Spoils go to the speed­i­est

The Weekend Australian - Review - - Books - Frank Car­ri­gan

IN the 1980s Michael Lewis scored a prized job in a pres­ti­gious Wall Street bank. He worked for Salomon Broth­ers and be­came a trader on world cap­i­tal mar­kets. Ini­tially the buzz from the ex­otic na­ture of the work and a hefty salary sat­is­fied him. But as dis­il­lu­sion­ment set in he de­vel­oped a sedi­tious streak. Lewis felt the grow­ing role of fi­nance that he was con­tribut­ing to was fu­elling spec­u­la­tive bub­bles. He left his priv­i­leged po­si­tion and strato­spheric salary.

In a best­selling whistle­blower book, Liar’s Poker (1989), he piti­lessly char­ac­terised the in­di­vid­ual and in­sti­tu­tional flaws of Salomon, and the casino cap­i­tal­ism that was start­ing to dom­i­nate Wall Street.

Gifted with rare abil­ity, Lewis wrote more books and be­came a cel­e­brated au­thor. But in a sense he never left Wall Street. For he has stayed a scourge of the fa­mous street that starts at a church and winds its way down un­til it reaches the East River. It is a mag­i­cal street that sym­bol­ises the ce­les­tial and the earthly. It is the flag­pole of the eco­nomic his­tory of the US, and Lewis was born to chron­i­cle the pulse of the ci­tadel of global high fi­nance.

In his lat­est book, Flash Boys, Lewis glo­ries in his role as a Tro­jan horse. He painstak­ingly sets out to spill the beans on the lat­est Wall Street ruse for mak­ing for­tunes. He charts how sta­teof-the-art com­puter tech­nol­ogy has led to key Wall Street trad­ing firms en­rich­ing them­selves by op­er­at­ing in a frac­tion of the blink of an eye to buy and sell shares that ex­hibit mi­nus­cule price dif­fer­en­tials at the 57 ex­changes that make up the US stock­mar­ket.

The strat­egy of ex­ploit­ing price dis­crep­an­cies has pro­duced short-term traders, or Flash Boys, who buy and sell or­ders at alarm­ing speeds that screw out­side in­vestors such as pen­sion and mu­tual funds.

This phe­nom­e­non re­sults in the rig­ging of the mar­ket and prof­its be­yond the dreams of Croe­sus. Lewis il­lus­trates how in­vestors have fallen prey to a form of vam­pire cap­i­tal­ism.

He be­gins with a group of ven­ture cap­i­tal­ists ea­ger to join the lat­est lu­cra­tive gam­bit on Wall Street. The vi­sion that drove these en­trepreneurs was the re­al­i­sa­tion that there was a big dif­fer­ence be­tween the trad­ing speed that was avail­able be­tween the main stock ex­changes in Chicago and New York and the trad­ing speed that was the­o­ret­i­cally pos­si­ble.

In an age when bro­kers have largely dis­ap­peared from the trad­ing floors as com­put­ers have taken over their role, the firms with ac­cess to the fastest elec­tronic sig­nal be­tween Chicago and New York would gain a com­pet­i­tive edge in the buy­ing and sell­ing of shares. The ven­ture cap­i­tal­ists un­der­stood you needed only a thou­sandth or a mil­lionth of a sec­ond to beat your op­po­si­tion to the punch.

Start­ing in 2008, the plan was to de­velop the straight­est fi­bre-op­tic ca­ble route be­tween the Chicago and New York ex­changes. The ex­ist­ing fi­bre-ca­ble route zigzagged to avoid moun­tains and rivers, and in the process added mil­lisec­onds to buy­ing and sell­ing stock­mar­ket or­ders.

The ven­ture cap­i­tal­ists were un­daunted by nat­u­ral hur­dles and, in one of the great un­her­alded build­ing projects of re­cent his­tory, they be­gan lay­ing a ca­ble line that cut through moun­tains and went un­der riverbeds, to shave mil­lisec­onds off trans­ac­tions. No­body not in­ti­mately con­nected with the project got close to cracking the rea­son for lay­ing an ar­row-straight ca­ble line be­tween Chicago and New York.

When the ca­ble was nearly laid the fun be­gan. Then it was time for the pitch to prospec­tive clients. The cream of Wall Street banks were paid a visit and in­cred­u­lous chief ex­ec­u­tives of glob­ally renowned firms lis­tened as they were told the aim and price of ac­cess to the line.

One of the sales­men told Lewis, “It was the big­gest what-the-f..k mo­ment the in­dus­try had had in some time.”

The rich and pow­er­ful of Wall Street re­alised “their en­tire commercial ex­is­tence de­pended on be­ing faster than the rest of the stock­mar­ket”. The line sales­peo­ple soon grasped that the tar­get au­di­ence “would sell their grand­moth­ers for a mi­crosec­ond”.

Some cus­tomers begged the ca­ble line own­ers to boost the lease price so com­pe­ti­tion could be re­stricted and mo­nop­oly rights as­serted. One cus­tomer lis­tened to what was on of­fer for 15

May 24-25, 2014 Flash Boys: Cracking the Money Code By Michael Lewis Allen Lane, 288pp, $39.99 (HB) min­utes in to­tal si­lence “then leapt to his feet and shouted, ‘SHIT, THIS IS COOL!’ ”

Cool it was. The buc­ca­neer­ing vi­sion of the own­ers of the line paid off.

The Wall Street firms that signed up were a se­lect group, and they un­der­stood what the fastest line be­tween two cities would bring. By ex­ploit­ing the count­less mi­nus­cule dis­crep­an­cies in prices on the Chicago and New York stock ex­changes, they would make a killing at the ex­pense of bro­kers and in­vestors out­side the loop.

Even be­fore the com­puter switch be­tween Chicago and New York was turned on, the st­ing was al­ready in full swing. This de­vel­op­ment just added some ex­tra juice for the speed traders on Wall Street bent on mar­ket ma­nip­u­la­tion. The st­ing was based on big banks hav­ing their pri­vate stock ex­changes and then phys­i­cally putting their com­put­ers as close to the com­puter pipes of the pub­lic stock ex­changes as pos­si­ble. This strat­egy en­sured the banks were a step in front of any­one else in view­ing price fluc­tu­a­tions on the mar­ket.

The big banks leased ac­cess to their ex­changes to firms will­ing to en­gage in high-fre­quency turnover of shares. The name of the game for the banks and their sis­ter trad­ing firms was to ex­ploit ev­ery mi­crosec­ond ad­van­tage they had over un­sus­pect­ing in­vestors.

Share prices bounce around through­out the trad­ing day at the var­i­ous ex­changes and it is this vo­latil­ity com­bined with trad­ing speed that al­lowed the out­fox­ing of slow-footed in­vestors. With just a mil­lisec­ond ad­van­tage the com­puter code that ex­e­cuted trad­ing de­ci­sions for priv­i­leged traders could iden­tify other bro­kers or a pen­sion fund seek­ing to buy a par­tic­u­lar share.

The preda­tor’s com­puter sys­tem iden­ti­fies what pub­lic stock ex­change is show­ing the re­quired share at a lower price. The sys­tem snaps into ac­tion and buys the block of shares, then re­sells them at the high­est price ap­pear­ing on stock ex­change screens. The prey failed to even re­alise what hit them. They got their shares, but at a slightly higher price per share than a fully trans­par­ent mar­ket would deliver.

As Lewis notes, the US stock mar­ket was now a class sys­tem, rooted in speed, of haves and havenots. The haves paid for nanosec­onds, the have-nots had no idea that a nanosec­ond had value. The haves en­joyed a per­fect view of the mar­ket; the have-nots never saw the mar­ket at all.

In brief, Lewis makes it clear that get­ting to see other people’s or­ders be­fore any­one else was pure gold in a mar­ket where the aver­age daily vol­ume of trade is worth $US225 bil­lion.

When the back­lash came it was not from the ex­pected quar­ter. In ev­ery ju­ris­dic­tion cor­po­rate law fa­cil­i­tates profit mak­ing. Lewis notes the US reg­u­la­tor was di­vided be­tween those staff want­ing to rein in the er­rant traders and those sit­ting on their hands or leav­ing their pub­lic posts to work di­rectly for the new wealthy mar­ket lead­ers or lobby on their be­half in Wash­ing- ton. The cap­tured.

The blow­back, as Lewis il­lus­trates, came from in­side Wall Street as a core of bro­kers and com­puter pro­gram­mers be­gan to flex their in­tel­lec­tual mus­cle to coun­ter­act those who had been hold­ing them to ran­som. It was a group based on the New York trad­ing floor of the Royal Bank of Canada that led the charge.

The RBC was re­garded as small fry on Wall Street. But it is the world’s ninth largest bank, and it had the will, re­sources and talent to tackle the preda­tors who were lim­it­ing its ac­cess to shares, then mak­ing the bank pay a pre­mium for its or­ders.

Hav­ing de­vel­oped a com­puter code to di­lute the im­pact of the preda­tors, the cap­i­tal­ist cru­saders at RBC took a log­i­cal busi­ness step. They left the Cana­dian bank, and em­ployee sta­tus, and set up a pri­vate stock ex­change ded­i­cated to pre­vent­ing in­vestors be­ing treated as prey. With cin­e­matic scope, Lewis nar­rates the in­cep­tion of a new Wall Street trad­ing firm gov­erned by the de­sire for trans­parency and de­ploy­ing com­puter ge­niuses who en­gi­neered al­go­rithms that fur­ther re­stricted preda­tory trad­ing.

Lewis is tall on anec­dotes and sketches of char­ac­ters who would be at home in one of Balzac or Christina Stead’s nov­els on fi­nance cap­i­tal. But there is a lack of the­o­ris­ing the role of Wall Street. There is no sys­temic anal­y­sis of just what func­tion the global icon of fi­nance serves. It is sup­posed to fund pro­duc­tive en­ter­prises but most cor­po­rate cap­i­tal ex­pen­di­ture is in­ter­nally gen­er­ated by prof­its sup­ple­mented by bank­ing cap­i­tal.

Wall Street fo­cuses on re­cy­cling ex­ist­ing shares. As the fund­ing pipe­line has nar­rowed the temp­ta­tion to spec­u­late by pour­ing money into stock­mar­kets on the ex­pec­ta­tion of ris­ing prices grips both good and bad guys.

The up­shot is in­di­vid­u­als reap re­wards that are out of whack with their pro­duc­tive con­tri­bu­tion. Min­i­mal eco­nomic value is added by spec­u­la­tive in­di­vid­u­als who ac­crue stel­lar wealth that adds to the es­ca­lat­ing eco­nomic in­equal­i­ties be­dev­illing the US.

Lewis’s moral­ity tale is spell­bind­ing. But at a deeper level he leaves un­solved and barely recog­nised is­sues of car­di­nal im­por­tance. He ide­alises those who put a spoke in the wheel of the preda­tors but fails to high­light their con­tra­dic­tions. At the end of the day, those he li­onises in this book are in­sid­ers who seek to al­ter the rules of the game but not change its cen­tral dy­namic.





Traders on the floor of the Chicago Board Op­tions Ex­change

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