The Times Michael Lewis. The Scourge of Wall Street Will Pavia An explosive new book reveals how, in the blink of an eye, money is skimmed off stock-market trades every day, making a powerful minority even richer. Now the FBI is investigating. Will Pavia meets its author, Michael Lewis “I’ll tell you a weird story,” says Michael Lewis, the writer whose weird stories have occasionally upended industries. In late March, Lewis was on an airport bus in Arizona, speaking on his mobile phone to his publisher about his upcoming book, Flash Boys. “There was a guy with what appeared to be his wife and kids at the front,” he says. “And he comes and sits right next to me. And he says, ‘I’m really sorry to seem to be stalking you, but I’m leading an investigation by the New York Attorney General’s office into high-frequency trading, and we’re very interested in your book.’” This was a book that had not yet been published. No review copies had been sent out; the contents had been kept a closely guarded secret. Yet there was already a great deal of speculation about what it might contain. The other group, besides law enforcement personnel, who were particularly interested in it, were high-frequency traders, the new panjandrums of Wall Street, who wield computer code and high-speed cable networks that nip in and out of the markets millions of times a day, buying and selling shares in a fraction of the blink of an eye. When Lewis had almost finished the manuscript, he began getting some frantic messages from members of that caste, demanding that he talk to them. “Big-time people,” he says. “These people – who had refused to be interviewed by me – were now e-mailing me and basically suggesting that I had an obligation to interview them. I said, ‘Why didn’t you let me know eight months ago when I asked?’ I think their first response was: ‘We just won’t tell him anything and then he won’t know.’” Lewis, 53, says he was perplexed by their reluctance to talk about what they did for a living. “Why is the stock market a secret?” he says. “That’s the thing that I wanted to know. All this secrecy, how much money they’re making, where the trades are – that this stuff is secretive is nuts.” We’re in a restaurant in the Four Seasons hotel in Washington DC. Lewis is dressed like a college professor on holiday: navy sweater, light blue cords and trainers with luminous laces. He is tanned, if not weathered, and his auburn hair now contains the occasional lonely strand of white. He hails from New Orleans, and as he speaks you sometimes catch the longer vowel sounds, the grace notes of a drawl. His expression is one part owl, two parts hawk. Flash Boys, his juggernaut of a book, has been out for five days now, and somehow, an account about a highly technical and marginally understood trading practice has become the talk of America. Lewis was once a trader himself, at Salomon Brothers, before abandoning that world on what seemed a flimsy pretext: someone had offered him a modest publishing contract. The resulting book, Liar’s Poker, came to be the set text on Eighties Wall Street excess, and other wildly successful works of non-fiction followed, studies of Silicon Valley (The New Big Thing) or the housing bubble (The Big Short), which read like thrillers and made him a mulitmillionaire. Even so, he claims to have been stunned by the sound and fury that has greeted his latest true story. “I’ve never experienced anything like it,” says Lewis. Moneyball, his book about a baseball coach – which became a film starring Brad Pitt – caused a huge stir, and is credited with changing the way a lot of teams now recruit their players. “But that was in the world of baseball,” he says. “I mean, the US Department of Justice wasn’t announcing an investigation of baseball scouts.” US Attorney General Eric Holder has just appeared before a senate committee and announced that his department is now looking at high-frequency trading and “investigating this practice to determine whether it violates insider trading laws”. Earlier in the week, both the FBI and the Securities and Exchange Commission declared that they, too, were now probing the so-called Flash Boys and their high-frequency trading practices. These are men (and they do seem to be mostly men) who make their fortunes in milliseconds. Here’s how it works: when an ordinary trader, let’s call him Ted, enters a bid for shares on a computer in New York City, that bid order takes fractions of a second to reach the computers of the various stock exchanges housed in warehouses in northern New Jersey. The order might take a couple of thousandths of a second to reach the nearest exchange, BATS Global Markets, and a few more milliseconds to reach the others. High-frequency traders’ computers are so fast they can detect Ted’s bid as it hits the first market, and streak ahead of it to the other exchanges. Before you can say “Jack Robinson”, before you have even begun to pronounce the J, the high-frequency guys have snapped up the shares Ted was trying to buy and sold them on at a marginally higher price. By zipping in and making himself the middle man between buyer and seller, the high-frequency trader skims a couple of pennies here and there, on millions of trades a day, and makes millions out of those milliseconds. Lewis became interested in these traders when he was covering the story of Russian computer programmer Sergey Aleynikov, who had been arrested by the FBI shortly after leaving his job at Goldman Sachs. Aleynikov was accused of walking away with a computer code he had been working on. Prosecutors said the code could be used to “manipulate the markets in unfair ways”. Lewis found it strange that no one questioned why Goldman Sachs had such a code. He also noted that the Russian was described as a high-frequency trading programmer, yet no one seemed to know what that was. It seemed to Lewis that there was a cadre of people who were making a lot of money and who had very little interest in telling anybody how they were doing it. In late 2012, when Lewis was still circling his subject, looking for a way in, he spoke to a mild-mannered Canadian named Bradley Katsuyama. “He had read Moneyball and Liar’s Poker,” says Lewis. “Katsuyama said, ‘I’ll teach you about this.’ After I’d talked to him for about an hour, I said, ‘Say what? It works like what?’ I couldn’t believe what I was hearing.” Katsuyama was particularly well placed to explain things – he had spent the previous five years investigating high-frequency trading himself. In the summer of 2007, Katsuyama began noticing that shares he was bidding on tended to vanish from his computer screen the moment he pushed a button to execute them. He wasn’t particularly technically minded, but he made it his job to investigate on behalf of his bank, the Royal Bank of Canada. He got in touch with Irishman Ronan Ryan, who had been laying fibre optic cables for high-frequency trading firms. Signals travel down a fibre optic cable at about two-thirds the speed of light; you lose millionths of a second over longer distances, and if the wire turns a lot of corners. High-frequency traders duly spend huge amounts of money on wiring, and pay fees to place their servers inside the stock exchanges themselves, as near as possible to the processor that handles the trades. Ryan’s company alone had charged firms $80 million between 2005 and 2008 to wire up computers inside exchanges. Lewis describes one company that was “digging trenches in places that would give Tony Soprano pause” and another extraordinary operation, carried out in great secrecy, to lay as straight a cable as possible between New Jersey and the futures exchange in Chicago by tunnelling beneath the mountains of Pennsylvania. All to avoid the circuitous routes of existing networks and thus save fractions of seconds. Katsuyama recruited a team of brilliant programmers and problem-solvers, a medley of Wall Street misfits. He interviewed others, too, waving the prospect of a job in front of them in order to pump them for information about what was going on on their firms’ trading floor. Lewis writes in Flash Boys that “the thread running through all these people, even the ones he didn’t hire, was their fear and distrust of the system”. Katsuyama, Ryan and the rest gradually realised what they were up against – most of the big banks were involved in high-frequency trading in some way, and this went all the way to the top. Katsuyama quit his job and took most of his team with him. They launched a new market, IEX, which was designed to thwart high-frequency traders by introducing a delay of 350 microseconds on every trade, a feat that required 38 miles of cable in a container the size of a shoe box. As Lewis chronicles this journey – a Canadian and his band of brothers, taking on Wall Street – you begin to understand why those high-frequency traders were worried. High-frequency trading is legal and above board, as far as we know, and it has been going on for years, but set out in plain English it looks more than a little odd. The ultra-fast line to Chicago was available only to the highest bidders, who wanted to keep it as exclusive as possible. One prospective customer, offered access for a fee of £20 million, asked: “Can you double the price?” We read of steak dinners in Omaha where high-frequency firms bought the customer “order flow” of online broker TD Ameritrade. (This is the mechanism whereby discount brokerages sell most of their clients’ orders to wholesale companies, which then trade them outside traditional stock exchanges.) “The payment for the order flow is as off the record as possible,” Chris Nagy, a former employee of the broker, told Lewis. The high-frequency guys were said to be particularly interested in seeing the share bids made by small-time investors with slower internet connections and computer processors. “Yours and mine,” Nagy told him. “Our quotes are late to the market, a full second behind.” We read of banks striking similar deals with high-frequency traders to give them privileged access to private exchanges, their so-called “dark pools”. The high-frequency traders also pay some of the exchanges to receive advance notice of bids coming in. Underlying this speedy new world are shades of a Hollywood-style dystopia, of ruling the world, of computer malfunctions that send the markets reeling. A cadre of Russian programmers build the computer systems, often not knowing what they are working on, or how valuable it will prove. Aleynikov was convicted because almost no one – not the prosecutors and certainly not the jury – had any real sense of what he had done. His conviction was overturned, but while in jail, he remained cheery, because it didn’t feel terribly different from the gloomy cubicle where he had laboured, writing his codes. We hear of trading algorithms with names such as Ambush and Nighthawk. Credit Suisse markets one called Guerrilla, with the aid of a flip-down chart that bears a picture of Che Guevara scowling, as if someone has told him how his image is being used. I tell Lewis that he makes Wall Street seem like a fantasy realm. The dark pools sound like somewhere Gollum would bathe and the Flash Boys, the new masters of the millisecond universe, are like a secretive group of alchemists, turning base metals into gold. It sounds like Game of Thrones or Middle Earth, only with less progressive attitudes towards women. Had Lewis declared that Merrill Lynch had begun breeding dragons, I’m not sure I would have been terribly surprised. “This is what it is,” says Lewis. “I didn’t think about it until after I wrote the book, but it is Lord of the Rings and Brad Katsuyama is Frodo. And he’s triggered a war, and he’s got a special power: his ability to explain things to other people.” This may not entirely defuse the arguments of critics who feel Lewis over-dramatises his subjects, picking out heroes and villains and generally making a great and very readable fuss about nothing. “I get accused of that, of course,” he says. “But the people who live this story would say it feels very dramatic: staring-at-the-ceiling-at-night dramatic, mind-spinning dramatic. I have to order the material; it is true that I have to make the drama clear, [but] I don’t feel that the emotions in the book are even an inch away from the real ones experienced.” Things didn’t get any less dramatic once Lewis had finished his book. Katsuyama read it a few days before it was published. “I don’t think he was surprised by his role in the book, but he was surprised his wife was interested,” says Lewis. “He’s got what appears to be a pretty narrow technical story. But he thinks, ‘Oh my god – my wife is liking this story. A lot of people might want to read the story.’” On the day of publication, Lewis was at home in Berkeley, California, where he lives with his wife Tabitha Soren and their three children. He writes in a cabin, made of redwood, that stands in their garden. It all sounds rather idyllic. “Where we live does look a bit like the Shire,” he says, in keeping with his Lord of the Rings theme. On Monday afternoon he left the Shire for Mordor, or at least for New York, where his Canadian Frodo was already at the centre of a storm. “His world blew up,” says Lewis. Katsuyama had never been on television; he made his debut on the prime-time CBS show 60 Minutes. Then he appeared live on business news channel CNBC. The network has a circular, open-plan studio slap bang in the middle of the New York Stock Exchange. There, Katsuyama squared off William O’Brien, president of BATS Global Markets. In the book, the exchange is portrayed as a creation of the high-frequency traders and a critical element of their hegemony; this was Frodo versus a lord of Mordor. O’Brien accused Lewis of writing Katsuyama a 300-page press release. He appeared enraged at the Canadian’s suggestion that the American markets were rigged. Katsuyama managed to keep his cool and just about hung on to his smile, but it must have been a terrifying experience. “He wasn’t terrified,” says Lewis. “He was angry. He was worried he was going to hit the guy.” Lewis said he thought the quarrel was interesting, “but I didn’t think it was nearly as interesting as Wall Street found it”, he says. “Trading floors on Wall Street stopped. A thousand guys stopped and watched. I heard a great story from a guy at one of the big Wall Street firms. They were watching it, and his colleague goes, ‘So the angry guy [O’Brien]. Do we have an investment in his exchange?’ My source says, ‘Yeah, we do.’ Then his colleague says, ‘So the little guy [Katsuyama], we don’t have an investment in his exchange?’ He replies, ‘No we don’t.’ So the colleague says, ‘We’re f***ed.’” Lewis laughs heartily as he retells this story. “And I had tears in my eyes when Brad stepped down,” he says. “All these guys on the exchange gave him a standing ovation and this big guy came and lifted him up.” Lewis met Katsuyama for tea the following afternoon in Midtown Manhattan. By now the book was becoming hard to avoid. “I sat there at the table, and I hear Flash Boys,” says Lewis, gesturing to one side. “I hear: ‘Have you read this new Michael Lewis book?’ I thought, ‘I’ve got to get out of here.’” Surely he wasn’t complaining? “It’s very good for the book, but it’s not healthy for me, or for Brad or for any of us. It’s not normal.” Lewis called Billie Beane, the baseball team manager who was at the centre of the controversy that followed the publication of Moneyball. “He was laughing,” says Lewis. “He was saying, ‘It’s Moneyball all over again.’ Someone does something disruptive like this to an industry [and] it realigns everybody…Every actor in the industry is forced to respond and the responses are all over the map. The person at the centre of the story ends up taking the bulk of the grief.” Lewis will spend a few weeks promoting the book and then, “I get to go home to Berkeley and hide, like someone who starts a fight and then runs away. It’s not a heroic role,” he says. “Brad Katsuyama gets to spend the next decade of his life in this war.” Lewis has found himself offering advice to Katsuyama and the other people in his book. He frequently refers to them as “characters”, as if he were a novelist rather than a non-fiction writer. “It will settle down after people have read it,” he says. “It will take longer than it did with Moneyball, but all the angst and unpleasantness my main characters are experiencing will turn into a gentle glow and they’ll feel good again.” The other unlikely hero in the story is Goldman Sachs, the bank widely known as a vampire squid and the sort of thing you can easily place in a Tolkien story. In a climactic scene, Goldman Sachs is transformed from squid to white knight, riding to the rescue of Katsuyama’s fledgling market. Lewis puts this down to two men newly installed at the top of the bank’s stock market operations. “They truly believed that the market at the heart of the world’s largest economy has grown too complex and was likely to experience some catastrophic failure,” he writes. Lewis admits hesitating slightly at the thought of praising the bank. “I thought, ‘If I end up helping to resuscitate Goldman’s reputation, how will I feel about that?’” he says. “I think the guys at Goldman who did this are good guys. I think they really want to do the right thing. If they aren’t rewarded for doing this – it’s going to cost them some money – then why will Goldman ever behave well? That incentive structure needs to return to Wall Street, right?” You may not get your Christmas bonus, guys, but glory awaits in a Michael Lewis book. The main criticism levelled at Lewis is that, far from being bad for markets, high-frequency trading helps to make them more efficient and better at serving small investors. Critics say Lewis has sided with hedge funds against the little guy. “I don’t know where this argument comes from, but it seems to me so obviously wrong,” says Lewis. “Big hedge funds, weirdly, are on the same side of the market, the losing side, as even individual investors. But even if you leave to one side the guy in his underpants trading on E-Trade, the mass of middle-class savings are in big institutions.” Lewis points to his account of the online broker selling its “order flow”. “Nobody wants it on paper; they want it to be handshake deals,” he says. “Nagy himself said their ‘order flow’ was the most valuable because their customers were the stupidest.” Lewis says the high-frequency traders benefit from volatility. “It creates instability in the market, and it’s offensive. It’s like rich people stealing from middle-class people.” Will there be any prosecutions? Lewis is not sure. “If they know that there’s this group of very smart people who have spent the past five years digging up information about how the markets work from the inside and they have managed to persuade Goldman Sachs that they’re right, that saves the investigators a lot of work,” he says. “So if there was any influence on the process it was that. Just finding out that Brad Katsuyama existed.” So when will the movie happen? I think the question might be a little premature, but it seems not. “The most responsible person I’ve dealt with in the past week is my Hollywood agent,” says Lewis. “He’s had 30 producers trying to buy it. And he said, ‘You can’t come back to me to make an offer until you’ve read the book and have some concrete idea of what you’re going to do.’” Lewis says he can already imagine the opening scene – the workmen laying a cable to Chicago. Then you have the medley of misfits who take on Wall Street. “The Dirty Dozen, Ocean’s Eleven, whatever it is,” he says. In the acknowledgements section of his book, the names of Katsuyama and every other employee of his new exchange are listed like the heroes of a revolution, “so people can look back and know them”. Lewis says he genuinely thinks the formation of their previously little known exchange could prove the starting point of a change in the relationship “between Wall Street and the rest of our society. It’s about reducing the role of Wall Street in finance, in our culture,” he says. Lewis says Ryan appeared on the front page of The Irish Times. Lewis describes him in the book as “having the look of a man who has survived one potato famine and is expecting another”. “He’s a hero there now,” says Lewis. “He’s the Irish guy who went and kicked some ass in New York.” Lewis says Katsuyama is now a national-hero figure in Canada, too. “The ambassador wants to come and see him,” says Lewis. “This guy seems like a normal Canadian, nice guy, but he’s about to change the world. And look what’s happened, right?” Will Pavia © Michael Lewis 2014. Flash Boys (£20, Allen Lane) is out now. It is available from the Times Bookshop for £16, free p&p, on 0845 2712134; timesbooks.co.uk Read an exclusive extract from Michael Lewis’s book in The Times on Monday
Posted on: Sat, 12 Apr 2014 20:40:36 +0000
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