An entertaining CNBC clip currently rocketing through social media networks shows William O’Brien, president of BATS Global Markets, having conniptions over Michael Lewis’s claim (in his new book, Flash Boys) that the markets are rigged. Now that O’Brien has finished reading Lewis’s book, I recommend that he pick up David W. Maurer’s 1940 classic, The Big Con.
The Big Con (not to be confused with a 2007 book with the same title by journalist Jonathan Chait) is an affectionate catalog of the elaborate confidence games played during the golden age of the grift – a period that began in the late 19th century and ended with the Great Depression. In the book, Maurer describes a big con called “the wire” that will be familiar to anyone who’s ever watched the 1973 movie The Sting (which drew heavily on Maurer’s research):
It was a racing swindle in which the con men convinced the victim that with the connivance of a corrupt Western Union official they could delay the race results long enough for him to place a bet after the race had been run, but before the bookmakers received the results.
In essence, the mark was invited to profit by receiving, illegally, information a few minutes before it was available to anyone else. (What the victim didn’t know was that the Western union office and the gambling den were both fakes.) This is, more or less, what Wall Street’s high-frequency traders and the proliferating exchanges that serve them do: they manipulate the speed at which market information travels so that a lucky few can benefit financially from privileged early access at the expense of everybody else. They do this not by slowing down the rate at which the information travels, but by speeding it up. In this instance, the acquisition of privileged information is perfectly legal. Also, the privileged access is real, making the dupe not the trader who seeks it but anybody who lacks it.
The rap against Lewis’s book is that he exaggerates the degree to which any of this affects the ordinary investor. And it’s true that any lone day trader who logs onto his E*Trade account expecting to outperform the big institutional investors should have his head examined. But Lewis makes clear in Flash Boys that it took many very intelligent bankers (and consequently many investors) several years to figure out why their computer terminals went blooey when they attempted futures trades. Prices were changing in mid-transaction, seemingly in response to orders they were still keying in. If that isn’t a rigged market, what is?
Lewis’s book describes an insane competition to provide the shortest fiber-optic link to market information (and therefore shave off a few crucial millionths of a second). The process leads to, among other travesties, the drilling of dedicated tunnels through mountains and under rivers in rural Pennsylvania. In Lewis’s view, this arms race can’t be regulated away. His book’s hero, Brad Katsuyama, fights it by creating a new exchange, IEX Group, that slows down all trades sufficiently to put all buyers and sellers on a level playing field. Perhaps Lewis is right that the market is better-positioned than the government to solve this particular problem, in which case good luck to Katsuyama and anyone who might set up a similarly un-rigged shop. The advent of a market-based “slow investment” movement comparable to the “slow food” movement advocated by Berkeley restaurateur Alice Waters and writer Michael Pollan would certainly be welcome. (Something like it seems to have worked out pretty well for Warren Buffett.)
But Flash Boys, along with Lewis’s previous The Big Short, conveys a larger message that the 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. As enthralling as Lewis’s new narrative is, his message that the markets are rigged won’t surprise anyone (except, apparently, the enraged William O’Brien). 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.