Flash Boys for the People

My defense of high-frequency trading in todays NYTimes is here.

Had I another couple of hundred words, I’d have elaborated on the fact that HFT can be viewed as the revenge of the sell side. After years of being condescended to by the buy side, regulated and having their margins squeezed, the sell side has found revenue in HFT. It’s still not an easy way to make a lot of money – it’s highly competitive and takes a lot of investment in infrastructure – but given the beating the sell side has taken in recent years, it’s not surprising they’ve been happy to make money of HFT.

I’d also not that IEX, the platform described by Lewis in Flash Boys is not the first to try to offer a cleaner platform for institutional traders. Pipeline Trading Systems, which existed from 2004-2012, offered an exchange for large investors to trade away from the high-frequency traders. It leased software from Fidelity and declared itself “predator proof.” Unfortunately, Pipeline could not drum up enough natural buyers and sellers on its exchange, and was found by the SEC to be illegally funneling them in from a trading affiliate.

Liquidnet is another platform which has struggled to become more than a marginal player. The biggest traders have been reluctant to antagonize the investment banks by using alternative exchanges. IEX’s solution of delaying trades so they hit the exchanges simultaneously may prove to be the solution to the market inefficiency the block traders have discerned. Time will tell if they’re really onto something.

And finally, investors I’ve spoken too seem very mixed on this. Some say, if you’re sweating fractions lost to HFT, you’re not much of an investor. Others that’s it’s a real and considerable cost on their trading. Others say that the real rigging of the system is in favor of short-term traders, who are rewarded with low commissions for trading a lot, and long-term traders who pay higher commissions because they trade less often. Yet for the health of the economy, who’d you rather have in business?

My friend Mungo Wilson at the Said Business School pointed me to this wonderful piece by Brad Barber and Terrance Odean from the Journal of Finance, April 2000: Trading is Hazardous to your Wealth. If you find HFT such a nuisance, perhaps easiest to avoid it altogether as well all the other frictional costs of trading, by trading less.

Review of Flash Boys


Caution: Stock traders at work.
Caution: Stock traders at work.

My review of Michael Lewis’ Flash Boys is in today’s Wall Street Journal.

And here’s my Twediction that high frequency trading will face a raft of new regulations within 12 months.

A great book on all kinds of levels: a takedown of high-frequency trading; a Dirty Dozen yarn of outsiders taking on the Wall Street establishment; a righteous tirade against the excessive complexity and insanity of the financial system; a cry for finance to stop sucking money and smart young people out of the rest of the economy. (There is even a wonderful echo from Lewis’ previous book, The New New Thing. On one side of the HFT industry, building a fiber-optic line from New York to Chicago to carry financial data, is Jim Barksdale, the former CEO of Netscape. On the other, backing an HFT-proofed exchange, IEX, is Jim Clark, Netscape’s co-founder. These guys never go away. They are always there applying technology in new, disruptive ways.)

My only caveat is that Lewis may be over-stating the villainy and importance of HFT. Long-term investors don’t worry about a few fractions of a cent when they buy or sell a stock. And even short-term investors may not either. Then there’s the ever rising cost of building the infrastructure for HFT, paying to see order flow etc. This is not a cheap business to get into and sustaining healthy margins is a sweat.

(I note in the review that there are reasonable arguments that the HFTs provide liquidity and greater price efficiency. You don’t have to agree with them, but here’s one, a paper published by the European Central Bank last fall.)

More convincing to me was Lewis’ point that all the frenzied HFT activity renders the exchanges unstable, and has already caused flash crashes and other market spasms. But again, how much of this is due to the simple onward march of technology vs. HFT? Standing athwart progress and shouting “stop, it’s all getting too complicated for the human mind” doesn’t seem the right answer.

Regulators are already all over HFT. I wonder if they’ll find any evidence of actual criminality. Even Lewis concedes the HFTs’ actions are legal. Not pleasant, but legal, the result of a regulatory loophole.

Flash Boys provides yet another cudgel for those who loathe Wall Street and blame it for all the economy’s ills. HFT will likely now be squeezed out of existence. I never thought I’d say this, but I hope this marks a temporary end to this recent era of Wall Street bashing. What’s transforming economic life in America isn’t Wall Street anymore. It’s the vaunted technology companies of Silicon Valley. They are rightly admired for their innovation and daring. But they’re also draining the economy of jobs much faster than they create them. And their revenues dwarf any made on Wall Street. They represent the toughest paradox in the US economy today. Taking them on will make HFT bashing look as one-sided as seal-clubbing.