Flash Boys: A Wall Street Revolt

“Like every other trader on the Chicago exchanges, he saw how much money could be made trading futures contracts in Chicago against the present prices of the individual stocks trading in New York and New Jersey. Every day there were thousands of moments when the prices were out of whack—when, for instance you could sell the futures contract for more than the price of the stocks that comprised it. To capture the profits, you had to be fast to both markets at once. What was meant by ‘fast’ was changing rapidly.”

Flash Boys focuses on a new version of an old problem. Time has always been a fundamental problem for stock traders as they try to figure out how prices will move. The problem is even worse when there is a gap between the expression of interest in buying and selling stock and the actual transaction, since the party on the other side can use their knowledge of that interest to shift the price in their favor. Computerization should theoretically solve that problem by taking away the possibility for human collusion, but algorithms can adjust the terms of trade in mere fractions of a second, where a person would need minutes or hours. Lewis’s blunt, colloquial tone presents him as a seasoned interlocutor of problems such as this, which he has encountered before in previous writing endeavors.

“What they were selling—speed—was only valuable to the extent that it was scarce. What they did not know was the degree of scarcity that would maximize the line’s market value. How much to twenty-five different players–to share the same advantage over the rest of the market? To answer these sorts of questions, it helps to know how much money traders can make purely from speed in the U.S. stock market, and how, exactly, they make it.”

Lewis is fascinated by how Wall Street culture pushes people to undertake enormous risks when they can barely conceive of what they are trying to gain, much less any guarantee of achieving it. In Lewis’s telling, Spread Networks undertook a massive project without any clear picture of what their product could offer, even if it worked exactly as they intended by reducing the speed of transfers by a few milliseconds. A cultural obsession with innovating, especially relative to others, seems to drive them forward with an almost doggedly ignorant hope of making the next great discovery. 

“If someone came in the door looking for a job and sounding like a typical Wall Street asshole, they wouldn’t hire him, no matter how much money he could make the firm. There was even an expression used to describe the culture: ‘RBC nice.’ Although Brad found the expression embarrassingly Canadian, he, too, was RBC nice. The best way to manage people, he thought, was to convince them that you were good for their careers. He further believed that the only way to get people to believe that you were good for their careers was actually to be good for their careers.”

The heroes of Lewis’s books often stand apart from the dominant culture of their milieu, which makes them better able to see things that conventional wisdom is ill-suited to detect. Brad Katsuyama clearly fits within this mold, as Lewis quickly establishes him as a kind, sensible man in a world of brash egos and risk-taking for its own sake. Lewis wants to show that good people can endure, even succeed, in a cutthroat world, and so Katsuyama is an ideal candidate for Lewis.

“Dark pools were another rogue spawn of the new financial marketplace. Private stock exchanges, run by the big brokers, they were not required to reveal to the public what happened inside them. They reported any trade they executed, but they did so with deficient delay that it was impossible to know exactly what was happening in the broader market at the moment the trade occurred. Their internal rules were a mystery, and only the broker who ran the dark pool knew for sure whose buy and sell orders were allowed inside. The amazing idea the big Wall Street banks had sold to big investors was that transparency was their enemy.”

A key part of Wall Street culture is the exploitation of the gap between the letter of the law and the spirit of the law. The SEC and other regulators are not ignorant of the faults of Wall Street, and work hard to come up with solutions to make their practices fairer, but they are operating at a massive disadvantage. Investors and exchanges easily flout the intended aims of the law while technically remaining within its parameters, such as reporting trades within a dark pool but on a delayed timeline that privileges their own proprietary traders. Technical innovation within this culture nearly always favors the side of disruption over regulation.

“The discovery of THOR was not the end of a story; it was closer to a beginning. Brad and his team were building a mental picture of the financial markets after the crisis. The market was now a pure abstraction. It called to mind no obvious picture to replace the old one people still carried around in their heads. The same old ticker tape ran across the bottom of television screens-even though it represented only a tiny fraction of the actual trading. Market experts still reported from the floor of the New York Stock Exchange, even though trading no longer happened there.”

People live their daily lives by taking several things for granted—they would not be able to function at all if they could not rely upon a certain set of steady expectations. This necessary quality can make it difficult to see when those assumptions start to break down, and this proved to be the case with the stock market in the late 2000s. Even after crowds of shouting traders left the New York Stock Exchange and other physical spaces, the idea of a trade as moving from seller to broker to buyer largely endured until Katsuyama had a tool capable of proving the problem existed. This led to the far greater problem of identifying the full scope of the problem and outlining a solution. The sheer inability to imagine the current state of the market in images and metaphors suggests that it is too gargantuan and complex to be described within the boundaries of language.

“A lot of people in and around the telecom industry were more knowing than knowledgeable. The people at MCI who sold the technology often didn’t actually understand it and yet were paid far better than people, like him, who simply fixed problems.”

Like Silicon Valley, Wall Street exhibits a strange imbalance of power between leadership and rank-and-file employees. Someone at the top might have a brilliant idea, or at least need to personify a brilliant idea to make their company attractive to successive rounds of investors. Even if that person was once a technician, their focus on the business side precludes them from keeping up with fast-moving technology, making them dependent on the people who take direct responsibility for implementing their product. But since their position is more public facing, they need to sustain a perception of knowing more than they actually do and denigrating the work of the people who actually provide the substance. This asymmetrical relationship between the rank-and-file and leadership echoes Aleynikov’s own relationship to Goldman Sachs that began Lewis’s investigation.

“Maybe because Ronan was so unlike a Wall Street person, he was granted special access and was able to get inside the heads of the Wall Street people to whom he spoke.”

On Wall Street, everyone has an angle, all the time, even when they are genuinely trying to help someone else, as Katsuyama and Ryan were. Katsuyama had a reputation for honesty, but he was also trying to sell THOR. The more effective ambassador in some respects was the foul-mouthed Irishman who had never held a job on a trading floor and who seemed incapable of speaking anything other than what was on his mind. With so many people telling different stories about an uncertain new development, the easiest one to believe was the one without guile. Ryan’s characterization places him as a foil to Katsuyama’s reputation as a mild-mannered insider. 

“The deep problem with the system was a kind of moral inertia. So long as it served the narrow self-interests of everyone inside it, no one on the inside would ever seek to change it, no matter how corrupt or sinister it became–though even to use words like ‘corrupt’ and ‘sinister’ made serious people uncomfortable, and so Brad avoided them.”

Lewis’s story has a few heroes but is short on villains. The abstract system of finance capitalism and stock trading itself which has for so long benefited the few at the expense of the many that such is taken as a fact of nature. Cynicism has become so entrenched that even talking about things in moral terms is considered unacceptable, depriving Katsuyama of the language he needs to describe the problem accurately. The restrictions around diction and connotatively weighted language are symbolic of the “moral inertia” inherent to Wall Street.

“The entire history of Wall Street was the history of scandals, it now seemed to him, linked together tail to trunk like circus elephants. Every systemic market injustice arose from some loophole in a regulation created to correct some prior injustice.”

People who raised dire concerns about fundamental injustices in stock trading were often dismissed as conspiracy theorists, and John Schwall’s obsessive streak made him an easy mark for such a caricature. Yet by tracing the problem all the way back to Wall Street’s origins, he did not find a sinister cabal pulling the strings in secret. Like its big firms that relied on a vast infrastructure that they could only reform one piece at a time, Wall Street is simply not suited for revolutionary change, as everyone is prioritizing the maintenance of day-to-day operations in systems that are so complex that they often operate independent of human input such as the algorithms of HFT. It is another way that the structure is tilted against reform, not necessarily because anyone intentionally did so—traders just exploit vulnerabilities as they become aware of them.

“Technology should have led to a reduction in this tax; the ability of investors to find each other without the help of some human broker might have eliminated the tax altogether. Instead this new beast rose up in the middle of the market and the tax increased-by billions of dollars.”

In its traditional form, stock market corruption involved human traders passing information to one another through illicit private channels, creating a tiered system between those with privileged knowledge and those without it. Shifting the system to computers should have leveled the playing field, but it instead created an even more implacable hierarchy based on speed advantage rather than personal connections. Since technological advantages are a far more exclusive privilege, its owners can sell access at a much higher rate. Lewis’s purposefully provocative language of the “new beast” portrays new technological advances not as helpful, but as fresh ground for predatory behavior under such a cynical and profit-motivated culture.

“’Why would anyone pay for access to the customers’ orders inside a Wall Street bank’s dark pool?’ The straight answer was that a customer’s stock market order, inside a dark pool, was fat and juicy prey. The order was typically large, and its movements were especially predictable: each Wall Street bank had its own detectable patterns for handling orders. The order was also slow, because of the time it was forced to spend inside the dark pool before accessing the wider market.”

The more Katsuyama and his team learn, the worse things appear. They already distrusted dark pools as a way for the big firms to skirt regulators and shield their investors from the risks of public exchanges, but upon further investigation they realized that dark pools are perfectly designed to maximize the advantages of HFTs. Lewis continues to build tension by using language that connotes predator and prey relationships, with the HFT as ominous, silhouetted predators lurking in the background. Lewis leverages the term “dark pools,” which adds to this vivid depiction of a predator hunting its prey by recalling a watering hole of sorts for “fat and juicy” prey animals.

“More than half the programmers at Goldman were Russians. Russians had a reputation for being the best programmers on Wall Street, and Serge thought he knew why: They had been forced to learn to program computers without the luxury of endless computer time. Many years later, when he had plenty of computer time, Serge still wrote out new programs on paper before typing them into the machine. ‘In Russia, time on the computer was measured in minutes,’ he said. ‘When you wrote a program, you are given a tiny time slot to make it work. Consequently we learned to write the code in ways that minimized the amount of debugging.”

Lewis places great importance on culture as a determinant of outcomes. The predatory practices of Wall Street endure not only because the structure is flawed, but because of a belief system that everyone is out for themselves and having a conscience is a sign of weakness. Likewise, Lewis highlights the cultural background of the major players, in this case Aleynikov, to show how certain people either thrive within Wall Street or become the greatest threats to its status quo. 

“Serge actually didn’t know what the speed was being used for by Goldman’s prop traders. As he worked, he become aware of a gulf in understanding between himself and his employer. The people at Goldman with whom he dealt understood the effects of what he did but not their deep causes. No one at Goldman had a global view of the firm’s computer software, for instance…’I think it’s done intentionally,’ he said. ‘the less you know about how they make the money, the better it is for them.”

The workings of the stock market are undoubtedly complex, but that complexity can also serve as an excuse to provide cover for willful misconduct. The big firms knew exactly what they were doing, and called for programs to carry out their wishes, namely favor their own investors, but then they could point to the complexity of the systems as evidence that no one could possibly understand their workings or predict their outcomes. This double-bind represents another exploitation of the law by remaining within its letter, but not its spirit. 

“Forty-eight hours after Goldman called the FBI, McSwain arrested Serge. Thus the only Goldman Sachs employee arrested by the FBI in the aftermath of a financial crisis Goldman had done so much to fuel was the employee Goldman asked the FBI to arrest.”

Sergey Aleynikov probably did commit a crime when he took proprietary software with him on his way out of Goldman Sachs, even if his intentions were good. Even so, Lewis makes a powerful point that the laws are designed to safeguard the interests of big firms like Goldman, so that a single programmer suffers a greater penalty for taking software he helped design than a whole group of executives who helped cause financial ruin for millions of people. The juxtaposition between Aleynikov’s relatively innocuous crime and the crimes of Goldman Sachs illustrate the strong connections between the upper echelons of power in both Wall Street and the federal government.

“There’d never been any collective pressure brought by investors on the big banks to route their stock market orders to any one exchange, but that was only because there was no good reason to prefer one exchange over another. The fifty or so places on which stocks were traded were all designed by financial intermediaries, for financial intermediaries.”

Stock trading was once the near-exclusive provenance of the New York Stock Exchange and Nasdaq, when it required direct human interaction. When the system shifted to computers, the initial thinking was that more exchanges would establish a balance of power. Instead, multiple exchanges increased the importance of intermediaries between them, and they had become powerful enough to make sure that the system continued to operate in their interest. Lewis uses repetition of “financial intermediaries” to stress the overwhelming power that such intermediaries hold; they leverage this power to ensure that every technological change works out in their favor.

“The third [HFT strategy] and probably by far the most widespread, they called ‘slow market arbitrage.’ This occurred when a high-frequency trader was able to see the price of a stock change on one exchange, and pick off orders sitting on other exchanges, before the exchanges were able to react…this happened all day, every day, and generated more billions of dollars a year than the other strategies combined.”

HFTs did not gain their privileged position simply due to technological advancement. It needed the proliferation of stock exchanges, so that any given trade could now bounce around several different options before matching sellers and buyers. These transactions would take longer, and in the meantime, cleavages in the markets could open and be exploited by those with the technological wherewithal.  

“If the Puzzle Masters were right, and the design of IEX eliminated the advantage of speed, IEX would reduce the value of investors’ stock market orders to zero. If the orders couldn’t be exploited on this new exchange–if the information they contained was worthless–who would pay for the right to execute them?”

IEX couldn’t eliminate HFT or its speed advantage, even if they had wished to. The next best thing they could do to reduce their competitive advantage was to reduce the role of intermediate brokers, vastly increasing the odds of buyers and sellers finding a mutually acceptable price within one dark pool rather than searching across multiple exchanges. The Wall Street firms were making billions from the fees resulting from transactions that had to pass through multiple exchanges, and so IEX was a direct threat to the big firms, and not just the HFTs. Lewis often uses rhetorical questions, directed at the audience, to engage the reader in formulating answers before they are revealed by the narrative; Here, he uses his rhetorical questions to suggest how threatening IEX’s model is to HFT.

“[Zoran Perkov] was somehow expected to cope with the demands made on Nasdaq’s markets by Nasdaq’s biggest customers (high-frequency traders) and, at the same time, keep those markets safe and stable. It was as if a pit crew had been asked to strip down the race car, rip out the seat harnesses, and do whatever else they might to make the car go faster than it ever had before – and at the same time reduce the likelihood that the driver would die.”

Flash Boys is full of Wall Street veterans whose experiences left them frustrated and even bitter. Lewis communicates Perkov’s frustration through analogy that suggests physically impossible tasks. Perkov’s case is particularly salient because his own contributions to HFT made his own position more unstable. His whole job was to avoid market volatility, and yet he was supposed to oversee reforms that everyone knew were making markets increasingly volatile. The more complex the system became, the easier it would be for the executives to place blame on incomprehensible technology, and the one person responsible for running it. 

“It was as if there was no way to explain how the financial market actually worked—or didn’t—without resorting to fuzzy metaphors and meaningless words. If stock market computer-related problems were to be reduced to a single phrase, Zoran preferred it to be ‘normal accidents.’”

Wall Street executives demanded increasingly complex and risky algorithms to maximize profits, leading to systems that were more likely to break for reasons that those executives were less and less able to understand. When things went wrong, as they inevitably would, they could not explain what happened, and so terms like “glitch” implied a purely technical error rather than a byproduct of design. The rhetorical maneuvers taken to shift blame on the technology, and the nameless programmers who made such technology, illustrates an inability to accept accountability within Wall Street, as well as an inability to interrogate the system itself.

“Brad’s biggest weakness, as a strategist, was his inability to imagine just how badly others might behave. He had expected that the big banks would resist sending orders to IEX. He hadn’t imagined they would use their customers’ stock market orders to actively try at their customers’ expense to sabotage an exchange created to help their customers.”

Katsuyama could not have succeeded as much as he did on Wall Street if he was simply a nice, optimistic person without guile. His whole mission in creating IEX was to challenge the corruption he saw around him. Katsuyama’s hope borders on naivety as he tries to pull some of his audience to his way of thinking. Regrettably, most decided to try and take advantage of as many others as they could, and if a crisis was coming, to make as much money as possible before it struck. Katsuyama’s naivety conflicts with the unrestrained, short-term greed that the market operates on, placing Katsuyama’s ideals in conflict with the very ideas that the system he is working within operates upon.

“Talking to a programming type about the trading business was a bit like talking to the house plumber at work in the basement about the card game the Mafia don was running upstairs.”

To the average juror, Aleynikov makes a fitting criminal; an asocial Russian who cannot explain what he was doing in comprehensible terms. To Lewis’s juror of experts, they quickly realize that his eccentric demeanor made him less suspicious, not more. All he cared about was the programming side, and whatever the wisdom of his actions, he took the code for his own personal edification. He had every opportunity to steal trade secrets and refused to do so. Lewis’s analogy makes the assumption that Aleynikov was a willfully malicious actor absurd and suggests that his conviction is at least partially to blame on unconscious biases held toward Russians by Americans.

“The process that ended with Serge Aleynikov sitting inside two holding facilities that housed dangerous offenders and then a federal prison may have started with the concern of some Goldman Sachs manager with his bonus.”

Lewis’s initial hypothesis was that Goldman was overzealous in handing Aleynikov over to the FBI, and hypocritical insofar as none of their executives saw any prison time for far worse offenses against the US economy. His “jurors” devise an alternative theory that Goldman went after Aleynikov because they knew what he held was not terribly valuable, as it was mostly based on open-source materials. By subjecting him to a dramatic arrest, trial, and conviction, they helped reify the perception that Goldman held onto priceless secrets, a perception even more important for being untrue. Lewis continues to use stark juxtaposition to contrast the world in which Aleynikov the everyman lives, and the faceless executives of Goldman Sachs and other such investment firms.

“There was a connection between Serge Aleynikov and Goldman’s behavior in December 19, 2013…the high-frequency traders would always be faster than Goldman Sachs-or any other big Wall Street bank. The people who ran Goldman Sachs’ marketing department had come to understand that what Serge had taken wasn’t worth stealing–at least not by anyone whose chief need was speed.”

A great puzzle at the end of the book is how Goldman could be so ruthless toward Aleynikov and yet so helpful toward IEX. The answer is self-interest. Aleynikov’s prosecution was, at least in Lewis’s estimation, a bid to shield their relative weakness in the HFT game. They then came to IEX’s rescue after concluding that they could never recoup an advantage of HFT and were better off helping IEX take their competitors down a notch.