Book Review: Flash Boys

Jerry Levine

Michael Lewis has written several great books about various marketplaces. Two standouts are Moneyball and The Big Short. These books extol the virtue of determining the true value of an item in an opaque market. How do you find the real value of a minor league baseball player or a securitized sub-prime mortgage bond fund, then exploit that knowledge to find a hole in the market?

Lewis’s most recent book, Flash Boys, takes the opposite tack. Here, the math oriented, technically superior high-frequency traders (HFT) who are exploiting the hole are the bad guys, even though they seem to have a lot in common with Oakland’s Billy Bean, or hedge fund manager Steve Eisman.

In Flash Boys Lewis takes on the innovators, the HFT, for their predatory behavior. He also goes after the big Wall Street banks and their so-called “dark pools,” where big trades are made but no official printed rules exist, and where the banks making the market assure buyers and sellers that they are both simultaneously getting the best price. But both sides can’t be winning, and this contradictory claim is one reason customers’ trust in the big banks has eroded in recent years.

Once upon a time, as many of us remember, if an investor wanted to buy or sell a stock he would call a broker who would find a way to execute the trade as efficiently as possible — talking to other human beings. The arrival of computerized exchanges eliminated many of the people from the process. Now bids and offers are matched by computers. In theory this means that markets should become more efficient and the cost of trading should fall. But the effects of technology are rarely so simple.

Today, if you place an order for 1000 shares of IBM, the order is supposed to ping from exchange to exchange claiming a few shares at each stop, seeking the best price until the order is complete. But the moment the order hits the first exchange the information is out, and the high-frequency traders (with ultra fast computers and shorter fiber optic cable) see your order (especially if it’s large), and race ahead of you to the other exchanges. They buy the stock you want, and then sell it back to you for a slight up-charge. All of this happens in a matter of milliseconds — millions of times a day.

High Frequency Traders execute a combination of two old Wall Street scams — first, insider trading (seeing your order), and second, front running the market. However, in this situation, it is entirely legal. It is an unintended consequence of SEC Regulation NMS passed in 2007, intended to protect the consumer from paying too much. But it opens the door for HFT to squeeze in between trades and create arbitrage opportunities worth billions.

The heroes of the book are the so-called “flash boys,” Brad Katsuyama and a team of talented oddballs who ferret out the schemes going on and create a HFT-proofed exchange called IEX, signifying “Investor’s Exchange,” where the price a trader sees is the price he gets.

The exchange is backed by some leading hedge funds and banks who felt they were getting bilked by the HFT. The average small investor is also being taken advantage of by HFT but likely doesn’t notice a penny or two per share on an occasional trade. But if the investor is invested in a pension fund or mutual fund, he is being hurt by HFT.

Currently, even though the new IEX exchange is well on its way to financial success, there doesn’t seem to be any evidence that high-frequency trading has declined. And, in reality, the villains of this story, the high-frequency traders are not quite villains. They are just smarter and faster than everyone else. Even Katsuyama comments, “It’s not their fault. It’s brilliant what they have done legally, within the bounds of the regulation.”

Lewis’s Moneyball revolutionized the way the market for baseball talent is evaluated from the major leagues to fantasy leagues. It will be interesting to see if Flash Boys has the same effect on the financial markets.

Question: Do you feel abused by financial institutions?

Jerry Levine is a writer for Today’s Machining World, and a retired engineer who worked in BP’s chemical division.

Share this post

9 thoughts on “Book Review: Flash Boys

  1. Jim Goerges

    Yes they conform to government regulations, Timothy Geitner and the rest of the bunch. Banks are puppets in the largest ponzi scheme in the World, our economic easing. The people in control have proven they are incompetent. Latest health care problem with over 2 million people is just coming to surface. Look at how our president deals with prisoners of war! Hillary is the chief author by the way. Look at the devastation of morals and values, why would anyone be surprised at the evil nature this country is going towards. Ish!

    I would like to give a shout out to all veterans on this anniversary of D-Day, and especially my prayers and thoughts are for our veterans, especially of the families who lost lives looking for the traitor/defector who OBAMA so proudly works with the Taliban releasing war criminals, it’s a disgrace! I would also like to call out to the soldiers who were left behind in Benghazi, again a disgrace, Hillary and OBama are also responsible for this.
    What’s next?

  2. Stan Lightner

    Even though Brad Katsuyama states it is not the fault of the HFTs I applaud him for finding a way to circumvent their unethical behavior. The television piece (Dateline?) on him was excellent and also did an outstanding job of explaining the HFTs and how he was able to make an end run around them. Yes the HFTs are legal, but that does not make it ethical or moral. Bottom line it is driven by greed, one of the seven deadly sins and unfortunately the majority of people do not receive Catechism, but a highly skewed and watered down version of religious education, if any at all. In addition there are numerous examples of those who did receive Catechism, but still adopted Objectivism as their “moral compass”.

  3. Tom B.

    I won’t waste any more time reading your e-mails. The trolls who use the comment section to push their own perverted political agenda have ruined what was once an intelligent newsletter.

  4. Lloyd Graff

    To Tom B and others who think folks like Jim Georges are out of line. YOU ARE RIGHT.
    I have been overly tolerant and permissive of the haters and buffoons who abuse this blog. I am going to continue to err on the side openness to contrary opinions but when somebody attempts to commandeer my blog for blatantly stupid tirades on a frequent basis I am going to clip them.
    Thanks for the wake up call.

  5. Maury Minerbi

    Jerry’s review of Flash Boys is excellent; accurate and objective.

    Trading activity tends to improve the efficiency of markets, by narrowing the spreads between bid and ask. To that end, it can be argued that a (unintended) benefit of high frequency trading is increased efficiency.

    By reducing the number of steps and human intermediaries involved in trades, and increasing speed, computerized trade matching has benefited investors by improving market efficiency. It doesn’t contradict the points made in Flash Boys to conclude that our securities markets are generally much more efficient today than they were a generation ago.

  6. Emily Halgrimson Post author

    Feeling screwed by financial companies has resulted in a passion for using their own sign up bonuses and new customer perks against them, especially with credit card rewards. Chase takes about $550 from me each month in mortgage interest while paying me $.02/month in interest on any savings I have, so I have no qualms in milking their outrageous credit card rewards for all they’re worth, signing up for cards, getting the bonus, then canceling the card. It doesn’t hurt your credit like is rumored, and I fly around the world for practically nothing and have gift cards and statement credits piled up. Here’s a good one going on currently. 200 bucks cash back. Take em while you can.

  7. Jim Armstrong

    Yes, it is abusive; it is legal thievery,it sucks productivity. Once more the big boys get to make the rules. A simple tax law could kill the practice. Long term capital gains should be taxed at near 0%; short term capital gains should be taxed at ordinary income levels and very short term capital gains at near infinitely high rates.

  8. Jerry Levine

    I want to thank Stan Lightner, Maury Minerbi and Jim Armstrong for their thoughtful comments on the book review. These are points that I would have made if I had written more. I have a self-imposed limit of about 700 words. On the other hand, Lewis had a whole book, and did write about the whole issue in much greater detail. I hope you go ahead and read the book. It focuses on a real problem. I hope it changes the paradigm of the financial markets, in much the same way “Moneyball” changed baseball.
    I tended to focus on the problem, with little about the solutions. Lewis covered both more problems and solutions in greater detail. He really held up Katsuyama and the other flash boys as models of ethical behavior, who as Stan Lightner says, work to “circumvent unethical behavior” for essentially no benefit for themselves, but just because it is the right thing. (Lewis does point out that the flash boys recognize they will profit as the IEX Exchange grows.) One could also write a long essay on the balance in our society between greed and a moral compass. (That is the necessary check and balance between business and religion.)
    Maury Minerbi is right on with his comment that the high frequency traders do improve the efficiency of the market. That is the argument they currently use in the political arena to fend off further regulation. But, I just wish we all weren’t getting abused in the process.
    Jim Armstrong points this abuse out and proposes a tax fix. That’s nice, but we all recognize how difficult that is difficult politically, because of the huge amount of money being made, and the political clout all that money presents.
    Again, I thank the three of you for your thoughtful additions to the book review.

  9. Brian

    To answer the question – Yes but the big financial institutions are only half of the problem the other half is big government. Fat cats & “polito-crats”……….. Neither are doing us any favors.

    On the book summary I think it is cool that there some good folks out there trying to do the right thing. Hopefully there are more folks who will do right.

    I think there is a very unhealthy relationship between big business & big government creating government regulated monopolies vs markets…….. Insurance companies & ACA – EPA & Refined Fuel Companies – Fed/Treasury/Dodd Frank & Brokerage Houses/Large Banks/Mortgage Insurance companies. All the above are huge financial machines that are no longer competing with each other as they are regulated to give us all the same product in a different wrapper that ends in the same result financed by a government guarantee to be paid or bailed out by us the tax payer. So basically we pay twice.

    Lastly to back up my point of view the following is the unintended consequences of the above. We basically have back room regulated markets where companies not competing/innovating for us the consumer. And that is why I think there is not much wealth for those of us who are not Warren Buffet types or the chosen business by the elite “Polito-Crats” running Washington.


Comments are closed.