Wall Street machinations laid bare in Flashboys
By Michael Lewis
W. W. Norton, 2014
288 pp, $39.99
Michael Lewis's Flashboys has had a dramatic welcome in the United States. It swept to the top of the best seller list and was only knocked from its perch by Thomas Piketty’s Capital in the 21st Century.
It is revealing of the contemporary US mindset that Flashboys, which turns the machinations of Wall Street into a classic US-style morality play, should alternate with Piketty’s history of capitalist inequality.
In reality, Lewis has not produced new information.
Ever since the Wall Street “flash crash” in early 2010, there has been widespread reporting of “front running” by High Frequency Traders (HFTs). Front running is the illegal practice of a stockbroker using advance knowledge of pending orders from customers to their own advantage.
In a 20-minute long “flash crash”, Wall Street prices plummeted without warning and then rebounded to normal. The US authorities brought in a rocket scientist (literally) to try to unravel the cause, but it was beyond him.
What is suspected is that HFT algorithms ― their systems’ mathematical heart ― somehow coincided in chaos. Why it happened is unknown and when it will happen again is impossible to say.
Lewis puts names and faces to people involved in the continuing, impending catastrophe that is Wall Street and cobbles together a narrative.
Flashboys follows Brad Katsuyama, a Canadian stockbroker who noticed that the moment he pressed enter on his computer to buy a stock, the price in front of him instantaneously changed.
He set out on a long odyssey to unravel the secrets of front running.
Along the way he assembled a team of computer boffins and mathematics geeks. They launched their own exchange, which aims to foil the practice.
However, Lewis's plucky-little-hero-taking-on-the-bullies story is not the book’s strength.
The background to the tale is the rise of computerised trading, the break-up of the trading monopoly of the New York Stock Exchange and, most importantly, the creation of competing exchanges distant from each other.
That simple physical reality created micro-second communications delays where it was possible, if you have the computer power, to note minute stock price variations in different markets and, when someone moves to buy, outrun their order.
It enables HFT’s to buy cheap and sell dear and never lose ― ever. They operate in total secrecy, but their profits are estimated to range between US$10 billion and $22 billion a year.
The HFTs are something like the medieval robber barons who exacted tolls from traders passing their castles. HFTs spot the computer traffic, run to the market at lightning speed, monopolise the supply and then fleece the buyer.
They contribute nothing, but extract a cost from society.
Lewis wants the reader to see Katsuyama as an honest hero, supported by his lovable gang of nerds, taking on the big end of town to return honesty to capitalism.
While we have all seen this in innumerable US movies, actually trying to save capitalism from itself is to seek to polish a turd.
However, the side information Lewis serves up on the inner workings of “the market” ― that mythical beast that gets quoted at ordinary people all the time as the arbiter of our lives ― is worth the price of the book.
The major Wall Street banks, such as Goldman Sachs, observed the rise of the HFTs and guaranteed their customers protection by creating internal exchanges. These are called “dark pools” due to their secrecy.
However, they then betrayed their customers both by trading against them within their dark pools and by selling the HFTs access to the pools.
The HFT model was exported to other countries. In passing, Lewis mentions that the Sydney Stock Exchange was similarly broken up, with its competitor set up in a suburb over the other side of the harbour.
That is, it was perfectly positioned for the micro-second communication delays that are the feeding ground for HFTs. When I read that I paused and wondered how big a bribe was paid to whom in New South Wales to achieve that outcome.
A near endless list of immoral, fraudulent and hypocritical things about Wall Street tumble off the book's pages. Clearly this is not a system that needs a bit more regulation ― it needs a complete cleaning out.
Let “Occupy and Demolish” be the slogan.