Review: Flashboys by Michael Lewis

By Allston Mitchell, April 21, 2014

Michael Lewis and the cover of Flashboys

Michael Lewis and the cover of Flashboys

Wall Street is rigged, and best-selling author Michael Lewis tells us how. Rollercoaster style, he recounts how a motley group takes on Wall Street, converting Goldman Sachs to the straight and narrow en route. Incredibly, morality and truth win out. Horrifying and fascinating in equal measure.

Michael Lewis has made a name and probably a considerable fortune recounting the nefarious deeds of Wall Street in his books: Liar’s Poker, Boomerang and The Big Short. This time he has caught them in the act.  It might have been safe to presume that given the massive economic crisis we are all working our way out of, Wall Street’s major players might have thought it sensible to keep a low profile and play according to the rules – at least for a while. Far from it. A group of high frequency traders and investment banks realised that with the help of recent technology they could actually rig the equity markets – so that is exactly what they did. How did they do it? With speed, using High Frequency Trading that allowed them to obtain a competitive advantage over their competitors – an advantage that was measured in microseconds.

Michael Lewis walks us through how High Frequency Trading works. This is not a book for experts. Lewis’s books are anything but impenetrable, in fact  they are perfect for the intelligent layman. A quick google of a couple of terms such as front running and dark pool arbitrage might not go amiss, but the incomprehension stops there. He  describes a world that is all new: gone are the days of quaint stock exchange brokers shouting and gesticulating at each other on the stock exchange floor in their colourful jackets.  If you are selling shares, most likely you are doing it via a server, a router and some fibre optics.  In theory this might have been a good thing, taking away the middle man, offering cheaper transaction costs and greater transparency but as it turned out,  quite the opposite happened.

Flashboys recounts, with its informative, gripping and amphetamine style, the tale of a group of unlikely misfits (mostly techies) on the margins of investment banking who decide to risk everything and take on the power of Wall Street, or at least those participating in High Frequency Trading who had created a system of front running that was a mystery to even many of the experienced honchos on Wall Street. In fact this is a recurring theme throughout the book that should cause some alarm: that is the degree to which the vast majority of Wall Street workers are totally ignorant about how their industry works. The group realise that the environment in which they are working is so compromised that they go for broke and decide to create their own exchange, the IEX which finally went live in late 2013.

In brief – but read the book – when a pension fund or investor sends in a buy order for say 10,000 shares of Microsoft, the order would be raced ahead to the phenomenally fast HFT networks where the order would be examined. The HFTs would see that you wanted to buy Microsoft shares at, for example, $100 dollars, they would search the, by now fragmented exchanges, find some shares at a fraction less say $99.99 and then sell them to you at your desired $100, making a profit, all in the blink of an eye, literally. This is front running and it is illegal. The High Frequency Traders had inserted themselves like parasites in between the investor and his order and nobody even knew. It was like a secret cabal that hid behind incomprehensible jargon about fibre optics and routers. The amounts being skimmed from afar might seem risible, but multiplied by the millions of trades every day, the pennies added up to billions over time.

Flashboys by Michael Lewis  - published by Allen Lane

Flashboys by Michael Lewis – published by Allen Lane

The phenomenal success and profits of the  companies specialising in High Frequency Trading, like Getco and Citadel were pushing the major Wall Street banks to participate in High Frequency Trading not only to stay alive in the equity markets but also to ensure their slice of a pie that is estimated to be worth between 10 billion and 20 billion a year, depending on who you believe.  This profits were risk-free – your position at the end of the day was zero.  The HFT traders were quite simply skimming US investors but to play their game you had to invest in expensive technology and, above all, get your hands on the brightest technology talent going – often Russian geeks.

The story is almost uplifting, an unusual thing to say about high risk finance, and even Goldman Sachs comes out on the side of morality and justice (at least in the HFT part of the story) although perhaps simply because they could not compete with the cutting edge technology so they decided to colonise the moral high ground for when the shit hit the fan.

It is an excellent read by a gifted writer but despite having caught Wall Street with its hands in the till, you get the impression that the environment is so incorrigible and pathological that Michael Lewis will have plenty of raw material for many more books in the not too distant future.

Without wishing to sound too dramatic, it is a book that looks like it will make Wall Street history and upset a lot of very wealthy players.  At the time of writing  New York’s Attorney-General, Eric Schneiderman, has just sent subpoenas to six high-frequency trading firms.

Michael Lewis was born in New Orleans and educated at Princeton University and the London School of Economics. He was written several books including the New York Times bestsellers Liar’s Poker, widely considered the book that defined Wall Street during the 1980s, Boomerang and The Big Short, ‘probably the best piece of financial journalism ever written’ (Reuters). Lewis is contributing writer for The New York Times Magazine and also writes for Vanity Fair and Portfolio magazine.

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