9.0 Is the Market Rigged?
This is my third Michael Lewis book and I am not getting enough of it! Flashboys has been named as one of the two most influential books of the year. (The other one is Capital in the 21st Century which I am still crawling through the tightly packed pages). I read it with high expectations and I wasn’t disappointed.
The market is rigged.
He did what he has done the best in his previous books: storytelling. Flashboys was made of a dozen stories from real people: a technologist accused by Goldman Sachs for corporate espionage, a Japanese Canadian who wants to create a fairer market and contractors who lay fiber optic cables to connect Chicago to New York in a straight line. The stories all interconnected eventually to deliver one single message: the system is rigged.
When the buzzing stock exchange floor was replaced by blinking routers and servers, it was supposed to eliminate the middle men so that it brings down trading cost and improves efficiency. The market is now directed by algorithms. Thanks to decentralization of stock exchanges and flawed regulations (or are they ever going to be perfect?) opportunities proliferated. The transaction cost has come down whereas the labyrinth of cables now connects the skyscrapers turned to be the promised land for the few enlightened. The few who saw the value to lay optic fiber straight through a mountain, to place their server one inch closer to the door and to connect a microsecond faster than the rest. They hit a gold mine, arguably at the cost of the investors. The algorithms powered by their faster machines appear to make an easy kill on the algorithms that now direct the market places.
“The market is fair, but it is fairer to some than to others”
The big banks and stock exchanges who were entrusted to safeguard investors’ interests turned a blind eye and acquiesce in becoming willing accomplices, pocketing millions in the process. Exchanges have created complex trade types and provided expensive co-location service (by selling the spaces surround their match engines) for High Frequency Traders. Big banks have created dark pool (where trades happens behind closed curtain) and sold access to HFT. HFT can always look into the future for a fraction of a second ahead the rest of the investors and benefit from it. Just a blink of eyes, HFT will execute thousands of trades to buy from unsuspecting sellers and resell them back to another unsuspecting buyers before the buyers/sellers ever aware there were better price available.
Michael did it again. In less than 300 pages, he stripped the Wall Street naked. In his accusation, he blamed a few powerful market players who are taking advantage of a flawed system. He picked the easy targets to blame for the “unfair” competition. But are they really guiltier than the flawed system that allowed the practices? Yes, HFTs are making risk free money. So were tens of thousands of Wall Street bankers before them. How are HFTs so wrong now? Can a system ever be flawless? It has never truly been, neither in the centralized Soviet nor in the free spirited Western markets. As the complexity grows in a system, the entropies will inevitably spread. Even if Brad successfully attracts enough supporter for his noble motion, it wouldn’t be long for someone else to figure out another way to rig the system. For bankers trained to answer “Are we in compliance?”, “are we beating next quarter estimates?” rather than “Will this be good for the market?”, this is bound to happen.
I can’t say more about how great Michael’s book is. Michael’s talent to know where to look is genius, rivaled only by his talent to know whom to talk to. Like his previous books, Flashboys is so rich in educational value that dwarfed many voluminous textbooks. It ripped apart the Bloomberg stickers and laid bare the murky reality underneath. Read it and get amazed.