It’s not a shock that Mark Gorton isn’t a fan of Michael Lewis’s latest financial book, Flash Boys. After all, in Flash Boys, Lewis takes aim at the world of Wall Street’s high-frequency traders, and Gorton — the managing director of Tower Research Capital — makes his living running a high-frequency trading firm.
So when Intelligencer called Gorton for his thoughts on Lewis’s latest, we decided to put the phone on speaker and let him rant. Fifteen-ish minutes later, we had an industry insider’s perspective on what it’s like to have a famous author write about — and, in Gorton’s opinion, grossly misrepresent — the work you do.
Gorton admits that he’s only read bits of Lewis’s new book (it’s been out for a day), but he’s read enough excerpts and seen enough TV interviews to know that he doesn’t like it. Here are his primary objections:
1. Flash Boys is too dramatic.
“Michael Lewis tells a one-sided story that overdramatizes it. I mean, just the way he says, ‘The stock market is rigged.’ What he’s really saying, if you drill down into the details, is that some brokers are using outdated methodologies to route their orders, and there’s a small amount of information leakage. Realistically, he’s talking about technologies that were updated mostly a few years ago, and I’m not sure how much it’s still a problem.”
2. High-frequency traders have made the cost of trading stocks lower, not higher.
“If you just listened to what [Lewis] said, you’d think, Oh my God, the stock market is incredibly unfair, I don’t stand a chance. But what he’s not saying is that empirically, transaction costs for the average investor are lower today than they’ve ever been in the history of the stock market. Studies by people like Vanguard and Blackrock are saying, ‘We’re saving a lot of money for our customers because of the new electronic market structure.’”
3. Lewis mixes up brokers and high-frequency traders, and gets the size of the problem wrong.
“There’s a lot of conflating what high-frequency trading firms do with what exchanges and brokers do. The biggest conflicts of interest and problems in the market have to do with how brokers treat orders. Have you heard of payment for order flow? If you order through eTrade or TD Ameritrade, that order doesn’t get sent to one of the stock markets. There are firms out there that pay eTrade and the other firms to have their orders routed to them, and then they execute the orders. This payment obviously creates incentives for brokers to do things that aren’t in the customer’s interest.
The problem that exists is small. The amount you’re talking about in any of these cases is fractions of a penny. So even if you do have this payment for order flow, it’s a fairly small amount. And again, I think it’s a practice that should be banned. But it’s not a giant amount of money. And it’s a broker practice.”
4. The problems Lewis identifies were real in 2007, but they were quickly fixed.
“As much as Michael Lewis gets worked up about this, once RBC recognized it had [a problem in which its orders were being picked off on their way to the major stock exchanges], he says it took them two days to solve it. People who are working on building the order execution algorithms at big banks should know this stuff by now. Maybe in 2007, this stuff was new to them. But any time you have a new technology rolled out, it takes people time to figure out what’s going on. And there’s certainly been a process over the last few years of firms figuring this stuff out.”
5. High-frequency trading isn’t big business anymore.
“One thing I’ve seen is that the U.S. stock market has gotten a lot more efficient in the last few years. And a lot of that has to do with the fact that firms are smarter about routing their orders, and they’re much better about controlling their information leakage. That’s making it a lot harder for firms like mine to make money.
Yes, high-frequency trading firms have made a lot of money. But if you look at the function we play in the market of being middlemen, the electronic trading community as a whole makes only a fraction of the money that the big banks and the specialists used to make. A lot of the people who are complaining the loudest are these old-school traders who can’t make money anymore because the market has gotten so efficient.”
6. The system high-frequency trading replaced was an even bigger ripoff.
“In the 1980s, banks were making billions of dollars a year trading NASDAQ stocks. You come to the mid-200os and you have high-frequency traders making hundreds of millions of dollars trading stocks. When Goldman Sachs makes a billion dollars, everyone yawns. When kids with computers make $100 million, they think it’s something revolutionary and people paint it as evil. What’s happened is that this community of tech firms is providing the same service these big banks did at a fraction of the cost.”
7. You wouldn’t be able to trade stocks as easily without high-frequency trading.
“What a lot of people don’t recognize is the function the electronic trading community plays in the market. Everybody in the country thinks it’s their right that, whenever they click buy or sell, there’s a tight market in all of these stocks, and they can trade whatever size they want immediately. The only way that’s possible is if you have a community of professional traders who are providing continuous liquidity and absorbing supply and demand imbalances.
You talk about people in pensions. Well, when time comes for the pension to pay out money, they have to sell stocks. There has to be a stock market, and someone to buy it. They don’t want to come back to someone and say, ‘You can’t get your money out right now, there isn’t a buyer.’ People expect the markets to be there.”
8. Michael Lewis is sensationalizing for the sake of book sales.
“I’ve read a lot of his books. I thought, Michael Lewis is going to do a book on high-frequency trading, great! I was so bummed when it came out, because it almost seems like he really rushed, and he only talked to a handful of people, and he didn’t bother to understand how markets worked really well. The stories he tells, they’re great stories. He’s a good writer. And if he wouldn’t use this overheated rhetoric, it would have been better. But if he just gets up there and says there’s been a change from manual to electronic markets, and there’s a bunch of interesting stories in there, but markets have gotten more efficient, people would have yawned. Nobody would have bought his book.”
9. High-frequency traders are being demonized for no reason.
“We’re a bunch of computer guys who want to sit here and program computers and be left alone, but somehow it doesn’t work that way.”
Obviously, take Gorton’s gripes with a large grain of salt — he is a high-frequency trading executive, after all. But it’s interesting to hear the perspective of someone whose industry is being written about for the first time on such a large, public scale.