Michael Lewis’s flawed new book
Iâm halfway through the new Michael Lewis bookÂ – 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, itâs written with great clarity and fluency: youâre not going to have any trouble turning the pages. And, like all Michael Lewis books, itâs 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 havenât seen anything that would qualify as the âlighting in a bottleâ he promised Boris Kachka. We were promised scoops, but so far itâs hard to see what the scoops are supposed to be. The most interesting thing Iâve discovered so far is the existence of something called âlatency tablesâ — 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 houseâs 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: itâs hard to keep track of time, and a lot of it seems to be an exposĂ© 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 doesnât 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 itâs not really there anymore. Because that fact doesnât fit Lewisâs narrative, however, I doubt Iâm 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.) Itâs 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 âall investors are small investorsâ 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, âlinked together trunk to tail like circus elephantsâ, 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, theyâre still making less than the big broker-dealers used to make back in the day. But thatâs 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 âBuyâ: 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, heâd think twice before he pressed it.
This is silly. Iâll tell you what happens when the little guy presses that key: his order doesnât 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 thereâs no reason whatsoever for the little guy to think twice before pressing the button.
HFT is dangerous, Iâd 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 (Iâll write something longer once Iâve finished the book) is that it actually misses the big problem with HFT, in the service of pushing a false narrative that itâs bad for the little guy.