‘The US stock market is rigged.’ That’s the j’accuse headline that screams out from Flash Boys, the new book by Michael Lewis. It’s a very big claim, made by America’s foremost financial writer. It’s also a claim that, after years of accumulating evidence, warrants extremely close and sustained official scrutiny.
Lewis produced Liar’s Poker, his first bestseller, in 1989 — after a four-year stint as a fresh-from-the-Ivy-League bond dealer at the now defunct firm Salomon Brothers. The book, an insider’s account, brilliantly lampooned the macho, aggressive behaviour of the ‘big swinging dicks’ who paced the carpet-tiled trading floors. Liar’s Poker defined popular understanding of Wall Street in the go-go, testosterone-fuelled 1980s.
Another Lewis hit was Moneyball, published in 2003. This explained how major league baseball coaches were increasingly picking teams on the strength of highly detailed performance data generated by obsessive statisticians, eschewing traditional attributes such as physique, athleticism and character. More fascinating ‘gee whizz’ reportage than finger-pointing exposé, Moneyball showed how poorer teams could beat the big boys by buying cheaper, yet more effective players. A riveting David versus Goliath story, Money-ball confirmed Lewis’s knack of conveying a complex subject via crystal-clear writing and larger-than-life characters.
While it was wildly successful, eventually generating a spin-off movie starring Brad Pitt, Moneyball was merely Lewis’s wind-up before delivering a much harder, more challenging pitch. The Big Short, published in 2010, took him back to Wall Street, providing a penetrating account of the build-up of the western world’s deeply destructive housing and credit bubble during the 2000s.
Described by Reuters as ‘probably the best single piece of financial journalism ever written’, The Big Short analysed how the international banking system came off the rails, with devastating consequences for the global economy, due to the crass, immoral behaviour of those running some of the world’s biggest banks. Although the book spent seven months on the New York Times bestseller list, a Hollywood adaptation has yet to happen. There’s no film version of Liar’s Poker, either.
I suspect there will be no messing about with Flash Boys. It deals with an aspect of financial markets even more impenetrable than the mortgage-backed securities that peppered the pages of The Big Short, and its story is even more jaw-dropping, its leading characters even more camera-ready. This book has the potential to spark a cultural uprising, marking the moment when the public forces our political classes to finally — finally! — grab the money-men by the lapels.
Flash Boys focuses on Brad Katsuyama, a Canadian-Asian who came to Wall Street and prospered despite lacking the dog-eat-dog narcissism of many of his fellow traders. He became suspicious after repeatedly noticing that when he sent a big stock order to the market on behalf of a client, it would be only partially filled. He would then have to pay a higher price for the rest of the order.
Katsuyama found out that orders travelled along fibre-optic lines and hit whichever of eastern America’s numerous exchanges was closest before hitting the others. This allowed computer–driven ‘high frequency trading’ firms (paying steep commissions to the exchanges) to nip in and buy ahead of the original purchaser, before selling the shares on to them at a slightly inflated price.
Tiny prices rises, multiplied over many millions of trades daily, obviously amount to big money. An even more lucrative strategy involves ‘slow-market arbitrage’ — that is, when a high-frequency firm sees the price of a stock change on one exchange and executes orders sitting on other exchanges before those exchanges are able to react. None of this involves quickwittedness or bold decision-making, by the way. What we’re talking about here is intermediaries ‘flashing’ (for a price, of course) early access to information that signals the trading intention of underlying customers — often pension funds and insurance companies trading on behalf of ordinary savers. And ‘quick’ is measured in terms of milliseconds.
‘Over the past decade,’ Lewis tells us, ‘financial markets have changed too rapidly for our mental picture of them to remain true to life.’ In the old days, ‘The speed with which a trader could execute had human limits,’ he says. Since 2007, ‘the exchanges are simply stacks of computers in data centres. The speed with which trades occurred are no longer constrained by people.’ The only constraint now is how fast an electronic signal can travel between, say, the data centre in Chicago housing the Chicago Mercantile Exchange and its equivalent beside the Nasdaq stock exchange in New Jersey.
During 2007-08, computer-driven, high-frequency trades surged to account for over half of all US stock trading. They’ve stayed around that level ever since. By early 2009, Lewis reports, the stock market had become ‘a war of robots’. This generated a lot more instability, over and above the 2008 crisis. ‘Price volatility within each trading day during 2010-13 was 40 per cent higher than 2004-06.’
Flash Boys opens with an astonishing account of one company’s obsession with laying a dead straight fibre-optic cable between Chicago and New York. The 827-mile line, ploughing across private land and involving hundreds of ‘easement’ deals, shaved just a few milliseconds off the Chicago-New York round trip — a fraction of the time it takes you to blink, but enough to rent it for millions of dollars to bulge-bracket investment banks so they can practise high-frequency strategies that skim from other investors.
Shocked by his discovery, Katsuyama teamed up with an Irish telecoms guru, Ronan Ryan, and a Russian maths whizz, Constantine Sokoloff, to set up their own Investors Stock Exchange — or IEX — that uses a fibre-optic ‘speed bump’ to level out transmission times in a bid to foil the high-frequency houses.
Now the book is out, a propaganda war is in full swing, with the Wall Street firms re-iterating that high-frequency strategies are legal, while Lewis, Katsuyama and others cry that technological warfare means the most iconic market in the world, the symbol of global capitalism, is now skewed and immoral. ‘The deep problem with the system is a kind of moral inertia,’ says Lewis. ‘So long as it serves the narrow self-interests of everyone inside it, no one on the inside will ever seek to change it, no matter how corrupt or sinister it becomes.’
More than five years on from the Lehman collapse, Lewis has lit the touch paper on the mother of all debates about Wall Street and global finance.
Liam Halligan writes the weekly Economic Agenda column in the Sunday Telegraph.