By Michael Lewis
Wall Street has never enjoyed a good reputation on Main Street. There’s a long tradition of seeing the “little guy” as a mark: a gullible target of wealthy elites who are able to manipulate the market at will. It’s the sort of thing you see Jason Compson railing about in The Sound and the Fury, just as he and much of the rest of the nation are about to be wiped out in the Great Crash.
This perception has been hard to shake for over a century now because it has some grounding in reality. No matter the bet, the house always seems to win. Even after the recent subprime mortgage meltdown some of the worst offending institutions, deemed “too big to fail,” walked away with bags of money, and with no criminal charges.
In addition to this general sense of unfairness, our financial markets – which now operate almost entirely in cyberspace – have become infinitely complex, making it harder, if not downright impossible, for the little guy to understand how they operate. Indeed, many within the financial community share that confusion.
One can excuse the little guy, then, for feeling that the game is rigged.
And according to Michael Lewis, a great explainer when it comes to the workings of the financial industry, they are right. In Flash Boys he takes as an example the phenomenon of “high frequency trading.”
HFT is a vague and confusing term, but what Lewis mainly means by it is the practice some trading companies have of using their relative advantage in speed to market to game the system by front-running stock orders (“scalping” stocks) or engaging in other forms of fast-as-light digital arbitrage.
This is a very lucrative business, with profits running into the billions, or even tens of billions of dollars. It’s hard to name an amount for sure because the companies engaging in HFT don’t want to talk about how much money is being made, or even how they’re doing it. As one of Lewis’s sources explains: “The less you know about how they make the money, the better it is for them.”
This has led to a fetish of secrecy in the industry: from data centers with armed guards and dogs patrolling the grounds, to servers wrapped in wire gauze to prevent anyone seeing into them, to security clearances for trading offices that are more rigorous than those at the Pentagon. And then there’s all of the top-top-secret code.
Luckily, Lewis has a knack for making comprehensible arcane financial matters in a highly-readable way. In Flash Boys he follows what has become a bestselling formula: focusing on a small group of individuals who are on their own journey into the industry’s “dark pools” and “black boxes.”
Chief among these is a morally-upright Canadian, a Wilfrid Laurier graduate and Royal Bank executive named Brad Katsuyama. As the story unfolds, Katsuyama and his team begin to solve the puzzle of what really goes on in HFT, and then proceed to create their own antidote in the form of a new “fair” stock exchange (the IEX), that just launched last year.
The publicity Flash Boys has received is testimony to widespread public concerns over the integrity of the market. Unsurprisingly, there have already been a number of industry apologists who have gone on counterattack. In large part, one suspects they are trying to protect the goose that has lain so many golden ages. HFT has thus far been the holy grail of stock trading: a system of guaranteed profit without risk. Indeed, some companies have apparently been at it for years without registering a single day of losses. And, best of all, it’s not even clear if any of this is against the rules.
But then nothing about the business is clear. Though the fact that so much money is being milked out of investors, without their knowledge and with no value added or benefit obtained, all while making the market less efficient and more liable to sudden breakdowns (like the so-called “flash crash”), gives off enough of a bad smell.
Flash Boys has struck a nerve because it seems to confirm our long-standing fears of being exploited by the mysterious and seemingly all-powerful workings of money and technology. Being paranoid doesn’t mean they’re not out to get you. Lewis may not provide the full story behind HFT here, but he does underscore an important point: The only cure for our fears is more knowledge and better understanding.
Review first published April 26, 2014.