An Old Story Told Well: Michael Lewis
The media blitz is now underway for Michael Lewis’s new book, Flash Boys: A Wall Street Revolt. The blitz began as the lead story for Sixty Minutes and was followed by an excerpt in The New York Times Magazine. Having covered the older demographic, Mr. Lewis will appear on The Daily Show April 1st. Mr. Lewis’s book has one overriding message: high frequency traders are systematically front running stock trades in order to make billions of dollars in profits. I wrote about this practice several weeks ago (see, “High Speed Trading: Who Does it Serve? [March 19, 2014]).
If the entire book is as good as the excerpt in the NYT Magazine, Mr. Lewis will have once again turned the often arcane world of Wall Street into a lively story. However, Mr. Lewis isn’t telling us anything we don’t already know. Wall Street has always sought ways to extract small amounts of change from the unwary and translate that into large profits through sheer volume. High frequency trading is just the latest iteration.
Mr. Lewis’s book may create public outrage and even spur the SEC to actually do something about high frequency trading. He will certainly generate headlines. However, this story has been widely available for the better part of five years. You need only search The Times or Wall Street Journal websites to find dozens of articles detailing the efforts of high frequency traders to build faster networks or co-locate their servers in order to front run stock orders. One of the folks featured in Mr. Lewis’s book, Joe Saluzzi of Themis Trading, is part of an amusing CNBC interview conducted nearly four years ago. During an animated debate with a proponent of high frequency trading, Mr. Saluzzi articulated the exact case Mr. Lewis is now making in his book.
Wall Street has two tools in its arsenal for hoovering up nickels and dimes from unsuspecting investors: speed and darkness. For a long time, darkness was the preferred method of extracting unwarranted profits from clients. Investors simply could not find out how securities were being marked up and priced. Today, the lights shine brightly on listed stocks and derivatives, as well as some bonds. However, there are still plenty of dark corners of the markets where prices can be manipulated, such as over-the-counter derivatives, credit default swaps, and even mundane securities like municipal bonds. Wall Street routinely resists the spotlight because it cuts into profits.
Before the proliferation of electronic exchanges, when orders were funneled to a few stock exchanges, speed was of limited utility. While a savvy investor might profit by hearing news first and executing a trade before the rest of us (and I’m not talking about illegal insider trading), it was hard to do on a systematic basis. In fact, the New York Stock Exchange built pipelines to ensure that small retail orders and large institutional orders reached the floor at the same time. However, as the number of exchanges proliferated and trading became automated, speed became a systematic and legal way of getting in front of other people’s buy and sell orders. It’s unfortunate that we have to wait for a great storyteller like Michael Lewis before we’re prepared to do anything about high frequency trading.