Is Wall Street rigged?
Michael Lewis's new book, Flash Boys, details how a group of financial firms, through technology and paid access, are able to get a fraction of a second heads-up on stock price movements.
Because of the way the US financial system is spread out over more than 40 individual "markets" - many of which are just banks of computer servers that match up buyers with sellers - these high-frequency trading (HFT) companies have devised computer algorithms that figure out when a large stock purchase is being made.
When the order hits on one exchange, there may not be enough shares available. High-speed traders then quickly place buy orders on other exchanges fractions of a second ahead of the original purchaser, to whom they then sell their stock for a slightly higher price.
Although each trade probably brings in only fractions of a cent of profit, on high-volume trades those numbers can add up quickly.
Lewis's book, and resulting publicity tour, which has included a in-depth segment on CBS's 60 Minutes, has sparked a debate over whether high-speed trading is legal - or moral. Lewis says these traders have "rigged" the stock market, and many pundits and analysts agree.
"The significance of Lewis's book is that it explains in user-friendly terms how the colossal profits of high-frequency traders really amount to an unconscionable tax on the ordinary investor, or at any rate on the pension funds and other financial institutions on which our livelihoods depend," writes the Guardian's John Naughton.
The stock market has become a virtual space - an interactive, computer-driven system of staggering complexity. And it turns out that there are several sides to this complexity: for the banks and the high-frequency traders who exploit it, it's a marketing tool for bamboozling investors and a means of intimidating regulators; and for smart programmers and entrepreneurs it offers limitless opportunities to play the system.
Eric Scott Hunsader, the founder of the market data firm Nanex, tells the Washington Post that having a speed advantage is "the equivalent of having tomorrow's Wall Street Journal in your hand today".
"This is wrong and it needs to be corrected," he says.
One of the central figures of Lewis's book is Brad Katsuyama, a trader for the Royal Bank of Canada in New York who discovered what the high-speed traders were doing and came up with a way to delay stock buy orders so they hit all the exchanges at the same time.
Mr Katsuyama tells Jason Kirby of Maclean's that he doesn't see computerised trading as necessarily a bad thing, but "some people use computers to cheat". The perception that the stock market game is rigged is driving ethical traders out of the business, he says:
Good people are leaving Wall Street to go into other industries, they're making moral decisions to leave Wall Street, and it's a shame, because as some of the good people end up leaving the industry, the ratio of good people to not-so-good people changes.
Not everyone is up in arms over Lewis's HFT expose, however. Critics of the book argue that the stock market has always been the province of the privileged and that high-speed traders are taking less of a cut than previous insiders did.
"The problem with Flash Boys is that the demands that master storyteller Michael Lewis makes of his narrative don't align well with the structural problems of HFT that Lewis the journalist should want to expose," Reuters finance blogger Felix Salmon writes in Slate.
"The result is that the general public, after reading this book or watching Lewis on 60 Minutes, thinks that the scandal of HFT is that they're being ripped off, and that the stock market is a scam. Neither of which is true."
"Rather, HFT is a ridiculously and unnecessarily complicated mechanism for divvying up intermediation revenues between banks, exchanges, high-tech telecommunications outfits, and various algo-driven shops," he writes. "Everybody is in on the game."
The Wall Street code has always favoured a small group of rich and well-connected institutions who can afford to pay enormous sums of money to maintain their edge in the market. The advent of HFT just created new entrants into that charmed circle, while causing many incumbents to lose their gilded meal tickets.
Time magazine's Bill Saporito agrees.
"Should you be outraged that some super-smart traders may have an edge on everybody else?" he asks. "Perhaps it's the cynic in me, but isn't Wall Street always rigged, in some sense?"
Shaving a few fractions of a cent really shouldn't be a concern for the average trader, he says:
The reason all of this doesn't really matter is that while the HFTs may be investing in microseconds the rest of us should be investing in years. Steady, diversified investing over the long-term still makes the most sense for most people. If there's a fairness problem regarding HFTs, the SEC and other regulators need to fix it, but trading the market has always been fool's game, and trying to trade again HFTs armed with supercomputers and algorithms is like bringing a peashooter to an artillery battle.
Yes, writes the Week's John Aziz, HFT is taking a "parasitic cut" from market transactions - but the benefits of computerisation far outweigh this cost.
"Computerisation has very much been a double-edged sword for investors," he says. "Even with high-frequency traders taking their cut, investors are benefiting from transaction costs that are lower than those of the pre-computerisation era."
"Life is too short to worry about computer traders sifting the stock market for pennies," writes Yahoo's Michael Santoli.
"If one were starting from scratch, no one would build the system as it exists today," he says, "with so many trading forums operating under differing regulatory mandates, dozens of order types, fragmented order flow and an over-reliance on electronic players who are under no obligation to smooth out trading in times of extreme market stress."
"Yet the noise and outrage surrounding the HFT issue far exceed the apparent inefficiencies or abuses in the system," he concludes.
Timothy Noah of MSNBC acknowledges the validity of these critiques, but he says there's a "larger message" in Lewis's book.
"Financial markets, with their 'dark pools' and ever-more-abstruse financial instruments, are rapidly losing the transparency necessary for them to work properly - a problem the 2010 Dodd-Frank financial reform legislation only partially addresses," he writes.
"Financial regulators' foremost task right now is to drag American finance into the sunlight in every way that it can. That Wall Street will fight them every step of the way merely confirms how rigged the game really is."
The American public is only now learning about HFT and how certain insiders have managed to acquire very lucrative financial information that the average investor is unable to access. US Attorney General Eric Holder announced on Friday that the Justice Department looking into the legality of the practice.
A poll last September found only 14% of Americans had a favourable view of New York financial institutions. Given the public relations beating Wall Street and the financial sector have taken over the past few years, is it any wonder that many Americans have concluded that the system is rigged for the benefit of insiders and we probably don't even know the worst of it?