Fast-forward a few weeks and I’d completed my own investigation, found the perp residing at a local campsite (they’d pivoted their business model from a campsite for countryside walkers to government funded housing for convicts on soft-release) and helped the police join the dots. It was a worrying time for my family but I don’t blame the perp. Although still only a teenager, he was already a prolific criminal, with an instinct for criminal opportunity. He walked past my house and thought ‘why not’. No, the system put him there, and I blame the system. And this is exactly how I feel having read Flash Boys by Michael Lewis.
Before reading this book, I was aware of the buzz, had read several other books written by Lewis, followed the use of dark pools and more recently the Barclays law suit, as covered on this very website here. My day job involves helping wealth managers scale their businesses and so I also have a passing professional interest in the subject matter too. The first thing to say is that you are left wondering what the ratio between fact and fiction is. The combination of complex subject matter and wonderful story-telling, does lead one to assume that it’s all true! However, a few rudimentary searches uncover plenty of criticism. You could assume that such an attack on Wall Street and the markets, which according to Lewis are ‘rigged’, will bring about a swift and vitriolic response from those accused, and that all the criticism is therefore defensive, but Lewis never actually recounts any direct contact with High Frequency Traders (HFTs) and glosses over the Flash Crash like it was a fender bender, so perhaps some of the criticism is fair.
So, what of the subject matter itself? Well, firstly, it’s complicated, but by no means impossible to understand. I’m no genius (far from it in fact) but I can follow the idea that if a trading venue (exchange) goes from being a service, to a business, you must expect competition. Add in the development of new technologies, improved methods (and in particular speeds) of communication and new business models and sadly, the same old cat and mouse between the regulators and those, ahem, forward-thinking organisations will ensue. The regulators are clearly several steps behind and appear to share Brad Katsuyama’s flaw as a strategist (according to Lewis), namely an inability to imagine just how terrible some organisations can act, given the opportunity.
I’m also left wondering whether it’s sensible to allow banks to vertically integrate some aspects of their supply chains. If they are acting as an intermediary, can they really manage the conflict of interest that’s brought about by offering their own dark pool, as an execution venue in the same transaction? When you also consider that (according to Lewis) some banks rent their dark pools to HFTs, allow them to co-locate for better speed, use routers that split and distribute their clients orders in a way that actually drives up share prices and do all this behind a wall of complexity and confidentiality, you can start to understand why this book has ruffled some feathers.
Having read (twice) and greatly enjoyed Flash Boys, I’m left with a few questions: -
- How do I set up an HFT firm, or is it too late already? Seriously, no risk, tiny capital requirement and not a single daily loss for most of the big HFT firms – sounds goods right?
- Am I missing something with regard to HFT? I cannot see any advantage to their existence but maybe I’m missing something inside the volatility argument?
- Is the ‘execution venue as a business’ viable and if so, should there not be greater control over what dark pools can and cannot do? Again, I’m not clear on why dark polls can be so, well dark and exchanges so transparent?
- How can the markets become more transparent for the benefit of customers? Surely any market should provide sufficient information and a fair price for buyer and seller and on the evidence in Lewis’ book and some of the recent law suits, this would appear not to be the case right now.
- How many more fines will come from this? Lewis doesn’t even bother to make a big deal about the fact that banks rent their dark pools to HFTs and as this appears to be the gist of the Barclays complaint, surely the other main Wall Street players will be lawyering-up shortly?
- How wide-spread is this activity? Are HFTs on exchanges and/or dark pools around the world and if so, does this activity affect just about everyone who has an investment of any type?
As you can see, this book leaves one with many questions and for me, that’s a sign of a true masterpiece of financial writing. Flash Boys is a brilliant book. It’s on a par with The Big Short, but better in that here, Lewis is telling a story that has yet to reach a conclusion. I look forward to finding out more and would suggest that if you are involved in investments in any way, you really should read this book and perhaps look into the wider questions it raises too.
As for the villain of the piece, try as I might, I can’t blame HTFs, in the same way as I can’t blame the young chap who tried to break into my home in broad daylight. Both are opportunists with a hunters instinct and will act, if the opportunity presents itself. No, the blame must lay with a system that allows these circumstances to arise and that must surely mean regulators carry this particular can. This would appear to be another moment in time, when we all wake up to the way our financial system actually works and the reality that there will always be those seeking to game it. Regulators need to get out in front, or at least try some new strategies to catch up faster. Maybe they should hire Michael Lewis!
Rob is active on Twitter and you can follow him @RobS_Kingmakers