Big-name too-big-to-fail-or-jail Wall Street players like Goldman Sachs, Credit Suisse, and Bank of America play a role in Flash Boys, Michael Lewis’s startling exposé of the inner workings of the American stock market — a market Lewis describes as rigged against investors — but the key actors are a band of idealists assembled and led by an unassuming Canadian named Brad Katsuyama.
While employed by the Royal Bank of Canada — a relatively insignificant Wall Street player with a reputation for being a “nice” bank — Katsuyama began to notice that the stock market frequently behaved aberrantly. Katsuyama would be poised to make a trade on behalf of a client, and poof, right before his eyes the stock would vanish, or move, in trading parlance, from his computer screen.
The search for answers to the odd behavior of the market led Katsuyama into the shadowy world of high-frequency trading, where proximity to a stock exchange and the speed of electronic networks rule. Forget the days when traders in blue smocks jockeyed on the floor of the New York Stock Exchange, waving scraps of paper and frantically shouting buy or sell orders. In the electronic age, machines rather than people make trades. As Lewis writes: “Every day, the markets were driven less directly by human beings and more directly by machines” — very smart machines running sophisticated algorithms with the ability to anticipate large-volume trades and front-run them where high-frequency traders want them to go. In an environment that now includes more than 50 stock exchanges and countless private “dark pools” run by banks, speed measured in milliseconds spells the difference between millions of dollars in profit or loss.
As was the case with mortgage-backed securities and collateralized debt obligations and credit default swaps, the automated stock market is stunningly complex. On its face, high-frequency trading seems like it should be illegal. But no, the system is merely riddled with perverse incentives. The reality is that between investors and the market sits a layer of middlemen who earn fees, commissions, and rebates from order flow and volume. This labyrinth adds little actual value to the market or the larger economy; middlemen profit from the complexity they have nurtured and sustained — and defend with every resource at their disposal. Katsuyama summed the arrangement up this way: “The fact that people who make the most money want the least possible clarity — that should be alarming, too.”
The next time the stock market takes a swan dive for no logical reason, think of Michael Lewis and Flash Boys. I know I will.
Michael Lewis talks about his latest book Tuesday, October 21, 8 p.m., at the Granada Theatre, 1214 State Street. For tickets, call 893-3535 or visit artsandlectures.sa.ucsb.edu.