Common Core and Liquidity Auctions

Is it too much of a stretch to claim that American Federation of Teachers President Randi Weingarten and New York Stock Exchange CEO Henry DeCoste share a common concern? Perhaps so, though it does appear that both are worried about the impact of performance metrics on their operating systems.

For instance, as the President of America’s foremost teacher’s union, Ms. Weingarten has protested long and hard against the student testing policies of the Common Core and No Child Left Behind programs. One concern appears to be focused on the harm that can be inflicted on the process of classroom instruction when the instructor “teaches to the test,” thereby diverting learning efforts from critical thinking activities to memorization tasks.

Meanwhile, last week, the NYSE applied for permission to launch a new initiative that addresses a similar premise. Although its adoption of a mid-day stock auction process might seem arcane to laypersons, the motivation behind the initiative is comparable to the concerns of Ms. Weingarten.

You see, investment management strategies have been shifting significantly from value trading to momentum trading activities. In other words, instead of assessing the long term value of firms and then purchasing undervalued equities, investors are increasingly assessing the movement of stock values during a trading day and then rushing through trades at the very end of that day (or at the very start of the following day).

But when large numbers of traders gravitate to such strategies, relatively few trades remain during the mid-day hours. As a result, large volumes of late day momentum trading transactions are based on relatively small volumes of mid-day trading activities, a situation that jeopardizes the stability of the entire financial system.

The NYSE’s solution is to stimulate mid-day trading by holding auctions, a strategy that may yield some incremental improvement. Nevertheless, such auctions do not address the fundamental problem that the widespread adoption of financial market performance metrics is significantly impacting the activity that it is purportedly measuring. And that very situation exists in regards to the Common Core and No Child Left Behind programs as well.

In other professional and academic fields, researchers have known for decades that the presence of investigators can influence the behavior of phenomena. In the 1920s, for instance, business engineers referred to this condition as the Hawthorne Effect. And in the 1960s, sociolinguists called it the Observer’s Paradox.

A similar effect now appears to be wielding an outsized influence today in fields from primary education to the investment industry. Thus, before we respond to metrics of sub-optimal performance by modifying our operating activities, perhaps we should pause to identify the disappointing outcomes that are attributable to the measurement process itself.