Americans Lack of Trust in Banks and Financial Services
This month marks the fifth anniversary of the current bull market on Wall Street, making it one of the longest and strongest in history. Yet U.S. stock ownership is at a record low, and less than half of Americans trust banks and financial services. In the last two weeks, the New York Attorney General and the Commodities Futures Trading Commission in Washington have both launched investigations into high-frequency computerized stock trading that now controls more than half the market.
Author Michael Lewis Book – Flash Boys Rigged Stock Market
The probes were announced just ahead of a much-anticipated book on the subject by bestselling author Michael Lewis called Flash Boys. In it, Lewis argues that the stock market is now rigged to benefit a group of insiders that have made tens of billions of dollars exploiting computerized stock trading. The story is told through an unlikely cast of characters who figured out what was going on and devised a plan to correct it. It could have a huge impact on Wall Street. Tonight, Michael Lewis talks about it for the first time.
Headline – Stock Market’s Rigged
Michael Lewis: The United States stock market, the most iconic market in global capitalism, is rigged.
60 Minutes Interviewer: By whom?
Michael Lewis: By a combination of the stock exchanges, the big Wall Street banks, and high-frequency traders.
60 Minutes Interviewer: Who are the victims?
Michael Lewis: Everybody who has an investment in the stock market.
What the Stock Market Looks Like Now – High-Frequency Computerized Stock Trading
Michael Lewis isn’t talking about the stock market that you see on television every day. That ceased to be the center of U.S. financial activity years ago and exists today mostly as a photo op. This is the stock market that Lewis is talking about, the one where most of the Trades take place now, inside hundreds of thousands of these black boxes located at more than 60 public and private exchanges, where billions of dollars in stock change hands every day with little or no public documentation. Trades are being made by thousands of robot computers programmed to buy and sell every stock on the market at speeds 100 times faster than you can blink an eye. A system so complex, it’s all but invisible.
Michael Lewis: If it wasn’t complicated, it wouldn’t be allowed to happen. The complexity disguises what is happening. If it’s so complicated you can’t understand it, then you can’t question it.
Fast Trading by Computers Eliminates Humans
60 Minutes Interviewer: This is all being done by computers?
Michael Lewis: All being done by computers. It’s too fast to be done by humans. Humans have been completely removed from the marketplace.
60 Minutes Interviewer: Fast is the operative word. Machines with secret programs are now trading stocks in tiny fractions of a second. Way too fast to be seen or recorded on a stock ticker or computer screen. faster than the market itself.
Who has Rigged the Stock Market with Computers?
60 Minutes Interviewer: High-frequency traders, big Wall Street firms and stock exchanges have spent billions to gain an advantage of a millisecond for themselves and their customers, just to get a peek at stock market prices and orders a flash before everyone else, along with the opportunity to act on it.
Michael Lewis: The insiders are able to move faster than you. They’re able to see your order and play it against other orders in ways you don’t understand.
They’re Able to Front Run your Order.
60 Minutes Interviewer: What do you mean front run?
Michael Lewis: It means they’re able to identify your desire to buy shares in Microsoft and buy them in front of you and sell them back to you at a higher price. It all happens in infinitesimally small periods of time. Their speed advantage that the faster traders have is milliseconds, sometimes fractions of milliseconds. It’s enough for them to identify what you’re going to do and do it before you do it at your expense. So it drives the price up and in turn you pay a higher price.
Brad Katsuyama wa the First Person to See How the Stock Market is Rigged
60 Minutes Interviewer: Michael Lewis is not the first person to allege the stock market is rigged or that high-frequency traders are front-running the market. He was the first to find Brad Katsuyama, who was the first to figure out how it was being done.
Michael Lewis: A very unlikely character, a trader at the Royal Bank of Canada, a young Canadian man named Brad Katsuyama, realized that the market that he thought he knew had changed. The market seemed to be willing to sell stock. But the minute he went to buy it, someone else bought it. It was if someone knew what he was doing before he did it.
About Brad Katsuyama and Explanation of the Rigged Market
60 Minutes Interviewer: Back in 2008, Katsuyama was 30 years old and running the Royal Bank of Canada’s stock desk in New York with 25 traders working for him. Every time one of them tried to buy a large block of stock for a client, their order would only be partially filled and the price of the stock would go up. It kept happening over and over again.
Brad Katsuyama: The best analogy I think is that your family wants to go to a concert You go on a StubHub, there’s four tickets all next to each other for 20 bucks each. You put an order by four tickets, 20 bucks each. And it says, you bought two tickets at 20 bucks each. You go back and those same two seats that are sitting there have now gone up to $25.
What did Brad Katsuyama Think was the Problem
60 Minutes Interviewer: At first, Katsuyama thought it must be that the technology at RBC was slow, until he went to Stanford, Connecticut and paid a visit to one of the largest hedge funds in the world.
Brad Katsuyama: The same things that I was experiencing as a trader, one of the most sophisticated hedge funds in the world was also having the same problem. Then the light bulb goes off, you say, holy cow, this is a huge problem.
60 Minutes Interviewer: You were determined to get to the bottom of it. Why?
What was the Problem? Maybe Fiber Optic Cables?
Brad Katsuyama: It didn’t feel right that people who are investing on behalf of pension funds and retirement funds are getting bait and switched every single day in the market.
60 Minutes Interviewer: Katsuyama suspected that the problem had something to do with plumbing, the way the trades were routed through fiber optic cables from his trading desk in lower Manhattan to the 13 public exchanges in northern New Jersey. No one would tell him exactly what happened to his orders once he hit the buy or sell button. So he put together a team of technical experts, traders, and most importantly, an Irish telecom guy named Ronan Ryan, who was an expert on high-speed fiber optic networks.
Ronan Ryan: I knew nothing about trading until my first day at RBC. When I sat in a three-hour meeting on algorithms, I called my wife afterwards, and I’m like, holy crap, I have no idea what they just said.
High Frequency Traders and Shaving Time Off Stock Trades
60 Minutes Interviewer: Brian had done work for the high frequency traders. He knew what they were building and he knew about the colossal amounts of money they were prepared to spend. He told Brad about a company called Spread Networks that had laid a high speed fiber optic cable from the futures market in Chicago to the exchanges in New Jersey. They spent $300 million just to shave three milliseconds off the fastest route and were leasing access to high-frequency traders at $10 million a pot.
Michael Lewis: From Brad Katsuyama’s point of view, when he heard they were willing to spend that kind of money for milliseconds, it told him that the sums involved are vast. That was one of the first questions he had. He says, all right, I’m getting ripped off, everybody’s getting ripped off, but what does it add up to? I think when he heard the story of spread networks, he realized this is tens of billions of dollars we’re talking about.
Investigating High Speed Cable Maps and Data Centers
60 Minutes Interviewer: Ronan Ryan also knew where all the cable was buried and had detailed maps of the fastest routes from the financial district in lower Manhattan to the various stock exchanges in New Jersey, all calculated down to the millisecond.
Ronan Ryan: So I would sit there, roll out maps, and draw out this data center as a box and a line going through it. They had no idea what I was on about. And then I’d be like, hey, are you guys aware of where these data centers are located? Of course you’re arriving there at different time intervals.
Realization of How They were Being Front-Run by High-Frequency Traders
60 Minutes Interviewer: For Brad, the maps turned what had been an abstract idea into something you could actually see. The first place his orders were landing was the BATS exchange across the river in Weehawken, New Jersey. High-frequency traders were lying there in wait.
Michael Lewis: Brad realizes, oh my God, that’s how I’m being front-run. I’m being front-run because my signal gets to the BATS exchange first, and they can beat me to all the other exchanges.
60 Minutes Interviewer: It only took a tiny fraction of a second for Brad’s trade to reach the next exchanges on the network. The high-frequency traders were able to jump in front of him, buy the same stock, and drive the price up before his order arrived. producing a small profit of just one or two pennies, but it was happening to everyone’s trades millions of times a day.
The Skimming of Stock Market Trades
Michael Lewis: One hedge fund manager said I was running a hedge fund that was $9 billion, and we figured that just our inability to make the trades the market said we should be able to make was costing us $300 million a year. That was $300 million a year in someone else’s pocket.
60 Minutes Interviewer: Is this illegal?
Michael Lewis: No, that’s the thing that’s so shocking about all this. Well, you used the word front-running. Front-running is illegal. This form of front-running is legal. It’s legalized front-running. It is crazy that it’s legal for some people to get advance news on prices and of what investors are doing. It’s just nuts. Shouldn’t happen.
How to Beat the High-Frequency Traders
60 Minutes Interviewer: Ronan knew the only way to beat the high-frequency traders was to take away their milliseconds advantage that allowed them to sniff out slower trades and beat them to the exchange. He had an idea how to do it.
Brad Katsuyama: Then he said, you’re probably better off trying to go slower, which means send the order to the exchange located the farthest away first and send the order to the one that’s located closest to you last. So stagger when you send them out with the goal of arriving at all places as close to the same time as possible.
60 Minutes Interviewer: Katsuyama and his team developed software that did just that, allowing the orders of Royal Bank of Canada’s customers to reach all of the exchanges at the same time, cutting the high-frequency traders out of the equation.
Brad Katsuyama: Essentially our fill rates went to 100%. We couldn’t believe it when we actually figured it out.
Brad Katsuyama Spreading the Word of What he Discovered
60 Minutes Interviewer: Katsuyama and his team went out and began selling and explaining what they had discovered to the big mutual funds, pension funds, and institutional investors, people who had had suspicions that they were being front-run, but didn’t know how. Nobody had really bothered or tried to figure this out until Brad Katsuyama came along.
Michael Lewis: It was in nobody’s interest to correct. I spoke to dozens of investors, big investors, famous investors, who said that when Brad Katsuyama came into my office and laid out to me how the market was rigged, my jaw hit the floor. I mean, I knew something was wrong. I just didn’t know what it was, and no one had told us.
Brad Katsuyama: Part of those meetings led us to believe, holy cow, this is really something, because some of the most sophisticated, the largest asset managers in the world, this is the first time they were hearing this story.
60 Minutes Interviewer: In some of the most famous names in the American stock market heard the pitch.
Michael Lewis: The Capital Group. T. Rowe Price, Fidelity, Vanguard. I mean, one after another. He was in their offices. They said, this man walked in. Why is he going to know how the stock market operates? At the end of an hour, they said, oh my god, he understands.
60 Minutes Interviewer: Hedge fund titan David Einhorn of Greenlight Capital is one of the believers. Was he able to show you how your orders were being front run?
David Einhorn: Oh yeah, they had a, they got the marker and the white board and started drawing maps and boxes and wires and locations and yeah, we went through it in some detail.
Starting Their Own Stock Exchange
60 Minutes Interviewer: Clients like Einhorn encouraged Brad and his team to do something bigger. That’s when Katsuyama, a conformist even by Canadian standards, decided to do something radical. In 2012, he quit his high-paying job as head trader at RBC and went off with some of his team to start their own exchange. Why did you want to go off and walk away from that job and start a stock exchange?
Brad Katsuyama: It wasn’t an easy conversation to have with my wife, that’s for sure. It almost felt like a sense of obligation to say, we found a problem. It’s affecting millions and millions and millions of people. People are blindly losing money.
60 Minutes Interviewer: They don’t even know they’re entitled to. It’s a hole in the bottom of the bucket. They set out to build an exchange funded exclusively by large traditional investors. They called it IEX, the Investors Exchange, and quietly launched it in October with the support of some of the biggest players on Wall Street. It comes with built-in speed bumps to eliminate the advantage of high-speed predators.
Michael Lewis: The way they did it… was they coiled 60 kilometers of fiber optic cable between themselves and the high-frequency traders’ computers. So they call it the magic shoebox. It’s a box, and it looks like it’s got a fishing line in it. But essentially, a high-frequency trader, if he tries to react on the IEX exchange, his trade goes for 60 kilometers until… So he’s an East Jesus. So it gets there at the same time as everybody else’s.
Do You Think That the High-Frequency Trader Can Game You?
Ronan Ryan: I think that they’ll try to game us. I think the fact, though, that we’ve gone and met with the majority of the biggest high-frequency firms to explain what the magic shoebox is doing, and that people haven’t said, oh, that’s rubbish, that won’t work. We’ve had many ask us for a backdoor, to be honest, so that says something that it’ll work.
