I’ve just finished Michael Lewis’s new book – Flash Boys – about the High Frequency Traders who have taken over the world of high finance. You must read it. It’s an incredible piece of work that vivisects the ugly beating heart of late stage western capitalism. I came away thrilled, horrified, depressed, incredulous, energized and plain confused about what it all means.
HFT’s – in case you don’t know; and unless you’ve read the book you don’t or couldn’t – have inserted themselves between buyer and seller in practically every stock trade that happens through amazingly sophisticated technology which has allowed them to arbitrage time (i.e. they can “see” deals before they happen, buy or sell before a deal, and take a fraction of a percent of a deal, without buyer or seller really knowing). This “time arbitrage”, or more plainly called “front running”, has generated billions and billions of dollars for companies the man in the (Wall) street has never ever heard of … Citadel, Getco, Jump, anyone? Time arbitrage has been far more lucrative than “labor arbitrage”, an issue far more front and center in the general consciousness.
As I was taking this all in I kept coming back to the thought – as Lewis does – that this all feels illegal, or just simply unethical, but is it? What laws exactly are being broken? And given that the laws that govern financial trading are at face value seemingly arbitrary why are some elements of trading legal and others illegal? We all know looking for honor amongst thieves is a fool’s errand.
This thought – and the fact that as Lewis goes on to debate, there are no good answers to these questions – led me on to think about the similarities between what goes on in the murky shadows of finance and what goes on in the murky shadows of a rugby scrum on a Saturday afternoon.
Say what? Bear with me! Rugby is a very complicated game with a large number of rules. Some of these rules are very clear and straightforward. But many of them are not and are open to wide interpretation by the referee. The rules are also frequently changed, often to deal with an unanticipated consequence of a previous rule change. Rugby teams obviously have to know the rules of the game and keep on top of changes. But, crucially, there is no tangible assumption that teams need to police their own actions. In rugby – a game for hooligans played by gentleman remember! – it’s commonly understood that you “play to the whistle” … i.e. you try and get away with as much as you can. The best players – Richie McCaw, Lawrence Dallaglio, Martin Williams etc, get away with more than mere mortals can. They play right “on the edge” and, to opposing fans, are the most annoying, frustrating “cheaters” out there. To the home fans though, they are the ultimate heroes. When they get penalized they just shrug their shoulders and go back in the next play to doing exactly what they were just doing. Very rarely do they get sent-off, very rarely do they give away penalties at crucial moments. In essence, they push the edges further and more effectively than anyone else.
See where I’m going with this? The HFTs are the financial equivalent of the Game They Play in Heaven’s best back-row forwards.
If you accept that the laws are arbitrary, and that everyone on the field – everyone in the financial markets – is trying to get away with as much as they can, the HFTs are just playing the game more successfully than anyone else. They’re ethically no worse than anyone else. Our shock at what they’ve got away with is mixed up with admiration that that they’ve got away with it in the first place.
As with rugby the only people that can make the rules of finance are people who can play the game of finance, at a really high level. Lewis writes about the revolving door between the SEC and the HFTs – but rightly points out that if you don’t even understand what’s going on how you can regulate it? These folks know that there are few “platonic” rights or wrongs. In rugby we can all agree with “no high tackles” or “no tackling a man in the air” because we don’t want to see people get really hurt. But “having to release the ball in a tackle” is a pretty random, arbitrary concept, subject, probably, to change in the near future. Finance markets have always been lubricated by information; “real time” information has long been the Holy Grail. Why should some companies be penalized or demonized if now, through fiber optics and 22nd century “algos” they can make “real time” even “realer” than “real time” used to mean?
But what if finance became more like American Football? What if there were seven officials like there are in the NFL rather than the three there are in rugby? What if more decisions could be sent for TV review? What would finance be like if there were 40 cameras covering the game like NBC has for Monday Night Football? Or what would it be like if finance was more like Tennis? The rules of tennis are much simpler and cleaner and with Hawkeye every decision can be 100% right.
American Football players are much “cleaner” than rugby players because they know they can’t hide from the cameras. Rugby is cleaner than it used to be because of cameras but the scrums and mauls still provide plenty of shadow to exploit. Tennis doesn’t have any shadow. Also tennis doesn’t have any culture of “trying to get away with things” (even in the pre-TV/Hawkeye days). Perhaps there’s a causal connection between those two things?
Ultimately though (and I say this with a mix of disillusionment and resignation) the future of trading - already in reality a robot war happening in data centers in New Jersey with Wall Street as just a show room kept on “for the optics” (the real action is via fiber optics!) - will remain more rugby than football, let alone tennis. The incredible force of the technology that drives it is so powerful that even if you wanted to stop it (through regulation), or somehow just change it for the better (whatever that would mean), the geeks who have taken over the world would find a new way to play “right on the edge”.
Lewis wraps his story by profiling the establishment of IEX, a new trading exchange which is using the tactics of HFT to stop HFT happening. All the talk amongst the founding team is of making the exchange “ungameable”. Good luck to them I say. They – Brad Katsuyama in particular – are the heroes of Flash Boys (I wonder who will play him in the upcoming movie? I guess his Asian features rule out Brad Pitt this time! Maybe it will be my colleague Rob Brown’s pal Tim Kang from The Mentalist.) But their chances, IMvHO, seem very slim. The HFTs can use technology to make anything and everything a game. Even your not wanting to play the game is gameable.
Rugby – to me – is the best game in the world because in its complexities it most mirrors the complexities of life. It needs all types of people (fat and skinny, clever and not-so-clever), requires all sorts of talent (the razor sharp reflexes of the fast twitch backs and the brute strength of a prop), has important rules which are stupid and stupid rules which people ignore, is frequently boring but sometimes fleetingly sublime, and is never fully understandable (after 40+ plus years of playing and watching it there are often moments when my 12 year old asks me “what happened?” to which I have to say “I don’t really know”).
Finance will remain like rugby because finance is so complex, involves all sorts of people, requires all sorts of talents, has important rules which are stupid and stupid rules which people ignore, is frequently boring but fleetingly sublime (particularly at bonus time), and is never fully understandable.
Technology is making the Richie McCaws of finance even better at what they do. No matter how the rules change the McCaws will be in there stealing the ball, getting away with murder, winning the game before the other players even know the game is lost. And picking up the biggest pay check as a result.
As with Lewis and Katsuyama it would be nice to think I’m wrong but somehow I fear I won’t be. But hey, if you have a moment, please tell me that I am!!!