What Michael Lewis didn't write.
Netted by a Salmon
Last week's column on high-frequency traders (HFTs) was inspired by Michael Lewis' new book, Flash Boys. In the book, as well as a provocative 60 Minutes interview, Lewis maintained that the stock market was "rigged" against the small investor. This claim caused much concern among Morningstar.com readers.
The charge, it turned out, is bogus. My column fired an early salvo, but Lewis' full defeat came a few days later courtesy of Felix Salmon's Slate book review, The Lewis Effect. Highlights:
"By creating an oppositional narrative of what he explicitly describes as "good guys and bad guys," Lewis runs the risk of turning a highly complex issue into an unhelpfully simplistic morality tale."
"The problem with Flash Boys is that the demands that master storyteller Michael Lewis makes of his narrative don't align well with the structural problems of HFT that Lewis the journalist should want to expose. The result is that the general public, after reading this book or watching Lewis on 60 Minutes, thinks that the scandal of HFT is that they're being ripped off, and that the stock market is a scam. Neither of which is true."
"If your mom has a brokerage account, or a mutual fund manager, or generally entrusts her retirement savings to any kind of intermediary, then the fees charged by her broker or fund manager will dwarf any profits being skimmed from her by HFT. And if your pop invests in the market himself--if he's among those people with a TD Ameritrade or E-Trade or Schwab account, the "easy kill" for the high-frequency algorithms, then, in reality, he is the one big winner of the high-frequency game."
"What we're seeing, in the world of HFT, is not fraud, nor is it insider trading. Rather, HFT is a ridiculously and unnecessarily complicated mechanism for divvying up intermediation revenues between banks, exchanges, high-tech communications outfits, and various algo-driven shops. Everybody is in on the game: not just the HFT guys, but also the exchanges, which optimize themselves for HFT game-playing, and the banks, which let HFTs into their dark pools, and especially the SEC, which has been cheering on the whole motley crew from the beginning."
More Smoke Than Fire
Michael Lewis has a story to pitch. So, too, do the heroes of his tale, the brokerage firm IEX and hedge funds, which have trades to generate and profits to reap. They benefit, handsomely indeed, by standing beside the little guy in the fight for truth, justice, and the good old American way of taking care of the small investor--which, of course, never did exist. Retail investors now get better deals on execution, brokerage commissions, and fund fees than ever before. The reign of HFTs coincides with the reign of the everyday investor.
"Coincides" being the operative verb. Although HFTs have helped to lower trading spreads and provide market liquidity, these effects aren't large for buy-and-hold investors. The improvement in their fortunes has come from elsewhere: the development of index funds and exchange-traded funds; the growth of discount and Internet brokers; and technological improvements that permit more-efficient stock trading.