Monday, April 7, 2014

Flash Boys or Macbeth: Choose Shakespeare!

By Gary DeWaal

I broke my habit this week of reading only softcover editions, and read the hardcover version of Michael Lewis’ “Flash Boys: A Wall Street Revolt”. It seemed the least I could do given all the hubbub in the media about this publication.

As I have mentioned before, one of my co-majors in college was English literature, and I certainly applaud Mr. Lewis for his writing style. He is a gifted author, and is able to leave you hanging after most sentences, only too eager to pounce onto the next.

That being said, I found Mr. Lewis’ non-fiction account of high frequency trading more like a novel than the factual account it purports to be. Many times, Mr. Lewis takes the mundane and ordinary but through exhilarating manipulation of language makes it seem illegal. In other circumstances, Mr. Lewis spends pages upon pages attacking something only to insert a single sentence or phrase actually exonerating the practice he just mightily condemned. But the brief sentence or phrase is buried and boring, and not written nearly as excitedly as his other prose.

For example, Mr. Lewis’ novel, I mean study, begins with an account of the secretive acquisition of property by a company known as Spread Networks, and the installation through sometimes impervious rock of a near straight fiber optic cable from Chicago to northern New Jersey. Clearly Mr. Lewis’ colorful description of these efforts is meant to cast aspersion on the purpose of this project, which is to offer high speed traders a quicker way to route their orders between a data center that hosts the Chicago Mercantile Exchange and one next to NASDAQ’s stock exchange in Carteret, NJ. Just read two sentences:

“[The initial investors] named the company “Spread Networks,” though they disguised the construction behind shell companies with dull names like Northeastern ITS and Job 8. [One investor’s] son… came on board – to cut, as quietly as possible the four hundred or so deals they needed to cut with townships and counties in order to be able to tunnel through them.”

However, buying land quietly in small parcels using many dummy companies is not illegal, and in fact is a smart tactic in order not to drive up the price of property unfavorably. Just ask Walt Disney. Disney used many shell companies (many with mysterious names such as M.T. Lott Real Estate Investments, the Latin American Development and Management Corporation and the Reedy Creek Ranch Corporation) to acquire almost 28,000 acres of land near Orlando, Florida that ultimately became home to Disneyworld. Nefarious? Well maybe because of the high price of an admission ticket these days and the very salty popcorn that is served on Main Street USA; but I think most kids and their parents don’t think so.

Another example: Mr. Lewis spends the first 96 pages excoriating the practices of high speed traders, then casually has one of the heroes of his story (John Schwall, a Wall Street technology insider whose “father had been a firefighter…like his father before him”) ask the question, “[h]ow was it legal for a handful of insiders to operate at faster speeds than the rest of the market and in effect, steal from investors.” Wait, this is a book about folks who have done nothing more than take advantage of market opportunities in a legal way? The problem is that by dramatically juxtaposing the word “steal” — which most folks think of as illegal — next to the word “legal,” it is easy to conclude that something is terribly amiss.

Others have written on both sides of the debate regarding high speed trading far more eloquently than I can and debates about good and bad liquidity will go on for a long time. But to me, since the day I began to be involved with the markets professionally as a trial attorney for the Commodity Futures Trading Commission in 1982, it was apparent that some persons had an edge when they traded, either because they were exchange members or had access to the latest technology, and that other persons who did not share that edge were envious (including me).  Every year, some folks clamored to acquire and use the latest, newest technologies while others decried progress or were frustrated because they did not possess such new advanced means (e.g., remember the outcry when some floor members wanted to use headsets or handheld computers).

This is not to suggest that some high frequency traders, like other traders, may not seek to bend rules illegally or engage in practices that cause real market harm (although, as Mr. Lewis acknowledges, the 2010 “Flash Crash” was precipitated by a mutual fund, not a high speed trading outfit).

This is not also to suggest that some market practices should be reviewed to understand their implications (e.g., make taker practices and rebates to promote market liquidity) and whether there have been unintended detrimental consequences to well-intended regulation (e.g., Securities and Exchange Commission Regulation NMS).

But in and of itself, the fact that some traders have been smart enough to exploit technology and take advantage of legal situations created by regulation is not a problem let alone a crime. And as Mr. Lewis also points out, some folks, like the new exchange IEX, can endeavor to fix perceived problems for their own commercial benefit. This is what capitalism is all about. Carpe diem!

Again, Mr. Lewis’ book is exceptionally well written and engaging, and if you like innuendo and suspense, it’s for you. However, once you begin to deconstruct his tale, you will come away thinking that, ultimately, Mr. Lewis’ story “…is full of sound and fury. Signifying nothing.” However, in my view, Shakespeare’s drama Macbeth, which contains this famous soliloquy, is far more compelling! Better to spend your money on a paperback of that — even an electronic version!

This commentary was part of Gary DeWaal’s “Bridging the Week” newsletter. Click here for complete newsletter.

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