In his V-neck sweater, dad jeans and white New Balance sneakers, Michael Lewis doesn’t look like a troublemaker.
Sitting in a tapas bar in Berkeley, California, he bears a passing resemblance to a stretched-out Michael J Fox and shares the actor’s boyish enthusiasm and easy charm.
This time last year, the bestselling author brought Wall Street to a standstill, and the book that caused the trouble continues to send shockwaves through the financial system.
Flash Boys tells the tale of a Canadian financial services executive, Brad Katsuyama, who spotted a gigantic ripoff in the financial markets and set up a company he hoped would end it. The book struck gold – Lewis has sold more than half a million copies in the US alone. The paperback has just been released along with an update from Lewis detailing just how enraged Wall Street remains.
“I knew this was a bombshell,” Lewis said. But even he was taken aback by the speed with which the FBI, Justice Department and others moved to comment on the situation. “It was louder than anything I had experienced.”
Katsuyama noticed that large stock orders were being “scalped”. Moments after an order was placed, high-speed traders (our titular Flash Boys) were snapping up shares before the order could be fulfilled, using powerful algorithms and super-charged computers to force buyers to pay a higher price. The difference in cost can be counted in fractions of a penny – but on massive orders the numbers add up and the losers are the pension funds of millions of Americans.
Katsuyama set up IEX, the Investors Exchange, as a market free from scalpers. While he had alerted many big investors about his concerns, he had not spoken to the media about his findings. “They were afraid that if there was a huge controversy, it would hurt their business as opposed to just quietly informing investors how badly they were getting screwed,” Lewis said. Instead they decided to work with the author of Moneyball and Liar’s Poker to tell their story. They didn’t escape controversy.
Trading floors came to a standstill in New York when Lewis and Katsuyama were confronted on CNBC, the financial news channel, by William O’Brien, president of Bats Global Markets, the second-largest stock exchange operator in the US. “Shame on both of you for falsely accusing literally thousands of people and possibly scaring millions of investors in an effort to promote a business model,” O’Brien said, accusing the pair of dishonesty and Lewis of writing a 300-page commercial for IEX.
Days later, O’Brien was being hauled over the coals by regulators for claims he made on the show. Months later, he was gone. Wall Street’s fightback, however, has not stopped. The opposition has launched what Lewis describes as “essentially a political campaign” to minimise the impact of his book and the work of IEX.
Last month, the former commodities trading regulator Bart Chilton called Lewis’s assertions that the market was rigged “a big lie”. Chilton, again on CNBC, asserted high-frequency trading had contributed to making markets cheaper, faster and safer than ever before. The former boss of the Commodities Futures Trading Commission now works with the high-frequency trade association Modern Markets Initiative. He said Lewis’s claims were irresponsible and had been debunked by academic research.
Visibly irritated by what he sees as a campaign to halt reform and serious discussion, Lewis said Chilton was “essentially a flack”. “He’s deceiving the public in order to make the markets less fair,” he said. “People are so cynical about Wall Street they don’t believe any of it.”
Nor has the financial media covered itself in honour since the debate started, he says. Lewis admitted to being “a little surprised by how uncomfortable the financial media has been with the subject”.
“There’s a feeling that CNBC would like nothing more than the book, me, Brad Katsuyama, to be totally discredited. But they are very uncomfortable discrediting the other side. They are very happy to have paid spokesmen who don’t know anything to come and shout on TV,” he said.
Investigations into high-frequency trading continue and into potential abuses in dark pools – private stock markets usually operated inside large banks. Dark pools were originally designed to let people trade shares before investors in the broader market could learn about the orders and bet against them. Instead they have become forums for exactly what they were supposed to prevent, says Lewis, and the costs to investors are enormous.
The most high-profile case over alleged market abuses to emerge so far is being brought by the New York attorney general. Eric Schneiderman has accused Barclays of “a systematic pattern of fraud and deceit” by operating its dark pool to favour high-frequency traders. The bank denies all charges.
Other regulators have been more circumspect. Last April, the Securities and Exchange Commission (SEC) chair, Mary Jo White, was asked about Flash Boys in Congress. “The markets are not rigged,” replied the US’s most senior financial regulator.
The chair of the SEC “cannot say the market is rigged”, said Lewis. “When you are at the SEC you are part of a system where the worst thing you can do is undermine the markets. Even if that confidence is unfounded, you are better off saying everything is OK and then working behind the scenes to fix what is not OK.”
But as Lewis points out, John Ramsay, formerly the SEC’s director of trading and markets who is now at IEX, has had no issue pointing out the cracks in the system. Ramsay has called US stock markets “convoluted” and “illogical” and likened their structure to the Death Star of Star Wars.
High-frequency traders may have become the focus of the debate after Flash Boys was published but Lewis said they were just a symptom of a larger malady. “They are exposing how messed up the whole system is. They didn’t create the system, they are exploiting it. And once you start making money from a screwed up system, you want to make it even more screwed up,” he said.
In a fairly short time exchanges have gone from being a place where trades happen and whose job it was to make sure that those trades happened fairly “to a pace where you sell peculiar advantages to a small handful of traders so that they can exploit the rest, that’s crazy”” he said. “How they do this with a straight face I’ll never know.”
Any chance of change coming from the top is stymied by regulators and politicians who are “hopelessly captured” by Wall Street, says Lewis, and therefore unwilling to act. “I have been amazed at how resistant people are to actually fixing an obvious problem that is an obvious source of a grotesque unfairness and basically a transfer of wealth from the middle class to the rich,” he said. “Who needs more transfer? Why do rich people need another advantage?”
For Lewis, the heat the book generated in the US in large part defeated its purpose. He says he wanted people to read it for pleasure and that Flash Boys is a positive story about people acting in the better interests of others.
Katsuyama could have looked the other way and just made his money. Instead he decided to risk his career by doing something different and changing a system he believed to be unfair. Lewis had hoped the book would be inspiring, he said, and that IEX’s example might encourage would-be Wall Streeters to stop worrying about getting their half-a-million-dollar bonus at age 23 and instead think “let’s figure out some useful thing to do in the world that happens to be on Wall Street”, he said. “That’s the only way the system is going to get fixed.”
“It does seem to me that the system is broken,” Lewis said. “No one has the balls to stand up and say we have to wipe it out and start over. The government has already shown that it lacks the political will to break up too big to fail banks. The regulators are captured, it seems at this point there is no point in having this discussion with regulators. All that’s left is market-based change.” Is it worrying that the market is our last defence? Yes, he says. “But worrying is different to hopeless.”
Lewis is hopeful that change is coming. Wall Street will be disrupted by the internet just as surely as it has disrupted so many other businesses, he says. “The internet has basically ruined a lot of intermediaries businesses. Wall Street has been very good at slowing that change but in the end, Wall Street will be transformed by technology. There’s no reason why we can’t have a financial sector that is not toxic. It doesn’t have to be that way.”
Katsuyama came up with the idea of IEX while working for Royal Bank of Canada in New York. He would walk through the Occupy Wall Street protests in Zuccotti park on his way to work and to the demonstrators he was part of the problem. However, Lewis remains hopeful that Katsuyama is part of the solution.“Things do change,” Lewis said.
Michael Lewis is discussing Flash Boys with Dylan Jones, editor of GQ, at the Royal Festival Hall, Southbank Centre on Thursday 9 April.
This article was written by Dominic Rushe in San Francisco, for theguardian.com on Friday 3rd April 2015 11.42 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010