It’s confession time once again. I spent 35 years in New York on Wall Street as analyst, hedge fund manager and banker. As a financially mature adult, I have a weakness. I love to use the Auto Pay option on most all of my bill payment accounts. If you ask me what I paid for electricity last month, I wouldn’t have a clue. Ignorance is truly bliss. If you ask how many minutes I used on my mobile phone this month, same answer. I don’t care because I think my plan includes unlimited usage. If you ask me how much my bank is charging me in service fees, account maintenance fees, late fees, overdraft fees, well, ditto. Now here is the real sin: If you ask me how many times I have been incorrectly charged a few cents too much for something or too often for something else on my credit card, I confess to being oblivious.
But according to Michael Lewis’ latest bestseller, Flash Boys: A Wall Street Revolt, all that I have confessed to pales in comparison to the amount of money that hyper-speed trading technology is ripping off from the average person. Like me, most people are oblivious. And please note the term “average person” — not just the average Joe playing the stock market. We’re talking about the largest pension funds, the most sophisticated hedge fund traders. How much are we talking about? Nobody knows exactly. Using Lewis’ arithmetic, it’s about $160 million per trading day — a staggering $40 billion or more each year. Not exactly chump change. (Lewis, by the way, is a master storyteller; he can make the most technical of finance topics into fascinating reading for the masses.)
So what, you ask — what does that have to do with me? Plenty. Hyper-speed trading is making one-percenters richer and thus more powerful at the expense of the rest of us. It erodes whatever confidence the public has in the stock market and the government that is charged with regulating it. Not exactly chump change, either.
The Anatomy of a Ripoff
Like virtually every industry, technology has profoundly impacted not just Wall Street but the global financial community. When I began my Wall Street career as a junior securities analyst, an average trading day amounted to 20 million shares; the average cost of trading a single stock share was roughly 50 cents. Almost all orders were channeled to the floor of the New York Stock Exchange. The amount of time required to execute a single buy or sell order usually depended on how long it took the floor broker to answer the telephone and walk the order over to the specialist post. Five to 10 minutes wasn’t unusual.
In those archaic days, there was often limited liquidity. NYSE required stock specialists to provide liquidity by taking the opposite side, when necessary, of a buy or sell order. Without going into all the details of this policy, it represented the first wave of pickpockets who could invisibly steal enough pennies from the general public to afford a home in Greenwich, Connecticut, while sending two kids to private schools.
In Flash Boys, Lewis recalls the stock market crash of Oct. 19, 1987, when human-based markets broke down and liquidity evaporated for several days. Trading volume spiked to a point where the system literally could not process orders fast enough. It was like standing in front of Wal-Mart at 5am on Black Friday. Only in this case, everyone wanted out — and only one door could be opened. Panic prevailed. Something had to be done to make the system better.
And so it was from 1987 that the whole concept of the human role in the market began to change. Today, we see a totally different picture. Technology has irreversibly changed the financial markets. What is amazing about this, as Lewis points out, is how almost nobody truly understood how the new technology worked. Sure, people understood what a computer screen looked like and how to enter an order. But what happened to that order once someone pushed “enter”?
To best answer this complex question, Lewis’ focus starts with Brad Katsuyama, a Canadian citizen in charge of trading for the Royal Bank of Canada. Katsuyama is portrayed as English-speaking but otherwise alien to the Wall Street culture of money, debt leverage and greed. This places him as the perfect guy trying to figure out the answer to the question — which goes something like this:
If I want to buy 20,000 shares of GM stock at X per share and my computer screen shows someone offering to sell 20,000 shares at the same price, why does the 20,000 share offering disappear just as I am beginning to enter my buy order? Even before I hit the “enter” key to execute the order, suddenly the 20,000 shares offered for sale disappears. And this is not one isolated case but order after order, day after day, as if someone could read my computer keystrokes. Why is this? Can someone do that?
A Nanosecond Worth a Billion Dollars
As Katsuyama would discover, some seemingly invisible source could decipher his keystrokes. The simple answer is that the conversion from human- to- technology-driven transactions in the 20 years since the crash of 1987 ushered in an era of hyper-speed. What was once a five or 10-minute transaction had evolved into a fraction of a nanosecond.
Computers, routers, servers and fiber optics alone were not enough, though, to determine trading success. It had to be just the right type of fiber optics traveling the straightest line and shortest distance to the Exchange computer. The physically closer to a stock exchange computer that any given trader was might mean a 20 or 25 millisecond advantage — an advantage that could be sold to the highest bidder, at the expense of, according to Lewis, the general public:
The U.S. stock market was now a class system, rooted in speed, of haves and have-nots. 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. What had once been the world’s most public, most democratic, financial market had become, in spirit, something more like a private viewing of a stolen work of art.
What makes this so scary is not only the level of deception involved, but obviously the level of ignorance. Putting financial nerds together with tech nerds is like putting someone from Hawaii together with someone from Ukraine. Yes they are both human but that’s about it. Thus in Katsuyama’s journey to unlocking the mystery he finds that the tech nerds could not explain the impact on stock trading and the financial guys were worthless when it came to how orders were routed. Lewis thus asks another question: Could these trading programs and high-frequency traders (known as HFTs) have caused the infamous “flash crash” of May 2010?
What Have We Learned?
Nobody has ever mistaken Wall Street for a 501(c)3 nonprofit. What Flash Boys reveals is the systemic nature of the $160 million daily ripoff of America. Lewis’ discussion of the New York Stock Exchange’s appearance of collusion in this game reinforces the public notion that the market is rigged. Then again, what else is new?
The priceless tidbit that I finally came away with after reading Flash Boys had nothing to do with nanoseconds. It had to do with Katsuyama’s character — his moral fiber. Katsuyama was shocked by the amount of debt that Americans use, and the Wall Street cycle of money and materialism. Upon unlocking the key to the trading ripoff, he could have joined the robbers. Instead, he chose to package his findings, selling his information to the very institutions that were victims of the ripoff. It would be hard to find a true-blue American that would do something that stupid — or that moral.