Book Award

Greed Meets Speed

High-frequency trading: where greed meets speed. Source: Coverpicture/seewhatmitchsee
High-frequency trading: where greed meets speed.
  • Why it matters

    Why it matters

    The Deutscher Wirtschaftsbuchpreis (German Business Book Award) is presented each year to honor an author keenly conveying an important business, financial or economic topic of our time to a general audience. Sponsored by Handelsblatt, the Frankfurt Book Fair and Goldman Sachs, the prize carries the motto “Understanding Business” and comes with €10,000.

  • Facts

    Facts

    • Michael Lewis, a former investment banker turned financial journalist, first gained notoriety with his book “Liar’s Poker” published in 1989.
    • His latest book “Flash Boys: The Wall Street Revolt” uncovers the secretive world of high-frequency trading.
    • The dubious practice costs regular investors tens of billions of dollars each year.
  • Audio

    Audio

  • Pdf

Those who suffer from high blood pressure should avoid this book at all costs – it raises your heartbeat, whether you want it to or not. The author knows how to generate waves of indignation and trigger surges of anger.

Along these lines, this book is bad for your health.

But without outrage, there can be no rebellion. And make no mistake: We need to rebel to prevent the destructive financial practices described in this book from taking hold in Europe.

And Michael Lewis leaves no doubt: It’s time for a revolution.

With “Flash Boys: A Wall Street Revolt,” Mr. Lewis, a Princeton graduate and former investment banker, has not produced another typical work of non-fiction, but rather a forceful indictment of an inbred financial industry and its latest threat to mankind, the technology behind automated high-frequency trading.

The two dominant, contentious debates over data – one on the power of information and the data collector, and the other on the change in banking culture, overlap in this book. The hyper-complexity of automated trading technology and the self-indulgence of its creators are the central themes of “Flash Boys.”

Mr. Lewis didn’t just write a good book, but an efficient one on these themes.

The book carries us into the dark world of New York high-frequency traders, who aren’t the usual market makers with contact to clients, but computer geniuses who can make fast networks even faster. The private trading networks they built are now so fast, in fact, that a securities order from Chicago to New York and back takes only 12 milliseconds – 12 thousandths of a second.

As Mr. Lewis vividly describes it, that’s one-tenth of the time it takes to blink an eye.

Greed meets speed.

This new species of stockbroker rents modern fiber-optic networks – so-called “golden roads” – and builds computer centers as close as possible to stock exchanges. They program automated selling and buying programs, which they feed with information about stock orders that have been placed – and here is the cruel punch line to the joke – but which have not yet been widely reflected in prices.

It is always about being faster than, one profitable step ahead of, the market.

Some high-frequency traders would have sold their “grandmother for a microsecond,” Mr. Lewis quotes one as saying in “Flash Boys.”

 

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The 2014 German Business Book Award winner Michael Lewis. Source: Reuters

 

But how does one speed up money?

Michael Lewis explains it to us: Take, for example, if Proctor & Gamble is selling on all U.S. stock exchanges for $80 a share.

Then a large bundle is sold in New York, and the price on the New York Stock Exchange declines to $79.98. The flash trader buys stock on the New York exchange at the new, lower price, and sells it on other exchanges for $80 before the rates there have been officially adapted.

Information about an order in itself becomes a product. It is not by chance that we remember Frank Schirrmacher, the late co-publisher of the Frankfurter Allgemeine Zeitung, who died suddenly earlier this year. Mr. Schirrmacher alluded to exactly this perverse development in the Google Debate: Those who seek, will become the suppliers, and those who buy, will become the product.

Data is indeed the new gold standard in “Flash Boys.” Silicon Valley and Wall Street apparently calculate in the same currency – which still seems oddly foreign to us as Europeans – those sets of data we create ourselves.

But who wins and who loses in this game?

At least for Wall Street there is a clear answer. The flash trader’s gains – profits that could run into the tens of billions of dollars each year – are a loss for conventional shareholders. They are the ones who ante up the money earned by high-frequency traders. Investors are milked twice: Once by the bank they use to place their order, and again by flash traders.

High-frequency traders stand before us as descendants of Count Dracula, sucking the blood of clueless investors and lethargic large banks.

But the worst and most shocking part of the story is still to come: Both of these milking machines are connected. The large Wall Street banks and flash traders work together. They do this by sending customer order information to “dark pools,” which are computer centers that sell the information to flash traders.

Or sometimes banks make flash trades on the advance information themselves.

Mr. Lewis writes: “The concealed doors and hidden pathways of the exchanges give a handful of players the possibility of fleecing the other market participants.”

The industry name for this is “dark pool arbitrage.” Or, as one hero in Mr. Lewis’ book calls it: “A system has sprung up that lets the investors down.” Not just speed, but also opacity is converted into cash.

The danger of shady actors being exposed is extremely small, because one can’t see in the dark. Things are always happening in milliseconds, so the normal investor has no chance of noticing this form of front running aided by technology. The cheating happens so fast that those who are cheated do not notice it. At work here are the simple slower limitations of human biology versus the machine, which humans have programmed to work against themselves.

 

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“Flash Boys” is more than a standard work of non-fiction. It is a horror story that has become reality. High-frequency traders stand before us as descendants of Count Dracula, sucking the blood of clueless investors and lethargic large banks. The slower, more traditional the participant, the quicker he becomes a victim who unknowingly offers up his own throat.

And what about the regulatory agencies? They are doing what they have often done: They are deep in an unsuspecting slumber. Or maybe put more charitably for those truly dedicated supervisors: The technological possibilities are faster and more complex than the capabilities of the watchdogs.

If a group of market participants has nothing else in mind than to harm the rest of society – Ann-Kristin Achleitner once referred to a “deformed generation” of bankers – then it is difficult for the state to prevent this.

Moral behavior cannot be mandated. Dysfunctional economic systems cannot be fixed by lawmakers and prosecutors alone. Albert Camus, the French Nobel Prize laureate in 1957, once warned: “A life whose purpose is money, is death.” But what do we do when this insight is so widely ignored?

“Flash Boys,” written from the current American perspective of a near-religious worship of money, is also a philosophical book because it reminds us that economies need an ethical foundation to survive. Otherwise, they will degenerate into a form of economic Darwinism which rewards those who have the fewest scruples and penalizes those looking out for the common good.

This book prize for an American author who sees what threats are heading in our direction is also a clear warning sign.

Unlike the technology evangelists would have us believe, technology does not, in and of itself, increase prosperity.

Instead, Mr. Lewis writes, technology has special implications for Wall Street.

Technology, he says, had increased efficiency, “but it had also been used to introduce a peculiar sort of market inefficiency. This new inefficiency was not like the inefficiencies that financial markets can easily correct.”

A danger foreseen is not a danger half-avoided. This book and its protagonists bring a message. As one said: “I look at us exporting our business model to all of these different countries, and I think, ‘It’s like exporting a disease.’”

Which brings us to our book prize.

Because this book prize for an American author who sees what threats are heading in our direction is also a clear warning sign. The politicians, the regulators and banks themselves are invited to isolate and stop this form of malignant capitalism, unless they want to lose their last friends.

There is reason for optimism.

Lastly, “Flash Boys” is also a political book, required reading for German chancellors and those who want to be chancellor. Because it contains warnings that we Germans should take to heart before high-frequency trading becomes a mass phenomenon here.

At the very least, we should learn from the mistakes outlined in “Flash Boys.” Ironically, we have an advantage this time in following the pack – or better put, choosing not to follow the pack. We in Europe can shape a better future, and better functioning financial markets. And that would make the prize money awarded to Michael Lewis money doubly well spent.

 

Gabor Steingart, the publisher of Handelsblatt, gave this speech on Thursday in Frankfurt while presenting the German Business Book Award. To contact the author: steingart@handelsblatt.com

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