If you bought shares on a US exchange in the past few years, you’ve probably been ripped off.
To the litany of sins of which American investment houses have been accused, Michael Lewis adds another: permitting and encouraging the siphoning of cash banks’ customers spend on equity transactions to high-frequency trading firms (HFTs).
These companies are faster than you. They find out when you’re buying or selling shares and change the prices before your order has been executed, profiting from the difference. Your bid order takes hundreds of milliseconds to process – in the meantime, an HFT has bought the shares and will sell them back to you at a fractionally higher price, ekeing out a tiny margin, but one which, when multiplied by an exchange’s billions of daily trades, starts to resemble a rigged slot machine at a casino, permanently dispensing coins. Nice work if you can get it.
Lewis's lastest book, Flash Boys, follows a team of investment bankers and tech wizards, initially at the Royal Bank of Canada, who discover widespread, but perfectly legal, rip-offs of consumers across the stock market by colluding HFTs, brokers, and major investment banks. The consumers include pension funds, hedge funds, and the biggest institutional equities traders. They set up a bourse that should be immune to HFTs' chicanery.
Lewis’s expose is a phenomenal work of journalism. He tells a perhaps unprecedentedly complex story in pellucid prose. It is a vital, important and stirring call to action.
There’s a bigger theme: the clash between regulators and Wall Street’s engrained culture. This is a system where the spirit of the regulations is never addressed, rules are bent beyond recognition by numerous actors in the endless pursuit of extra business, and where major institutional players – many of whom are the biggest names in the business – are willing simply to disregard their clients’ best interests at the first opportunity.
Perhaps criminal penalties following the financial crisis might have done something to change behaviour. We’ll never know, and, as Lewis points out, there is no small irony in the fact that the only individual to be arrested on Wall Street following the crisis was arrested at Goldman Sachs’ request.
Something’s rotten in the skyscrapers on Wall Street.
q&a middleman takes his cut
Does high-frequency trading have any defenders?
Yes. Market making is the service brokers provide by offering to buy (the offer) and sell (the ask) the same financial product, with a difference in prices for the same product, known as the bid-ask spread. They work in the same way as a currency exchange kiosk does. They are economically useful – they contribute to price transparency by increasing the likelihood that advertised prices reflect the prices of actual trades, and they make buying and selling more efficient by ensuring that customers at an exchange usually have someone to trade with at prices they are willing to pay. Some argue that HFT firms act as market makers.
Are HFT firms market makers?
There’s nothing to stop them acting like ultra-speedy brokerage services. But this wouldn’t be quite as lucrative as an alternative strategy called front-running: the HFT firm learns of an order by getting data from a major institutional broker, then quickly executes orders designed to change the price of the security traded, while pocketing the difference.
Does this have any of the advantages of market makers?
Defenders of HFT think so. But this isn’t true, because the HFT firm will facilitate a trade only where a buyer and seller already exist and have been matched by the market. So stated prices will already reflect the value of the transaction, and the mutual coincidence of wants required to complete the trade already exists. So the HFT firm skims money off the top of other transactions that would have happened anyway.
abouyamourn@thenational.ae
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