The intrepid investigative journalist and author Michael Lewis is burning up the headlines and sparking shouting matches on financial TV programs with his new book Flash Boys: A Wall Street Revolt. In it, Lewis addresses the sneaking suspicion that many Americans have about the stock market: that it is rigged, that certain insiders have access to information that lets them get rich at the expense of everyone else. And Lewis’ verdict is: Guilty as Charged.
There are plenty of technical arguments about the details of Lewis’ thesis, but what it boils down to is this: A small number of high-tech, high-powered traders have set up super-fast computers with unique software and ultra-fast Internet lines, which allow their computers to learn about stock prices before other traders’ computers do, and buy or sell stocks in the blink of an eye, gaining an “unfair” advantage over competitors—such as you and me—who don’t have such equipment.
What most outsiders don’t realize about Wall Street today is that few trades are made anymore by the shiny-suited, loud-mouthed guys from Staten Island who used to throng the floor of the New York Stock Exchange. The vast majority of stock market trades are made silently by computers—increasingly by sophisticated algorithms that buy and sell stocks automatically, in milliseconds. Long gone are the days when investors would carefully scan the fundamentals of a company, determining whether its profits-to-earning ratio justified its stock price. Such considerations still move large-scale, long-term investors, and the banks that determine whether to invest in or underwrite companies. But nearly all stock trades nowadays are much more like commodity trades: automated guesses made by software programs as to whether trouble in Ukraine or gridlock in Congress will nudge up the price of a Nestle for a few minutes or even seconds—long enough for the stock to be bought low and sold a little bit higher. Virtually all firms, including the firms that invest your 401k, and those you might use to invest your own money in the market, employ such software and such techniques. Lewis’ contention is simply that a few firms have grabbed hold of such superior software and hardware that they have an unfair advantage. Time will tell if he is correct; if so, then some regulatory tweaks, and a flurry of software development by competitors, will probably right the ship.
If stock-trading as I have described it sounds less like prudent investing than like gambling, that’s because it is. At a meeting of the Catholic Finance Association in New York City, after an inspiring talk by a devout and successful investment banker, I spoke to one of the young techies who works behind the scenes at a Wall Street brokerage. “All this talk about morality is really nice,” the techie told me, “but really… what we do is indistinguishable from gambling. I try to be an ethical gambler.”
Now I know a bit about gambling. The Diocese of Brooklyn, where I grew up in the 70s, sucked in millions of dollars running illegal, high-stakes gambling at parishes throughout Queens—where my mother lost hefty portions of my father’s mailman salary at games that were guarded by off-duty Irish cops and managed by Italian Americans with very pointy shoes. To this day, when I hear names like “Most Precious Blood,” “St. Joseph” and “Corpus Christi,” my first association is “poker,” followed by “poverty.” (Thank you, Bishop Mugavero!) The problem with such games—apart from the fact that they violated just laws—was that they permitted people to lose almost unlimited amounts, to clean out their family savings and run up debt to the gents in the pointy shoes. Those are precisely the aspects of gambling which the Church rightly condemns. A pastime that can be innocent, indulged to the point of irresponsibility, turns into a dangerous vice—just as the first innocent glass of bourbon transforms into poison when you slam down your eighth or ninth. The evils of uncontrolled gambling can be seen in the crushing addictions that plague the state of Nevada, and other gaming meccas. You can sum up such evils with something I saw once on a casino boat in Baton Rouge: an ATM right next to a slot machine that would let you mortgage your house.
What is sobering about the underlying realities that Michael Lewis has helped to expose is the cultural disconnect between what we think investing amounts to—prudent, cautious judgment about what customers will want and what suppliers should try to make—and the facts on the ground on Wall Street. What do we typically think of someone who travels casinos, playing blackjack for a living? Even if he is successful, and regularly wins high-stakes games against the other best players in the world, we are still likely to think of a guy like that a kind of a rogue, an irresponsible risk-lover whose work adds nothing of value to the world. He simply transfers money from one set of hands to another. By contrast, a broker is likely to have some social prestige, a degree from a pricey business school, and a track record of philanthropy. Does he deserve more respect than a roving counter of cards, simply because he gambles with other people’s money and wears an Armani suit?
The answer is a qualified “yes.” The money that sloshes around, and is betted, won, and lost on Wall Street serves more of a social purpose than the quarters that slot machines suck out of seniors at Indian reservations. Companies “go public,” or sell shares of their equity to the general public, in order to raise the capital to expand and create more jobs, or upgrade their technology and compete with foreign companies that would otherwise eat their lunch. The stock market is nothing more than a highly elaborate means for determining how much those equity shares are worth. The vast earnings that successful brokers take home are a measure of how valuable to our economy such an enormous and highly responsive information system really is.
We would not be better off if we imposed heavy regulations that crippled the system’s ability to swap information back and forth—any more than you are better off when your PC is infected with viruses. For all the problems in our monetary system, it is a whole lot better than barter. A highly efficient system attracts the brightest, most ambitious people to come and tinker with it, in the hope of getting rich. It doesn’t sound like the high-speed traders whom Lewis denounces are doing anything dishonest. They are simply using the best technology out there to fight for their share of the pie, and grow it a little.