Spoils go to the speediest
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