is a plea. Can we have a dispassionate and accurate view of where the (vast) trading profits of Wall Street in general (and Goldman Sachs in particular) come from? The last big boom in trading profits was followed by a bust which came at huge social costs. [Look what happened to Lehman.]

We cannot understand the risks “Wall Street” is taking and hence the economic downside if it all turns pear shaped, and the appropriate regulatory structure, unless we know what is happening.

Mindless articles such as the recent New York Times one – grossly inconsistent with facts are less than helpful. They are distracting.

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