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A fraction of a second can make a difference between who profits and who pays in the ultra high-speed world of computerized stock trading. A new book by “Moneyball” author Michael Lewis says American exchanges give the edge to a small group of insiders at the expense of everyday investors. In “Flash Boys: A Wall Street Revolt,” Lewis introduces a disparate cast of programmers and traders who set out to right the system and introduce fairness for those of us with a pension fund and 401(k) investments.
- Michael Lewis Author, "Flash Boys: A Wall Street Revolt" (Norton, 2014)
MR. KOJO NNAMDIFrom WAMU 88.5 at American University in Washington, welcome to the "The Kojo Nnamdi Show," connecting your neighborhood with the world. In bygone days, stock trading took place on the floor of an exchange with men in colorful jackets watching a ticker glide by and shouting out trade orders. Today, computers do the trading using complex algorithms to make transactions at lightning speed.
MR. KOJO NNAMDIA new book by author Michael Lewis says speed is now so crucial that a millisecond can mean the difference between getting a fair deal or having insiders skim off some of your money to keep for themselves. Lewis tells the story of a disparate band of Wall Street traders and computer coders who become crusaders for fairness. They contend that most American stock exchanges are rigged to favor a small slice of high frequency traders at the expense of the rest of us and set out to right the system.
MR. KOJO NNAMDIMichael Lewis joins us to talk about how this imbalance in the stock market affects ordinary investors and the economy as a whole. Michael Lewis is the author of "The Blindside," "Moneyball," "The Big Short," and his new book, "Flash Boys: Wall Street Revolt." Michael Lewis joins us from studios in New York. Welcome.
MR. MICHAEL LEWISThanks for having me.
NNAMDIAnd thank you so much for joining us. If you'd like to join the conversation, give us a call 800-433-8850. Have we created a financial system that's so complicated it invites abuse by insiders? 800-433-8850. How well do you understand the stock market? You can also send us a tweet @KojoShow or email to email@example.com. Michael Lewis, can you give us the big picture? You're saying that American stock exchanges are rigged to exploit everyday investors like those of us with pension funds or 401 (k) s.
NNAMDIHow does a fraction of a second make a difference in who wins and who loses?
LEWISSo it would be less alarming if it was just me saying it was rigged. The main characters of this book, people who were, themselves, Wall Street insiders start to investigate the market. And what they see in the stock market circa 2008 is that every time they go to make a trade, to buy or sell stocks, that the market seems to know what it is they want to do before they do it and jumps in and does it and then buys and sells for them at a worse price.
LEWISSo what has happened, broadly, is that the people got taken out of the stock market. You know, the mental picture most people have of the stock market is of guys on the New York Stock Exchange shouting at each other. All the transactions now are automated and they are all done in black boxes inside 13 different exchanges in New Jersey. It's a very fragmented situation.
LEWISAnd the problem with the market is that the market that all investors see, that anybody from, you know, someone sitting at his computer terminal and trading through his E*TRADE account, to the most sophisticated hedge fund managers is slow in relation to what a handful of high frequency traders see, that they see -- they pay -- high frequency traders pay exchanges for actual access into the exchange so they can place their boxes right next to the exchange box so they can see prices move before the market realizes the prices have moved.
LEWISAnd so they can react to those price changes and the different in speed between the high frequency traders and ordinary investors is just -- ends up being opportunity for high frequency traders to exploit the investors in various complicated ways.
NNAMDIYou use the analogy of predator and prey to describe...
LEWISRight through the book, that's right. So Brad Katsuyama, who is the main character of the book, was the head of stock market trading at the Royal Bank of Canada and he was sitting at his desk in 2008 trying to buy stock. So, for example, and he looks at his trading screens and his screens tell him that at 13 different exchanges there are 20,000 shares of Microsoft offered at $20 a share. Up to a point in his life, when he hit his button on his computer and said buy, he just bought them.
LEWISNow, he hits his button and all of a sudden, they go away. And he realizes that -- they go away and the price go up so he can't get them. He realizes that there's like a ghost in the machine. It takes him awhile to figure out what the ghost is, but he realizes that the market is preying on what he wants to do, anticipating it, taking advantage of it and that he thought he was a Wall Street trader, that he's actually the prey and there are high tech predators out there trying to take advantage of what he's trying to do.
LEWISAnd I think that, you know, that the story, basically, ends up being this person trying to figure out the nature of their predation, the different kinds of predatory activities that are going on in the market. And it's predatory because it's completely unnecessary. It's not as if the high frequency traders are actually offering a valuable service to the market. They're performing the function of, like, ticket scalpers.
LEWISIt's a scalping operation. The prey, in this case, is everybody who's got dollars invested in the stock market and anybody who's got broadly an interest in the integrity of the stock market. That every transaction, every investor trade, gets essentially handed to high frequency traders to exploit and in each case, the exploitation is trivial. It's pennies, a penny, but spread over the course of a trading year over the whole market adds up to many, many billions of dollars.
LEWISAnd the predator/prey analogy, it just seemed to be the right one simply because the predators, they're in a naturally exploitive situation.
NNAMDIIn case you're just joining us, we're talking with Michael Lewis. He's the author of "The Blindside," "Moneyball," "The Big Short." We're discussing his new book. It's called "Flash Boys: Wall Street Revolt." We're taking your calls at 800-433-8850. If you have questions or comments, you can also send email to firstname.lastname@example.org. Are you a hands on or a hands off investor?
NNAMDIYou can also go to our website, kojoshow.org. Join the conversation there. Michael, the men on the stock market floors following the ticker tape, shouting out numbers, they're mainly for show today. Talk a little bit about how computers have taken over the actual trading.
LEWISWell, it is true. The New York Stock Exchange is essentially a backdrop for television, for financial news now.
LEWISIt is -- well, if, yes, and there are not even that many tourists there anymore. And what happened was, essentially, the financial regulators responded to bad behavior by the people on the stock exchange to increase the possibility of automating that trades. I think this story starts in a funny way in the crash of 1987. In the stock market crash of 1987, a number of brokers who didn't want to trade with their customers, who didn't want to -- customers were calling to sell stock in a panic market and the brokers didn't want to buy the stock, they simply didn't pick up their phones.
LEWISAnd this provoked the SEC to make it easier for investors to enter their orders electronically so they didn't need the human being to pick up the phone to enter an electronic order to the marketplace. There's a long and drawn out story from there -- for how we get from there to here, where there are no people at all in between. And to a large extent, it's been absolutely splendid for investors in that in removing the middle men they have decreased the cost of trading for most people.
LEWISThe problem is that what should've happened, technology should've basically removed Wall Street altogether, that buyers and sellers of stock can now meet together without the help of anybody from Wall Street, you know, in a single computer and the trades could be matched off. But instead, Wall Street firms have found a way to interpose themselves between buyers and sellers in a way that's completely unnecessary.
LEWISAnd it's complicated how they do it, but the gist of it is, one, the market's fragmented. There are 13 public exchanges now and there are 45 or 50 dark pools, which are private exchanges run by the banks themselves and buyers and sellers are sort of kept apart in the various places and they're intermediated by the traders because the other traders are faster.
LEWISSo when you back away from this, it's this curious sort of ecosystem that has risen up around the profit...
NNAMDIBecause if you go back to 2005 when there was only the New York Stock Exchange trading stocks or the rest of stocks were traded on NASDAQ, today you're saying that 13 public exchanges and 45 or 50 exchanges that exist in what you characterize as the dark side.
LEWISAnd dark -- no, they're actually called dark pools.
LEWISThey're called dark pools because they're private exchanges and nobody quite knows the rules that the exchanges abide by, what goes on inside them. And they're not required to report their activities in real time and they're owned by big banks, these exchanges. So you've got -- and the market, generally, what's curious about this market is that all the exchanges are owned by intermediaries, by Wall Street firms, one way or another.
LEWISSo you've got a market that seems to be sort of run for benefit of the intermediaries. And into this world rolls these people who realize that the effectiveness has been to queer the stock market systematically for the benefit of the intermediaries and is done by, like, the system organizing itself to maximize the profits of high frequency trading firms who then, in turn, pay exchanges for special speed, for special access and who pay -- turn around and pay the brokers for the stock market orders that they can exploit.
LEWISThe wonder of the story to me is that anybody bothered to actually tried to do anything about it, okay?
NNAMDIWell, that brings me back to this and I'll ask our callers to just hang on the phone for awhile. We will get to your calls. The number's 800-433-8850. If you are on the line, stay there. We will get back to your calls. If the lines are busy, you can shoot us an email to email@example.com. With Michael Lewis, first, could you tell us about Sergei Aleynikov, if that's how it's pronounced, a Russian immigrant who was arrested in 2009 for stealing computer code from Goldman Sachs?
NNAMDIHow did his plight catch your eye and how did that spark your curiosity about computerized stock trading?
LEWISWell, I read about this story in the newspaper just like everybody else and it struck me, this young Russian computer programmer who was a high frequency trading programmer at Goldman Sachs and the phrase had not really existed in the newspaper until this young man was arrested. But all of a sudden, there's this thing called a high frequency trading programmer. He's left Goldman Sachs and mailed himself computer code and two or three days later, he's arrested by the FBI and he is eventually sentenced to seven years in jail for stealing computer code from Goldman Sachs.
LEWISAnd on top of that, when he is arrested, the prosecutors say that he has to be denied bail and kept in prison because in the wrong hands, the computer code that he's taken could be used to crash the world markets. They used some inflammatory language. And I thought to myself -- there were actually three thoughts that occurred all at once.
LEWISOne was how it is that on the heels of the financial crisis, this subprime mortgage crisis that Goldman Sachs played such a role in, how is it that the only person who goes to fail from it is the person Goldman Sachs wants to put in jail. The second thought was, you know, if this computer code -- Goldman Sachs is the right hands for this computer code? Like, the idea that anybody could be worse hands, that just surprised me.
LEWISThen, thirdly, I thought how is it that this high frequency trading code is so important to a Wall Street bank that they would take the radical step of calling the FBI. I mean, banks just don't do that. I mean, it's a very unusual situation. I did know that people take things from Wall Street banks when they leave. They take their personal files. Coders -- programmers often mail themselves code. And what was it about this situation that caused them to react the way they did? So that got me interested in the question. And the first obvious question was, what is high frequency trading? I mean, why is it so valuable?
LEWISAnd so I called people I knew in the investment business, money managers. And one of them said, well, it's funny you ask basically. A young man just came through my office and has laid out for me the best single description of how high frequency trading works in the stock market I've heard. And my jaw is still on the floor. And this led me to Brad Katsuyama, the main character of the story.
NNAMDIBecause as you tell it, Aleynikov really didn't do anything wrong, but no one really understood how code is operated and why he copied some open source code he'd worked on to a so-called subversion repository...
LEWISYou know, the whole thing was -- so one thing that is very clear is that the judicial system is not set up to evaluate modern finance, that the FBI made a decision to arrest this young man on the basis of basically 48 hours inside of Goldman Sachs talking to no one but Goldman Sachs about the value of Goldman Sachs' computer code. And by further investigation revealed that the code he took actually wasn't valuable at all to him. It was like -- I don't know, it was like you taking your notepad from work...
NNAMDIBecause the FBI guy himself was no expert on any of this.
LEWISHe had no idea. He had no idea. No, of course. I mean, but nobody -- I mean, you almost couldn't blame the FBI guy for not knowing about any of this because no one knew anything about this. But he shouldn't -- they shouldn't have reacted the way they did. There was widespread ignorance. But even inside of Goldman Sachs it became clear, they did not know the value of what this guy did. They didn't have a good sense of it.
LEWISAnd I think they regretted having overreacted and call the FBI. But when they did they set this process in motion and they couldn't really stop. But when it then gets into the courtroom and you've got people on witness stands trying to explain to a jury what all of this is -- and, you know, one person who was a witness at the trial said, basically I looked over and the entire jury was asleep. And it was just -- it was crazy. It was crazy. And the...
NNAMDII could see myself as a juror sleeping in that situation. I could. I absolutely could.
NNAMDIWell, I could -- I could too. And so the moving thing to me about all this, it was that Sergei Aleynikov, the victim in this story, the person who's sentenced two years in an American prison, a Russian who'd come to America to seek freedom, that he had a kind of detachment about it all, that he didn't -- he didn't -- he turned to his lawyer when he was convicted and he said, well it didn't go the way we hoped. But all in all it's been kind of an interesting experience for me.
LEWISBut, my god, he'd lost -- by the time this was done his wife had left him, he was denied access to his children, he had lost his house, he was bankrupt and in hock to his lawyer. Now, since then after spending a year in jail, his conviction was overturned on appeal. Goldman Sachs has been ordered to pay his legal bills and he's back trying to get a job. But it's -- the injustice that was perpetrated, it was made possible by the complexity of Wall Street and the lack of understanding about what actually -- what these things actually do, and what high frequency trading is.
NNAMDIIn his case, a remarkable personal odyssey, obviously.
LEWISThe punch line was that Goldman Sachs actually was very bad at high frequency trading and they didn't actually know -- really know what they were doing. And so nothing he took from there could've been of much value to a high frequency trader.
NNAMDII'd like to go to -- before we take a break, to the phones to talk with Mike in Tyson's Corner, Va. who, Michael Lewis, I think might actually gets it from what I can understand. Mike, you're on the air. Go ahead, please.
MIKEThanks. It seems to me that what these co-located machines are doing is the very definition of front running. And there are already rules against that so why didn't that -- you know, why doesn't that apply?
LEWISIt's a really, really good question and I think that the -- because it -- it is the very definition of front running. You could also construe it as insider trading because the high frequency traders are getting price information before everybody else. It's a big like finding out the results of the horse race before the betting stops and being able to place bets against other people on the basis of your knowledge.
LEWISBut -- so why don't the rules apply? Why isn't -- and so the question's why isn't the FCC more interested in this? They say now, right now that they are very interested in it but they've turned a blind eye to it for some years now. And the main character of my story, Brad Katsuyama, when he discovers himself being front runned while a trader at the Royal Bank of Canada, he basically calls his superiors and says, I figured out what's happened. I figured out how I'm being front runned. Let's go tell investors so we can help them -- they can help us stop it from happening. Let's go spread the word.
LEWISAnd his superiors say, oh well -- you know, they're in Canada -- we don't want to annoy the American government. Let's go tell the government first. And he goes to the FCC to explain to them what happened to him. And he said it was a surreal experience. He was sitting in the room with, you know, dozens of FCC people and he starts telling them about what's happening. And a few of the older guys say, that's bad, man. I mean, you know, this shouldn't be happening. But the younger guys seems to think that it was all okay. They didn't understand what the problem was. And they thought -- they were sympathetic to the high frequency traders basically.
LEWISAnd why they were, he didn't understand. He came away befuddled, bewildered. So he goes back to the Royal Bank of Canada. And the Royal Bank of Canada commissions a study. And the study is to determine how many FCC staffers have gone to work for higher paying jobs at high frequency trading firms and for lobbyists of high frequency trading firms. And the numbers are in the hundreds. So at that point he says -- he has two thoughts. I'm filtering this whole answer through him because I do feel like I'm telling his story. And his view of this thing is much more expert than mine.
LEWISBut the -- he has two thoughts. One is that given the incentives, the financial incentives of a young FCC staffer, it's no wonder they're unable to see what the depredation of high frequency trading. But too he thought, the fact is this is all very complicated. And we're talking about the amount of time that's required to front run is now a millisecond. You know, what is a millisecond? It's -- a blink of an eye is 100 or 200 milliseconds. It's an imperceptible fraction of time. To anybody watching the market on a computer, everything seems instantaneous. It's not but everything seems instantaneous.
LEWISSo I think part of the problem is just the difficulty of the human imagination to get its -- to wrap itself around these really small increments of time in which the front running occurs.
NNAMDIWell, if the FCC employees seem to be sympathetic to the high frequency traders, Michael Lewis, there's this. You've said you wrote "Liars Poker" as a cautionary tale to steer people away from jobs on Wall Street, but it had, well, the opposite effect. Any danger of the same thing happening with "Flash Boys?" Will it despond a new wave of high frequency traders?
LEWISAll right. So I think in this case the early results are in. And the early -- it's a -- this is a story about this kind of -- this Navy SEAL team of reformers within Wall Street trying to build a business to destroy the practice.
NNAMDIWe'll get to that.
LEWISAnd two days -- the book was only published two days ago. They've been inundated with resumes. There are over 1,000 resumes come into them to come work for them. So I think the effect is the intended effect but I can't swear to it. I also think that, look, in the last two weeks the attorney general of the State of new York has announced he's investigating the whole racket of high frequency trading exchanges, their relationship to the banks, etcetera, etcetera.
LEWISYesterday or the day before, the FBI announced an insider trading investigation about high frequency trading. The FCC is now making noises about being extremely interested in this. I think it's extremely unlikely that nothing happens this time. I think that sort of the genie's out of the bottle. The public interest is too great for nothing to change.
NNAMDIWe're going to take a short break. When we come back, we'll continue this conversation with Michael Lewis, apparently grateful that he hasn't started a stampede in the direction of high speed trading with his new book "Flash Boys: Wall Street Revolt." If you'd like to join the conversation, give us a call at 800-433-8850, anything you'd like to ask Michael Lewis, any questions or comments. You can also send us an email to firstname.lastname@example.org or a Tweet @kojoshow. I'm Kojo Nnamdi.
NNAMDIWelcome back. We're talking with Michael Lewis about his new book. It is called "Flash Boys: Wall Street Revolt." He joins us from studios in New York City. Michael Lewis is also the author of "The Blindside," "Moneyball" and "The Big Short." We're inviting your calls at 800-433-8850. And on the line we have David in Hedgesville, W.V. David, you have a question that, in part, Michael may have already answered, but go ahead, please.
DAVIDYes, hi. This is Dave, Kojo. Michael, I followed you on several shows already. And I wanted to know if you thought there was any way the government could intercede for the small investor. And I -- when I first heard of this nano trading, I call it, I suggested that the government could simply raise the short term capital gains tax to a minimum of, like, 30 -- 50 percent for less than 30 days. What do you think of that?
LEWISWell, that would hit a lot more people than just the people in this story. So the question, what could the government do to make things better rather than worse.
LEWISAnd it is a really good question because when you look at basically the history of the stock market, is a history of the government responding to some crisis so -- with some new regulation, and then smart people on Wall Street figuring out how to gain the regulation? So what could the government do in the way of regulation to reform the market? I think there are a couple things, but it's not -- I think the big answer is, this isn't just a government problem.
LEWISI mean, one of the things I loved about this story is that the flash boys, the people who are the protagonists of this story, they look at the government, the U.S. government and they say, the government's not going to do anything. So we can't rely on the government to fix the problem. If we create a fair exchange that's actually honest, that's actually a level playing field for all investors where the little guy has exactly the same chance as the big guy, and there's no speed advantages, if we create that and make enough noise about it we force people to make a choice.
LEWISYou're actively choosing to trade on an unfair exchange when there is a fair exchange. So they create a market kind of solution. They created a new exchange. It's called IEX. So I think that's the big solution to the problem, a market-base solution. But the government could do a couple things to help. One is transparency. Right now investors have a very hard time figuring out what their online brokers or what their mutual fund manages their money or their pension fund, what happens to the orders they place in the stock market.
LEWISPension -- big money managers, when they ask Wall Street Bank to transact for them in the stock market, have a very hard time figuring out how that order was executed. That transparency would be extremely, extremely helpful to the market.
LEWISThe other thing they could -- the government could play with I don't think -- and I just don't know what the unintended consequences of this are, but it does seem to me that in a sane world the FCC would never allow people to have -- co-locate their machines inside of exchanges so they have speed advantages. They could regulate the speed of the exchange or they should require that the exchange sort of be faster than any of the participants on it. But I don't have a lot of hope in the government -- in the total government solution just because it does seem that whenever our government gets involved in anything there are lots of unintended consequences. I like the market solution.
NNAMDIWe had a Tweet from someone else who says, "Where does the Consumer Financial Protection Bureau stand on this?" Do you know, Michael?
LEWISI think they're probably trying to figure it out.
NNAMDILike everybody else in the government.
LEWISLike everybody else, like this book. I mean, it's a very odd experience. I mean, the book has landed like a stink bomb and it did kind of surprise me to the extent to which it's done this. Because, I mean, the number of people on Wall Street have been aware of this problem for several years. This isn't -- the nature of the predatory activity improving the predation is the -- and describing it and finding a solution. Those are all original contributions of the main characters of the book.
LEWISBut they've been telling investors about this -- big investors, for the last couple of years. And the investors have been calling the FCC or calling their congressman. And there's been very little traction in -- I mean, I -- in Washington on the subject. And the reason is that you bring a high frequency trader into the room at the FCC, or with his campaign contributions into the Senate of the House, and what he will say is that there are going to be a lot of unintended consequences if you remove us from the market. We're half the market, half the trades in the market.
LEWISYou know, the liquidity in the market will decline, so on and so forth. There's a great unknown in removing someone who's half the trades. But if you back away and you think about it, if you just -- if you, like, made a law and the law said there has to be front running in the marketplace, that all of your stock market trades have to be front run, and you introduce this body to front run you, so to buy the stock in front of you and sell it to you at a higher price, that front runner would become exactly half the market.
LEWISAnd it does not add anything. It's just scalping from the market. I think that the -- but I think that there's enough mystery and mystification about the financial world and in the minds of people who might regulate it or legislate about it, that people have been very slow to introduce any change. I think that's going to change now though.
NNAMDIOne critic of your account, a director of a high frequency trading firm, says the front running of stock orders that you describe has basically been fixed, that it was an issue when electronic trading took over six or seven years ago, but that firms have figured it out now.
LEWISIt's completely false. I mean, if it's -- this is a problem with going on and talking about the book is that I have found that the head of an exchange and high frequency traders are willing to kind of get on the air and just say things that are just false, like made up.
NNAMDIThis was Mark Gorton of Tower Research Capital telling that to New York Magazine.
LEWISWell, so you can get yourself front runned right now if you would like. I mean, this story starts in '08, '09, 2010 with traders actually identifying how the front running's happening. I mean, this is one form of the predatory activity. It's interesting. So the hero of the book Brad Katsuyama is sitting at his desk in lower Manhattan. He pushed the button to buy the 20,000 shares of Microsoft that are scattered across 13 exchanges in northern New Jersey. Instead of getting the 20,000 shares, he gets a fraction. He can't figure out why.
LEWISHe hires people who, like, know where the fiber optics that carry the trading signals are laid. He hired computer software people to analyze the software that's making his trades. He finally figures out -- after a year they realize that what is happening is that his signal travels from his desk in lower Manhattan up the Westside Highway of Manhattan and goes out the Lincoln Tunnel where it reaches the first exchange, the nearest exchange to his desk, which is the BATS exchange where high frequency traders are sitting there, trying to identify what he wants to do.
LEWISThey identify he wants to buy lots of Microsoft and they race him, because they have faster networks, to all the other exchanges and buy up the Microsoft that he wants to buy. I mean, you can get that done to yourself now and people -- it happens now. So it's baloney that it's been fixed.
NNAMDIYeah, it happens to me by scalpers at basketball games too. Basically the same thing. Here is Semen in Springfield, Va. Semen, you're on the air. Go ahead, please.
SEMENEHello. Thank you for taking my call. You know, I just -- I have known for a long time that Wall Street is rigged at different levels but it gets rigged more every day. And the government, like, Obama has been the pocket of Wall Street. They're the biggest people that provided him money for when he ran. And the government is not really, at this time, going do anything to help the small investor. In fact, they're helping the big guys because they keep the interest rate as little, which means helps the big guys.
SEMENEAnd so someone like me, who is a retired person, has no option because...
NNAMDIWell, let's not say that because I'd like to have Michael Lewis offer you some advice. Michael, what advice do you have for someone like Semene -- I'm sorry, Semene who, as an individual investor, about how to get a fair deal in the stock market?
LEWISWell, so her point is actually well taken. It is really -- it is absolutely true that the zero interest rate policy, which has been in place since the financial crisis, really to bail the banks out. It's a backdoor bailout of the banks. They're able to borrow money from the fed for free and relend it if they want back to the U.S. government and just take out the spread, and have been doing so for a long time.
LEWISThis policy is very bad for people, especially for retirees, but people who are on fixed -- who have fixed income investments are really paying a price. There's no question about that. And I -- I'm afraid I can totally sympathize with people who are disillusioned and upset with the solutions that our government came up with to the financial crisis because it was on the one hand, an extremely well-executed bailout of the financial system and probably prevented a great depression.
LEWISOn the other hand, did not provide for a reform of the financial system. It instead empowered the very characters who created the problem in the first place. And so what we got was very pallid reform. I mean, some things happened but there was not -- the kind of things that would change behavior in the financial system, which is changing incentives in the financial system did not happen.
LEWISSo I wanted to say I totally sympathize with her. I think her point is well taken. Now what do you -- so is there a way -- to the more narrow question of how do you make sure that when you're trading in the stock market you're trading on a level playing field? For a very small investor this isn't -- we're not talking about a huge sum of money that you're losing to high frequency traders. It's kind of pennies transactions as a scalp that is only big because it's spread over the entire market and it adds up to many billions a year.
LEWISHowever, it's offensive that it happens. And it has also fueled the creation of a way too complicated and unstable stock market that really can, you know, can do all kinds of strange spasmodic things like flash crashes that a reform movement needs to take shape. And it's a reform movement that I think -- I mean, I haven't given up on the idea that Wall Street can be reformed. The Occupy Wall Street movement didn't really have any specific goals.
LEWISWhat I like about this is it has a specific goal. Here's a fair exchange. IEX, the investors exchange. They have a website. It's called IAmAnInvetor.org, which is on the side of the exchange but it will explain to you the steps you can take to contribute to reform. And if the stock market can be reformed, if it actually can be made fair and the unnecessary Wall Street intermediation can be removed from it, you create a model, you create an example of how it can be done which can spread to other markets. So I don't think...
NNAMDICan Semene say to whoever has her pension money or her 401K, I want to know how you're routing your stock market orders?
LEWISYes. That's a very good question. and if you go to that website, will explain exactly how you do that. Yes, she can. And the...
NNAMDIYou can go to the IEX website and...
LEWISIt's the I -- it's called -- the website's called IAmAnInvestor.org.
LEWISAnd it's not -- it's separate from the company's -- it's an educational website. And just -- it tells you how to be part of a reform movement in finance. And I think this is the way -- these specific reform goals, which are very sensible and really incontrovertible. Who can argue against having, you know, a fair stock market where people can't be front runned? It's -- that is the way to go. You create an example of reform and then it spreads.
NNAMDIGot to take a short break. Semene, good luck and thank you for your call. If you have called, stay on the line. We will get to your calls. If you'd like to, the number's 800-433-8850. What would you like to ask Michael Lewis? You can also send us an email to email@example.com. I'm Kojo Nnamdi.
NNAMDIWelcome back to our conversation with Michael Lewis. He's the author of "Flash Boys: Wall Street Revolt." That's his latest book which we are discussing today. He's also the author of "The Blindside," "Moneyball" and "The Big Short." Michael, I'd like to combine an email we got with a question from a caller. I'll read the email first from Randy. "Could Mr. Lewis comment on the story today about the FBI investigation of high frequency trading that's from the Wall Street Journal."
NNAMDIQuoting here, "The Federal Bureau of Investigation is probing whether high speed trading firms are engaging in insider trading by taking advantage of fast-moving market information unavailable to other investors. The investigation launched about a year ago involves a range of trading activities and is still in its early stages, according to a senior FBI official and an agency spokesman. The Financial Times however, points out the investigation has been going on since last year."
LEWISAnd here now the question from our caller, Neil in Silver Spring, Md. Neil, you're on the air. Go ahead, please.
NEILHey, Kojo. You know, really quickly, Mr. Lewis, it sounds like a great book and if I can get the time I definitely will read it. The question I have, or the comment, what's to keep and why -- if it hasn't already happened, to keep a civil litigators to file a class action lawsuit against these high frequency traders? The damages, if the action is sustainable, could be colossal and put these companies out of business.
NNAMDIAny idea, Michael Lewis, what's going on in the investigation and the litigation firm?
LEWISI mean, so the shorter answer is no. The one thing I would add to that is it's not clear who should be sued because the high frequency traders, they're -- it's like -- blaming the high frequency traders for front running people is like blaming the lions for eating antelope. But who gives them the opportunity to get at the antelope? And it's the exchanges have completely advocated their responsibility to treat all investors the same, and the stock exchanges.
LEWISThere used to be just basically a public utility. And now -- and a pretty simple one and one that was easy to use. They've become incredibly complicated and they have bent over backwards every which way to accommodate the demands of high frequency traders, because the high frequency traders pay them lots of money to do so. So the exchanges are clearly at some sort of legal risk I think.
LEWISThen the other group, the other collection of people who have to be considered in any kind of pursuit of damages is -- none of this could happen if the brokers that handle the stock market orders were handling them in the best possible way. They too are paid by high frequency traders to handle them in a way the high frequency traders like. And this is like a mystery to me. When I found out this -- and I thought I kind of had a sense of how the stock market worked when I started working on the book.
LEWISBut when I found out that when you do a trade at, you know, TD Ameritrade or E*TRADE or even Charles Schwab, that you don't only just pay the commission. You pay a commission and that's the price you see for executing your trade. But then the broker -- and the banks do this too for the bigger stock market investors -- the broker turns around and sells the order flow, sells the right to trade against your order to high frequency traders. And this is a business that's, you know, I don't know, many hundreds of millions of dollars a year for these firms, selling essentially the right to exploit you.
LEWISAnd they auction this to high frequency traders. And when I found that out it's sort of like, I thought, how could this be legal, but how these people not feel exposed legally to these sort of lawsuits if they're doing this? Because it's -- you know, I don't know exactly what the legal obligation of a broker is to his customer but you would think that the -- you would think it would come before the pursuit of profit on the other end by high frequency traders.
NNAMDIYou know, this is not the first book that you've written about financial complexity and the people who exploit it. In your first book "Liar's Poker" you wrote about stock and bond trading at Salomon Brothers in the '80s, a business so complicated the CEO didn't understand it. In "The Big Short" you wrote about complex subprime mortgages and the housing bubble. Why have we allowed these financial systems to become so complex?
LEWISThis is a very -- I think this question cuts to the heart of the matter of all these stories I've written. And I think that the raw -- so "Liar's Poker" was written by me when I came out of Salomon Brothers in the late 1980s. And that was the period where we really saw the birth of financial complexity, of the creation of instruments of different kinds of stocks and bonds and derivatives that were created in some cases simply because -- simply to befuddle the people who would be on the -- who would buy them.
LEWISAnd I think what's happened is -- and this is the radical me speaking -- but I think what's happened is technology has sort of eliminated a lot of the usefulness of Wall Street. It's replaced Wall Street that, for example there used to be a time when you needed a human being on Wall Street to bring together buyers and sellers of stock. The information technology has eliminated that. We can all just meet together by -- everybody could just push a button on their community when they wanted to buy and sell stock. And we could all meet in the same computer without the help of a Wall Street broker.
LEWISSo the question then becomes, if technology -- if information technology is eroding the old line business of Wall Street and there's not a way to make money that way, how do you make money? And one way you make money is by kind of creating these inefficiencies, creating misunderstanding, creating things that you understand and other people don't. the subprime mortgage crisis was directly result of this, that no one would have lent money to a lot of the people who got lent money to if it had been as simple as, here's -- you've got to make a loan to this guy who wants to buy a house he can't afford.
LEWISBut when you package all those loans up into a subprime mortgage CDO that no one can parse and persuade rating agencies to say they're triple A rated, all of a sudden you hide it. You hide the truth behind complexity. This is what's happened in the stock market. The stock market -- once you describe -- once Brad Katsuyama, the hero of my book, describes to you how it all works you say, oh that's just front running. There should be rules against that.
LEWISBut the way it's done is sufficiently complicated. You can't see the front running. You need someone as smart as Brad Katsuyama to explain it to you. So the complexity, to my mind, is a byproduct of Wall Street's desperation for revenues. And why do we allow it to happen? Well, we have in our kind of nature, in our market DNA that innovation is good no matter what. And this...
NNAMDIWell, I was about to say...
LEWIS...presents itself as innovation.
NNAMDI...it's facilitated by technology and that's what Nick in Washington, D.C. wants to ask about. Nick, you're on the air. Go ahead, please.
NICKOh, thank you. Just want to say I have been a fan of yours since "Liar's Poker." And what I wanted to ask, I saw you on TV this morning and one of the folks you're appearing with made the point essentially that the high frequency traders were able to exercise a certain advantage because of lags and infrastructure. And so maybe this isn't the intention of your book but I'm wondering what the birth of this and the exploitation of this says about things like net neutrality and what we're doing about infrastructure and why are we...
LEWISYeah, well, I think the -- so I don't -- I think I have nothing intelligent to say in response to the question. But I do want to -- but his point is -- what he describes is accurate but what -- the point that was made this morning was that -- so the exchanges have this old technology that actually is -- that determines the speed of the market that investors see. It gathers all the quotes, all the different stock quotes from all the different exchanges and it presents it as kind of one market.
LEWISAnd it doesn't matter what it's called. It's got an acronym but in any case, this technology that does this is slow and old. And no one has an incentive to speed it up because the value to high frequency traders is the speed with which they are -- is the greater speed they have than that. So the narrow interests of the people involved is not to upgrade that technology because the investors are more easily exploited if that technology is bad.
LEWISAnd that -- it is shocking that that happened and it raises the obvious question, why haven't investors made more of a stink about this. And it's partly investors that are to blame for this but partly they just haven't understood until these characters I write about came along and explained it to them.
NNAMDIThe volume of stock trading in the United States has declined since 2008. Is that because of a crisis in confidence among investors? How is this complexity affecting our trust in the market?
LEWISI think you just put your finger on the biggest question at the heart of this story, and it is -- so let me answer it this way. In the last few months, Goldman Sachs, of all people, have basically flipped a switch inside of their firm and said, we no longer want to be in the racket with high frequency traders. We want to throw our -- we want to put our customers' orders on this fair exchange IEX, even if it costs us money.
LEWISAnd the argument that the people inside Goldman Sachs had to make to the CEO of Goldman Sachs in order to do this was, you don't understand. There is a crisis of trust and you can measure this crisis of trust. The stock market has basically tripled from the depths of the financial crisis and yet individual participation in America -- of Americans in the stock market has declined. That's unprecedented.
LEWISEverywhere you turn there's signs of mistrust of the market. And this is a big problem. And it is a big problem. It's a problem because the degree of trust affects what it costs companies to raise capital to do productive things. So what this story is about, the story I've just told, is about -- at its core is the effect in the financial world when someone walks in and is trustworthy who actually deserves the trust you give him. And that is Brad Katsuyama.
LEWISHe-- instead of trying to make money out of the rigging he found, he went around and tried to explain to people what it was and how to fix it. And the effect is galvanizing. The effect is that within a couple of years he finds himself sitting really in the middle of the American financial system with a lot of big banks wondering if they're not at his -- if they do not need his good opinion in order to do their business with their customers because the customers don't trust them, they trust him.
LEWISSo trust is the oil on which this whole system runs. We have had a depletion of that trust in large part because of the financial crisis. And this is an attempt to restore it.
NNAMDIAnd we are just about out of time but we got a Tweet from someone who said, "This arms race has been going on since 2008 and may have already peaked. Volume and profits are way down." True or false, Michael Lewis?
LEWISSo I'm told -- it's impossible -- I think it's impossible to know because the high frequency trading firms are so secretive. But all you can do -- and it isn't the profits that is really the issue. It's their revenues. The money -- if they have to -- their profits may be down just because the exchanges are demanding more payment in exchange for the access. But it's still -- the revenues represent the scalp. So I don't know but if it's down it's not down a lot.
NNAMDIMichael Lewis. His latest book is called "Flash Boys: Wall Street Revolt." He's also the author of "The Blindside," "Moneyball" and "The Big Short." Michael Lewis, thank you so much for joining us.
NNAMDIAnd thank you all for listening. I'm Kojo Nnamdi.
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