Michael Lewis‘ newest book Flash Boys goes on sale today, but last night Lewis detailed how some of the world’s largest hedge funds are getting jobbed just as small investors with E-Trade accounts are over a matter of milliseconds or even fractions of milliseconds.
In one of the more interesting moments in the fifteen minute piece, Lewis shows a diagram of the “plumbing” behind this “skim.” The moving diagram shows an order leaving Wall Street and going to the BATS exchange servers in Weehawken, N.J. As all exchanges are connected, the order then goes to the NYSE servers in Mahway, N.J. This is where high-frequency traders who account for over half the trades on the exchanges each day, “hijack” the information in these trades and use high-priced fiber optic lines to beat these trades to the NYSE servers by milliseconds.
The “public lines” just aren’t fast enough to not allow the trade to be filled by others and sold at a higher price than when the trade was made.
“The United States stock market, the most iconic market in global capitalism, is rigged,” Mr. Lewis told Steve Kroft on the CBS News program.
“If it wasn’t complicated, it wouldn’t be allowed to happen,” he went on. “The complexity disguises what is happening. If it’s so complicated you can’t understand it, then you can’t question it.”
Who is Brad Katsuyama?
But someone did question it. That person is Brad Katsuyama, a former trader at the Royal Bank of Canada who made millions of dollars a year trading but felt he needed to even the playing field for investors rather than continuing to line his own pockets at RBC. While 60 Minutes didn’t interview any high-frequency trading firms, the show did concentrate on Mr. Katsuyama and his teams’ efforts to foil high-frequency traders on their new “transparent” exchange IEX.
IEX has found a way to beat this speed used by HFTs and that is by slowing down trades so they arrive at each exchange at the same time. While there is more to it, Mr. Kasuyama explains a “magic box” that has 60 kilometers of spooled fiber-optic lines that trades need pass through. One of the investors in IEX is hedge fund billionaire David Einhorn.
“I think it’s going to succeed in a very big way,” Mr. Einhorn said on the program.
“Why is this kid, why is he able to all of a sudden sit at the center of the American stock market?” Mr. Lewis said referring to Kasuyama. “And the answer is, when someone walks in the door who is actually trustworthy, he has enormous power. And this is the story of trying to restore trust to the financial markets.”