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Flash Boys, by Michael Lewis (2014)

24 Apr 2014
I remember that day in October 1987 when the stock market crashed. Since I was not in the market at the time, I stood outside the event, watching, wondering if this would lead to another depression as it had almost 60 years before. I was young with a wife and child, financially unprepared, and completely at the mercy of what was to come.

I got lucky: Neither depression nor recession were in the cards, but the crash did lead to clumsy attempts by the Securities and Exchange Commission to shelter small time investors from the effects of such events. Those attempts in turn led to a federally mandated computerized trading system that foreshadowed the Rise of the Programmers

I have been a computer programmer for 45 years as well as stock market investor, off and on, since 1981. For the last two years, while posting buy orders for stock, I have often watched the price of the stock tease upward  like a shop owner who jacks up prices when he sees how much a shopper wants his goods. Similarly, my attempts at sales would result in the stock teasing downward. In each case I learned that if I took the bait, it promptly popped back to the original price I had tried to target. I imagined writing a program that intervened in the middleware and played with bids and offers in order to make money. Dang, can't a daydreamer like me imagine something happening just once without it actually coming true?

As we learn in Michael Lewis' latest expose of the dark inner workings of the financial world, Flash Boys, this is Wall Street at work, not my imagination. If you hear a TV pundit or reporter speak of this book, as I have this week, as an expose of high frequency trading (HFT), that is proof they have not read it or they have not understood it. HFT is merely the context. Lewis reveals that new stock exchanges are springing up right and left around Wall Street, run by computer programmers who deal in micro seconds (millionths of a second) not just so they can trade faster, but so they can use their extra speed to spy on the opposition and do end runs so they can buy and sell the stock out from under the order makers.

The shocking news of the story is this: for investment bankers like Goldman Sachs or Morgan Stanley, the opposition is their clients. Banks and investment houses that handle trading for their clients now run the trades through dark pools that strip the metadata from the proposed trade, run out and steal the trade, then re-sell at higher prices, at a profit, to their own clients. Some of them make a billion dollars a year and more doing this, so you know it is a serious business.

Lewis' story goes into more depth than the point I've just made. As usual he does a masterful job, taking projects like mundane utility digs and making them endlessly fascinating. He also has an interesting sociogeopolitical story of Russian nerds overcoming adversity from their homeland. While making themselves rich, they accomplished something never approached by their Communist forebears: sabotaging, through technical innovation, the stable capitalist foundation on which Wall Street has been based for more than two hundred years

If you trade or invest in the stock market, or trust someone to do it on your behalf, these revelations are far more disturbing than the knowledge that Wall Street is a big casino. We've known that for generations. Now we know that Wall Street is a rigged casino. Insider trading is a joke compared to this travesty. Martha Stewart should demand a retrial! Imagine the Mafia completely controlling modern-day Las Vegas without state gaming regulation, and multiply that by 1,000: that gives you a modest notion of the seriousness of the problem that Lewis presents to us.

Should you stay out of the market altogether? Truth is, modern America provides limited choices for parking our investment and retirement funds. Keep your 401K or IRA in the market, but otherwise the smartest thing you can diversify your funds. Buy real estate, buy businesses, buy CDs, buy gold, and keep cash in CDs. Five years ago I bagged a long-term CD at five percent. The yield is not massive but it beats anything available today, and it is rock solid; CDs never lose money. And when you do have to invest, leave the trading to experienced professional money managers with strong institutional resources to weather the coming computer-generated crash

As for Lewis' latest book, it is a quick and easy read  if you are a computer programmer. Time and time again the book demonstrates the difficulty of explaining the situation to bankers with no programming background. My hunch is that you can understand a lot of the book fine without it, and if you invest in the stock market, you can't afford to ignore it. Michael Lewis hits another home run with Flash Boys.

You may also like this related article: Trust Is a Tricky Thing (158)
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