Tuesday, May 06, 2014

Flash Boys

With Michael Lewis, you never really know who's going to show up.  Will it be the Michael Lewis who is one of the best non-fiction writers in the English language, or the Michael Lewis who's all too aware that he is just that?

I saw the latter guy give a talk at a Sungard conference sometime back in 2010 or so, not so long after The Big Short came out.  I was excited, as I was hoping the first guy would show up and give us something we hadn't heard before.  But Lewis preferred to slouch back in his comfy chair on stage, wave his arms around a little, and give sort of a condensed version of the book, adding not even a fresh anecdote. I was, truth be told, rather disappointed, I felt like I hadn't gotten my money's worth, even though it was free.

The curious thing was that, when I talked later to my colleagues from an industry analyst firm dedicated to financial services and the technology that undergirds it, nobody had read the book.  Not a single person.  I was a little shocked by that, as The Big Short was, by consensus -- including me -- one of the more important and best books about the financial crisis, so this was our home turf.  What's more, there's really no good reason not to read one of Lewis's good books, because when he's clicking, he's the most readable guy in the world. They're the kind of books that the only reason not to read them in bed is that they'll keep you up late, wanting to turn pages to see what happens next.

At the end of that conference, in front of 300-400 members of the slightly tawdry demimonde that is financial technology, one of my colleague's faces was shown up on an enormous screen.  He said something like "high-frequency trading is good for markets because it provides liquidity."  The party line.  Somewhere inside I nodded, because really it was words on a page to me, I knew nothing.

Fast forward a few years to a month ago. I was on vacation in Texas when Lewis released his most recent book Flash Boys, on the subject of high-frequency trading (HFT) and what it's doing to the markets. There was a lot of press coverage, no little hue and cry, and the New York State Attorney General and the SEC both hustled up to the microphone to tout their own efforts to curb the excesses of the HFT crowd.  On the one hand, it's unseemly to see our regulators whipsawed by the publishing industry.  On the other, that's what a free press is for, and we should maybe be proud to see this kind of thing happen.

It took me a few weeks to get my hands on a copy of the book.  I was too cheap to buy it at an independent bookstore at full price, but I also didn't want to stick it on my iPad Kindle, because I hate for Bezos to have all my money.  I compromised and bought it at 30% off of cover price at B&N, because they too are hurting and the book ecosystem needs more than one big player so it is not entirely captive to Amazon.  But I digress.  Imagine that.

So now I have read the book.  I will confess that I was initially inclined to think Lewis was overblowing things in his focus on how the HFT players are racing in and skimming pennies off of each trade, seeing orders pop up on one exchange and racing off to the next or a convenient dark pool, microseconds in front of the order, to buy the stocks cheaper and then fulfill the order.  How, I asked myself, could this happen in the wake of Reg NMS, which was supposed to fix this problem?  Lewis bats that one down, showing how Reg NMS paradoxically made things worse in its ham-handed attempt to create a national best price for each security.

Flash Boys is a traditional story of good and evil.  The evil is obviously the high-frequency traders, and the good is no less evidently Brad Katsuyama and the motley crew he assembles first at the Royal Bank of Canada, and then at the new exchange they opened to level the field against HFT.  Part of me hesitates to fully embrace these guys, perhaps because I know them only from this one book, and Lewis is so very breathless in support of them.  I'll learn more, time will tell.  He paints a pretty convincing picture, but then so do trompe l'oeil painters, now don't they?

And, on the one hand, I'm not really sure that HFT is worse in aggregate than other forms of mediation.  Trading costs are lower now than they were in the days of open outcry in the pits, and in the days before prices were decimalized, right?  Then again, if HFT isn't serving a useful purpose in the markets and there's a chance to root it out, we might as well.

Lewis has written a number of important books:  Liar's Poker, Moneyball, The Big Short, and now this one.  Having read it, I can at least have a semi-intelligent conversation on the topic of high-frequency trading.  The key for most of us is, as always, to know ourselves, and trade less.

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