The publication of Flash Boys, Michael Lewis's bestselling exposé of high frequency traders (HFTs) in the finance industry, could hardly have been better timed as a call for the Feds to step in. In the wake of the book's launch in early April, several regulatory agencies rushed to disclose that they were already taking action. For much of the past year, it appeared, the Justice Department, the FBI, the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority had been investigating HFT firms and exchanges for violations of insider trading and other Wall Street rules. Not to be upstaged, the New York state attorney general, Eric Schneiderman, threw his own white hat into the ring. His office recently announced that subpoenas were being sent out to exchanges as part of a probe into their relationships with the HFTs. On the same day, the NYSE, now only one of the many exchanges driven by electronic trading, reported it had reached a $4.5m settlement with the SEC over related violations regarding "co-location" – the practice of allowing HTFs to site their computers right next to the exchange's "matching engine" so that information can be accessed more rapidly.
Closer scrutiny of these kinds of relationships is sure to follow, along with some new rules. There may even be some prosecutions, though it is widely held that receiving trading data a few milliseconds ahead of someone else – which is the raison d'etre of HFT – is not very illegal. Wrong perhaps, but technically above board, if only because the SEC rules actually oblige brokers to seek "the best price" for a security. Even so, the outrage and pushback from Wall Street (Lewis, unsurprisingly for a sales seeking author, has described it as a "shitstorm") has been cacophonous, and it's easy to see why. After all, Lewis's takeaway argument is that the stock market is being rigged in favour of front-running traders, and that other players are being screwed for having slower connections. This allegation is especially threatening to the all-important image of the stock market as open and transparent. If the odds really are being stacked against those Lewis calls "mom and pop investors" (middle-class retail investors), then we can retire the myth that finance is a clean game for all – as opposed to a turbocharged machine, or even a vampire squid, for sucking up revenue for the very rich 1%.
Perhaps this also explains why so many government regulators have lined up to show how zealously they are hunting down wrongdoers on Wall Street. For one thing, their hot pursuit of the miscreants is a handy response to the consensus view that elected officials have been lax in cracking down on the highly publicised transgressions of the finance industry. It might be late in the day, but here we are, working hard to nail the swindlers! And, perhaps more importantly, the unspoken (and unspeakable) goal of the regulators is to ensure that the illusion of market fairness is maintained. Every so often, that requires making a spectacle by throwing out some of the bad apples.
The HFT scandal is only the latest evidence that the stock market's clubby insiders have always enjoyed an advantage from better and faster information. Yet the fiction of equal access is necessary to draw the punters into the casino, and to ensure that the market escapes the fate of being heavily regulated. Lewis goes one step further: he does not trust that the regulators can do very much at all, so he showcases how the market can reform itself.
The moral champion in Flash Boys is Brad Katsuyama, a very well-paid stock trader at the Royal Bank of Canada, who figured out that the high-frequency guys were front-running his orders. Using fibre-optic cables that link superfast computers to brokers, the HFTs intercepted and bought his orders, selling the shares back to him at a higher price, and pocketing the margin. The mother of all schemes is an 827-mile cable running through mountains and under rivers from Chicago to New Jersey that reduces the journey of data from 17 to 13 milliseconds. A transatlantic cable still under construction will give a 5.2 millisecond advantage to those looking to profit from the spread trade between New York and London. Convinced that a level playing field was a better business proposition, Katsuyama responded by helping to launch a fully transparent exchange (IEX), to ensure that trading information reaches all investors at the same time.
Lewis has written an effective exposé, but in arguing for the "commercial heroism" of IEX's founders, he ends up polishing the myth of the market as a self-correcting mechanism. Left to its own devices, and drawing on the non-stop innovation of the finance industry, the market will flush out impurities and revert to its benign state of nature in which all participants have an equal shot at beating each other. According to this scenario, the failure of the regulators is preordained. Besides, the second-string graduates who take government jobs in regulation can never outperform the brainiacs who flock to Wall Street.
Let's be clear about one thing. The inability to put "banksters" behind bars has nothing to do with the market's invisible hand or the mental superiority of the quantitative analysts who create algorithms for the supercomputers. Rather, it is a blunt reflection of the power of the creditor class to hold elected officials in thrall. Attorney general Eric Holder's confession, in Senate testimony last year, that the kingpins of high finance were "too big to jail", was a candid acknowledgment of the impotence of such officials. It confirmed the growing perception that the US has joined the ranks of failing democracies, where governments cannot protect their debt-burdened citizenry from economic damage caused by the "creditocracy".
The hefty fines doled out in recent years to JP Morgan Chase, Wells Fargo, Citigroup, Bank of America, RBS, Barclays, UBS and other banking titans are now merely regarded as the wrist-slapping cost of doing business. Federal prosecutors are now threatening to bring criminal charges against BNP Paribas and Credit Suisse. But no one expects to see top executives in handcuffs any time soon. Mass economic disobedience in the form of debt refusal is more likely, and would be a more effective threat to Wall Street and other banking centres, though it is far off at present.
If the brouhaha around Flash Boys helps to pre-empt a jumbo meltdown automatically triggered by the HFT machines (the "flash crash" of 2010, which saw a 1,000 point swing in the Dow, was an advance warning), then it will have done some good. But let's ask why the publication of a book such as Matt Taibbi'sThe Divide has generated so much less attention. Drawing on his Rolling Stone reporting in the five years since the 2008 crash, Taibbi fully details the record of bankers' malfeasance and extortion. The result should enrage everyone who has been on the wrong end of the predatory lenders, crooked collection agents, illegal foreclosures, PPI ripoffs and other swindles that are considered business as usual by the finance industry. The dupes in Lewis's story are the Wall Street brokers and hedge-fund managers who were outrun by flash boys "who would sell their grandmothers for a microsecond". The victims in Taibbi's book are the rest of us.