Michael Lewis’s flawed new book
I’m halfway through the new Michael Lewis book — the one that has been turned into not only a breathless 60 Minutes segment but also a long excerpt in the New York Times Magazine. Like all Michael Lewis books, it’s written with great clarity and fluency: you’re not going to have any trouble turning the pages. And, like all Michael Lewis books, it’s at heart a narrative about a person — in this case, Brad Katsuyama, the founder of a small new stock exchange called IEX.
The narrative is interesting enough — but so far I haven’t seen anything that would qualify as the “lighting in a bottle” he promised Boris Kachka. We were promised scoops, but so far it’s hard to see what the scoops are supposed to be. The most interesting thing I’ve discovered so far is the existence of something called “latency tables” — a way for HFT shops to work out exactly which brokers were responsible for which orders. The trick is to realize that because every brokerage is in a slightly different physical location, each house’s trades will hit the various different stock exchanges in a slightly different order. And so by looking at the time difference between a given trade showing up on different exchanges, you can (or could, at one point) in theory identify the bank behind it.
This vagueness about time is one of the weaknesses of the book: it’s hard to keep track of time, and a lot of it seems to be an exposé not of high-frequency trading as it exists today, but rather of high-frequency trading as it existed during its brief heyday circa 2008. Lewis takes pains to tell us what happened to the number of trades per day between 2006 and 2009, for instance, but doesn’t feel the need to mention what has happened since then. (It is falling, quite dramatically.) The scale of the HFT problem — and the amount of money being made by the HFT industry — is in sharp decline: there was big money to be made once upon a time, but nowadays it’s not really there anymore. Because that fact doesn’t fit Lewis’s narrative, however, I doubt I’m going to find it anywhere in his book.
Similarly, Lewis goes to great lengths to elide the distinction between small investors and big investors. As a rule, small investors are helped by HFT: they get filled immediately, at NBBO. (NBBO is National Best Bid/Offer: basically, the very best price in the market.) It’s big investors who get hurt by HFT: because they need more stock than is immediately available, the algobots can try to front-run their trades. But Lewis plays the “all investors are small investors” card: if a hedge fund is running money on behalf of a pension fund, and the pension fund is looking after the money of middle-class individuals, then, mutatis mutandis, the hedge fund is basically just the little guy. Which is how David Einhorn ended up appearing on 60 Minutes playing the part of the put-upon small investor. Ha!
Lewis is also cavalier in his declaration that intermediation has never been as profitable as it is today, in the hands of HFT shops. He does say that the entire history of Wall Street is one of scandals, “linked together trunk to tail like circus elephants”, and nearly always involving front-running of some description. And he also mentions that while you used to be able to drive a truck through the bid-offer prices on stocks, pre-decimalization, nowadays prices are much, much tighter — with the result that trading is much, much less expensive than it used to be. Given all that, it stands to reason that even if the HFT shops are making good money, they’re still making less than the big broker-dealers used to make back in the day. But that’s not a calculation Lewis seems to have any interest in.
In his introduction to the book, Lewis writes this:
The average investor has no hope of knowing, of course, even the little he needs to know. He logs onto his TD Ameritrade or E*Trade or Schwab account, enters a ticker symbol of some stock, and clicks an icon that says “Buy”: Then what? He may think he knows what happens after he presses the key on his computer keyboard, but, trust me, he does not. If he did, he’d think twice before he pressed it.
This is silly. I’ll tell you what happens when the little guy presses that key: his order doesn’t go anywhere near any stock exchange, and no HFT shop is going to front-run it. Instead, he will receive exactly the number of shares he ordered, at exactly the best price in the market at the second he pressed the button, and he will do so in less time than it takes his web browser to refresh. Buying a small number of shares through an online brokerage account is the best guarantee of not getting front-run by HFT types. And there’s no reason whatsoever for the little guy to think twice before pressing the button.
HFT is dangerous, I’d like to see less of it, and I hope that Michael Lewis will help to bring it to wider attention. But my tentative verdict on Flash Boys (I’ll write something longer once I’ve finished the book) is that it actually misses the big problem with HFT, in the service of pushing a false narrative that it’s bad for the little guy.