I don’t skateboard. But the title of Michael Lewis’s new book on high-speed trading, Flash Boys, made me think Lewis could’ve called it DC-town & Flash Boys.
Legendary skateboarder Stacy Peralta directed the 2001 documentary Dogtown & Z-boys chronicling the meteoric rise of a craze involving slapping wheels on little boards and engaging in aerobatic feats using public infrastructure such as steps and handrails. From Dogtown, slang for south Santa Monica near Venice Beach, Peralta’s Sean-Penn-narrated film tracked the groundbreaking (and wrist-breaking) 1978 exploits of the Zephyr skateboarding team, thus the “Z-boys.”
Skateboarding has got nothing to do with trading, save that both are frantic activities with dubious social benefit. We’ve been declaiming on these pages for more than a half-decade how fast intermediaries are stock-market cholesterol. So, more attention is great if the examiner’s light shines in the right place.
If you missed it, literary gadfly Lewis, whose works as the Oscar Wilde of nonfictional exposé include Moneyball (loved the movie), Blindside, Liar’s Poker and the Big Short, last week told 60 Minutes the US stock market is rigged.
The high-frequency trading crowd was caught flat-footed. But yesterday Brad Katsuyama from IEX, a dark pool for long investors that rose out of RBC, dusted it up on CNBC with Bill O’Brien from BATS/Direct Edge, an exchange catering to fast orders.
Which brings us to why Lewis might’ve called his book DC-town & Flash Boys. The exploitation of speedy small orders goes back to 1988. In the wake of the 1987 crash, volumes dropped because people feared markets. The NASD (FINRA today) created the Small Order Execution System (SOES – pronounced “soze”) both to give small investors a chance to trade 100 shares electronically, and to stimulate volume. Banditry blossomed. Professionals with computers began trading in wee increments. Volume returned. The little guy? Hm.
Regulators have always wanted to give the little guy opportunity to execute orders like the big guys. It’s admirable. It’s also impossible. Purchasing power is king. Attempt to make $1 and $1,000 equal in how trades execute, and what will happen is the big guys will shift to doing things $1 at a time. The little guy will still lose out but now your market is mayhem confusing busy with productive.
These benighted gaffes seem eerily to originate in Washington DC. Michael Lewis says big banks, high-speed traders and exchanges have rigged markets. We agree these three set prices for everybody. But they’re following the rules.
It’s like basketball. Rules now say that every play-stoppage in the last two minutes of a game must be reviewed. So in the final 2.3 seconds of the Wisconsin-Arizona game, an epic and nearly perfect sports achievement up until that moment, play was halted for FIVE MINUTES while referees scrutinized film for who touched the ball last. Basketball depends on tempo. Alter rules, and you change the game.
Regulation National Market System similarly confuses the purpose of the enterprise. Reg NMS linked markets around a national best price, forcing competitors to share orders and to undercut each other, while perversely rewarding data revenues to exchanges setting the price most often.
What did we get? Pandemonium in pursuit of price-setting that coalesced into a game controlled by big banks, HFT firms and exchanges. But we should single out the refs. The SEC. Penalizing people for adroit rule-following is – well, as dubious as HFT.
Look, I like the folks there. They’re eminently approachable and they mean well. Give the little guy a shot. But we can all see that the entire purpose of the enterprise has been altered for an objective that is unachievable.
Maybe it’s time we pulled the plug on Reg NMS. HFT would then be a sideshow. And I bet the SEC would throw in monthly ownership and daily trading data for public companies. That would be face-saving. So now is the time to ask!
And, thank you, Michael Lewis!
PS – Come join us at the Philly NIRI chapter April 10 as we discuss this in part, and whether the case ahead for markets is bullish or bearish. Should be interesting!