Why Should “Flash Boys” Shock Us?
Media coverage of Wall Street scandals often vilifies individuals or specific practices as corrupt while failing to grapple with deeper problems posed by the financial sector. Missing from most coverage, too, is an examination of the growing role Wall Street has come to play in both our economy and our democracy.
This familiar pattern is repeating itself this week, with the publication of Michael Lewis’s new book, Flash Boys. The book, which has been featured in a 60 Minutes segment and excerpted in the New York Times Magazine, is being breathlessly hyped as an illuminating exposé of high-frequency trading. High-frequency trading is a form of rapid securities trading based on complex computer algorithms. (This type of trading is short-term by nature and should not be confused with long-term investing.)
Lewis is making headlines by charging that “[t]he United States stock market, the most iconic market in global capitalism, is rigged.” High-frequency traders use lightning-fast computers to rip off investors by “front-running” trades: taking advantage of advance knowledge of an order for their own gain. Front-running can be enormously profitable, and though it’s illegal, it’s difficult to detect. In short, in the words of Janet Maslin, who reviewed Lewis’s book for the New York Times, high-frequency trading has opened up “immense new opportunities for skimming, kickbacks, secret fees and opacity.”
None of this is new, however. In recent years, everyone from finance journalists to finance bloggers to Nobel Prize-winning economists have warned about the serious problems with high-frequency trading. Besides being a rip-off for investors, these trading practices also increase the vulnerability of financial markets to systemic risk. This is why the parade of notables vying for the Captain Reynault Memorial Award and declaring themselves shocked (shocked!) at corrupt practices within the high-frequency trading sector is mystifying, to say the least. For example, Maslin, describing what she deems Flash Boys’s “shock value,” claims the book is “guaranteed to make blood boil.”
Well, okay, Janet Maslin is not a finance industry professional. But how, then, does one explain the reaction from David Einhorn—billionaire hedge fund manager, former subprime mortgage lender, and known insider trader—who also, in the New York Times Magazine excerpt, expresses “shock” after being filled on in the details of the industry’s sleazy practices? In his case, the protestations of stunned disbelief seem performative, at best.
I haven’t read the book beyond the Times excerpt, but the excerpt’s portrayal of Einhorn is consistent with the way Lewis depicts him in interviews. That Lewis takes Einhorn’s “shock” at face value is emblematic of what’s troubling about his approach. For Lewis, the financial sector is divided into the guys in the white hats and the guys in the black hats. He actually has his “hero” character saying the following to his wife: “It feels like I’m an expert in something that badly needs to be changed. I think there’s only a few people in the world who can do anything about this. If I don’t do something right now—me, Brad Katsuyama—there’s no one to call.”
If I heard dialogue that corny in a movie, I’d throw popcorn back at the screen.
The tale Lewis spins is a sordid one, albeit one for which Lewis supplies a conveniently happy ending. With support from Goldman Sachs and other major investors, the hero of his book develops his own private high-frequency trading exchange, one that is supposedly much more on the up-and-up than the existing ones. Market forces ride to the rescue once again; markets are self-adjusting, don’t you get it?
Others have better ideas about how to fix the serious problem posed by high-frequency trading. The economist Dean Baker has called for a transactions tax on the practice. There is support for such a tax among Congressional Democrats, but Treasury secretary (and former investment banker) Jack Lew has thus far staunchly opposed it. However, a transactions tax, Baker says, “could make this sort of rapid trading unprofitable since it depends on extremely small margins. . . . [It] would quickly wipe out the high-frequency trading industry while having a trivial impact on normal investors.”
Would we want to wipe out high-frequency trading? Its defenders claim that this type of trading satisfies the market’s demand for “liquidity,” but there’s little evidence that it produces anything of economic value. In fact, it’s an excellent example of the kind of practice the financial sector has become notorious for: wealth appropriation. The traders involved are lavishly rewarded, not for performing an economically useful service, but for manipulating markets for personal gain. High-frequency trading has virtually nothing to do with what is supposed to be Wall Street’s primary task: efficiently allocating capital toward optimal investments.
As Joseph Stiglitz, among others, has pointed out, the financialization of the American economy has been one of the primary causes of our country’s soaring economic inequality. That’s why it’s urgent we dramatically step up regulations and increase taxes on the financial sector. High-frequency trading is a problem, but it’s only one small-time hustle. The entire financial industry has become a gigantic con. The public outrage over high-frequency trading is a welcome development, but let’s hope it doesn’t stop there.