Flash Boys: A Wall Street Revolt

by Michael Lewis

  The cost, in the end, is a tangled-up financial system. Untangling it requires acts of commercial heroism—and even then the fix might not work. There was simply too much more easy money to be made by elites if the system worked badly than if it worked well. The whole culture had to want to change. “We know how to cure this,” as Brad had put it. “It’s just a matter of whether the patient wants to be treated.”

  FOR A LONG stretch along the Spread Networks line, there was no happy place for a rider to stop. The road’s shoulder was narrow, and the cornfields beside it were planted with No Trespassing signs. Apart from the plastic soda bottle and the carcasses of deer killed by the speeding pickup trucks, and a shop or two, the landscape looked a lot like it once did from the Philadelphia-Erie stagecoach. The most insistent signs of modernity were the white poles with their bright orange domes, every few hundred yards, installed three and a half years earlier. After ten miles or so we found an open field without a sign and pulled over beside a white-and-orange pole. The poles stretched into the distance in both directions. An ambitious hiker or cyclist could follow them all the way to a building beside the Nasdaq stock exchange, in New Jersey; or, if he turned and headed west, to the Chicago Mercantile Exchange.

  Across the road was a local landmark: the Red Round Barn. One of the women repeated a rural legend, saying that the red barn had been built in the round so that mice had no corners in which to hide. “People don’t know how to live in a world that is transparent,” Brad Katsuyama had said, and mice were probably no better at it. Beyond the barn was a mountain. On top of the mountain was a microwave tower—a string of them, in fact, perched on the mountains above the valley in which the line was buried.

  It takes roughly 8 milliseconds to send a signal from Chicago to New York and back by microwave signal, or about 4.5 milliseconds less than to send it inside an optical fiber. When Spread Networks was laying its line, the conventional wisdom was that microwave could never replace fiber. It might be faster, but whatever was going on between New York and Chicago required huge amounts of complicated data to be sent back and forth, and a microwave signal couldn’t transmit nearly as much data as a signal in a fiber-optic cable. Microwave signals needed a direct line of sight to get to wherever they were going, with nothing in between. And microwave signals didn’t travel well in bad weather.

  But what if microwave technology improved? And what if the data essential for some high-frequency trader to gain an edge over investors in the market wasn’t actually all that complicated? And what if the tops of mountains afforded a direct line of sight between distant financial markets?

  The risks taken by high-frequency traders were not the usual risks taken by people who purport to sit in the middle of markets, buying from sellers and selling to buyers. They didn’t risk buying a bunch of shares in a falling stock, or selling a bunch of shares in a rising one. They were too skittish and well informed for that—with one obvious exception. They were all exposed to the risk that the entire stock market would move, by a lot. A big high-frequency trader might “make markets” in several thousand individual stocks in New Jersey. As the purpose of these buy and sell orders was not to buy and sell stock but to tease out market information from others, the orders would typically be tiny in each stock: 100 shares bid, 100 shares offered. There was little risk in any individual case but great risk in the aggregate. If, say, some piece of bad news hit the market, and the entire stock market fell, it would take all the individual stocks with it. Any high-frequency traders who did not receive advance warning would be left owning 100 shares each of several thousand different stocks they did not want to own, with big losses in each.

  But the U.S. stock market had an accidental beauty to it, from the point of view of a trader who wished to trade only when he had some edge. The big moves occurred first in the futures market in Chicago, before sweeping into the markets for individual stocks. If you were able to detect these moves, and warn your computers in New Jersey of price movements in Chicago, you could simply withdraw your bids for individual stocks before the market fully realized that it had fallen. That’s why it was so important for high-frequency traders to move information faster than everyone else from the futures exchange in Chicago to the stock markets in New Jersey: to flee the market before others. This race was run not just against ordinary investors, or even Wall Street banks, but also against other high-frequency traders. The first high-frequency trader to reach New Jersey with the news could sell 100 shares each in thousands of different stocks to the others.

  After some obligatory staring at the Red Round Barn, we jumped back on our bikes and continued. A few miles down the road, we turned onto the road leading to the summit of a mountain with a tower on top of it. The woman who had won the silver medal at the downhill mountain biking world championships sighed. “I like going down more than going up,” she said, then took off at speed, leaving everyone else behind. Soon I was watching the backs of female riders, climbing rapidly. It could have been worse: The Appalachians are mercifully old and worn. This particular mountain, once the size of a Swiss Alp, had been shrunken by half a billion years of bad weather. It was now almost beneath the dignity of the Women’s Adventure Club.

  It took maybe twenty minutes to puff to the top of the road, where the women adventurers stood waiting. From there we turned onto a smaller road leading into the woods, headed in the direction of the mountaintop. We rode through the woods for a few hundred yards until the road ended—or, rather, was barricaded by a new metal gate. There we ditched our bikes, leapt over the signs warning of various dangers, and hiked onto a gravel path that continued to the mountaintop. The women didn’t think twice about any of this: To them it was just another adventure. A few minutes later the microwave tower came into view.

  “I climbed up one of these towers once,” one of the women said a bit wistfully.

  The tower was 180 feet high, with no ladder, and festooned with electrical equipment. “Why did you do that?” I asked.

  “I was pregnant and it was a lot of work,” she replied, as if that answered the question.

  “And that’s why your baby had seven toes!” hooted one of the other women, and they all laughed.

  If one of the women had hopped over the fence around the tower and climbed to the top, she would have had an unobstructed view of the next tower and, from there, the tower beyond. This was just one in a chain of thirty-eight towers that carried news of the direction of the stock market from Chicago to New Jersey: up or down; buy or sell; in or out. We walked around the site. The tower showed some signs of age. It could have been erected some time ago, for some other purpose. But the ancillary equipment—the generator, a concrete bunker to hold God knows what—was all shiny and new. The repeaters that amplify financial signals resembled kettle drums, bolted onto the side of the tower: These were also new. The speed with which they transmitted signals, and with which the computers on either end of the chain of towers turned the signals into financial actions, were still as difficult to comprehend as the forces of nature once had been. Anything said about them could be believed. People no longer are responsible for what happens in the market, because computers make all the decisions. And in the beginning God created the heaven and the earth.

  I noticed, before we left, a metal plate attached to the fence around the tower. On it was a Federal Communications Commission license number: 1215095. The number, along with an Internet connection, was enough to lead an inquisitive person to the story behind the tower. The application to use the tower to send a microwave signal had been filed in July 2012, and it had been filed by . . . well, it isn’t possible to keep any of this secret anymore. A day’s journey in cyberspace would lead anyone who wished to know it into another incredible but true Wall Street story, of hypocrisy and secrecy and the endless quest by human beings to gain a certain edge in an uncertain world. All that one needed to discover the truth about the tower was the desire to know it.

  ACKNOWLEDGMENTS

  The
U.S. financial system has experienced many changes since I first entered it, and one of them is in its relationship to any writer who attempts to figure out what’s going on inside of it. Wall Street firms—not just the big banks but all of them—have grown greatly more concerned than they were in the late 1980s with what some journalist might say about them. To judge only from their behavior, they have a lot more to fear. They are more likely than they once were to seek to shape any story told about them. At the same time, the people who work in these firms have grown more cynical about them, and more willing to reveal their inner workings, so long as their name is not attached to these revelations. As a result, I am unable to thank many of the people inside banks and high-frequency trading firms and stock exchanges who spoke openly about them, and helped me to comprehend the seemingly incomprehensible.

  Some other people not mentioned in this book were important to its creation. Jacob Weisberg read an early draft and had shrewd things to say about it. At different times and in different ways, Dacher Keltner, Tabitha Soren, and Doug Stumpf listened to me drone on at length about what I was working on, and responded with thoughts that never would have occurred to me. Jaime Lalinde helped me, invaluably, in researching the case of Serge Aleynikov. I apologize to Ryan Harrington, at W. W. Norton, for sending him chasing around for illustrations that I thought might be useful but which turned out to be a dumb idea. He did it very well, though.

  Starling Lawrence has edited my books since I first started writing them, with his peculiar combination of encouragement and detachment. He edited this one, too, and I’ve never benefited so much from his unwillingness to allow me to enjoy even the briefest moment of self-satisfaction. The third member of our team, Janet Byrne, is the finest copy editor I have ever worked with. Many mornings her enthusiasm got me out of my bed, and many evenings her diligence prevented me from getting back into it.

  Finally, I’d like not only to thank the employees of IEX but also to list them by name, so one day people can look back and know them. They are: Lana Amer, Benjamin Aisen, Daniel Aisen, Joshua Blackburn, Donald Bollerman, James Cape, Francis Chung, Adrian Facini, Stan Feldman, Brian Foley, Ramon Gonzalez, Bradley Katsuyama, Craig Katsuyama, Joe Kondel, Gerald Lam, Frank Lennox, Tara McKee, Rick Molakala, Tom O’Brien, Robert Park, Stefan Parker, Zoran Perkov, Eric Quinlan, Ronan Ryan, Rob Salman, Prerak Sanghvi, Eric Schmid, John Schwall, Constantine Sokoloff, Beau Tateyama, Matt Trudeau, Larry Yu, Allen Zhang, and Billy Zhao.

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  EDITED BY MICHAEL LEWIS

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  by MICHAEL LEWIS

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  “It is the work of our greatest financial journalist, at the top of his game. And it’s essential reading.”

  —Graydon Carter, Vanity Fair

  “Lewis has such a gift for storytelling . . . he writes as lucidly for sports fans as for those who read him for other reasons.”

  —Janet Maslin, New York Times

  “This delightfully written, lesson-laden book deserves a place of its own in the Baseball Hall of Fame.”

  —Forbes

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  —Fortune

  Copyright © 2014 by Michael Lewis

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  The Library of Congress has cataloged the printed edition as follows:

  Lewis, Michael (Michael M.)

  Flash boys : a Wall Street revolt / Michael Lewis. — First Edition.

  pages cm

  Includes bibliographical references and index.

  ISBN 978-0-393-24466-3 (hardcover : alk. paper)

  1. Stockbrokers—United States. 2. Wall Street (New York, N.Y.)

  3. Finance—United States—History—21st century. I. Title.

  HG4628.5L49 2014

  332.6'2092273—dc23

  2014003208

  ISBN 978-0-393-24467-0 (e-book)

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