It’s Very Clear People are Being Front-Run – Lewis

Michael Lewis, author of ‘Flash Boys,’ appeared on Bloomberg Television today to discuss his book, trading and the stock market. Joining Lewis at the tail end of the hour long interview was IEX Group President/CEO Brad Katsyuama and Tradeworx Inc. CEO/Founder, Manoj Narang.

Lewis told Bloomberg Television anchors Stephanie Ruhle and Erik Schatzker that in today’s “rigged” U.S. Stock Market, large investors such as Greenlight Capital’s David Einhorn are like “dumb tourists” led to a casino where the card games are fixed, “It’s very clear people are being front-run.”

Lewis also said: “I don’t regard high-frequency traders as villains….They are wired that way. I think the system is screwed up to exploit opportunities, exploit glitches in the system. They’re not wired to say that this is moral or immoral; they aren’t wired to say is this good for the world. They don’t think that way. “


STEPHANIE RUHLE, BLOOMBERG NEWS: And we have a very special hour, as we mentioned, ahead. Michael Lewis is here. He is the author of the hottest book out there right now, “Flash Boys”. It has sparked quite a revolt against high-frequency trading. Erik said top selling book on Amazon today and it’s already had a huge impact on the national conversation. The FBI says it’s opened an investigation into whether any laws have been broken. And today, high frequency trading firm Virtu announced it’s delaying its planned IPO because of all the bad publicity.

Michael, thank you for being here. Clearly, you are the author when it comes to Wall Street culture. There is no one else out there. But in terms of reaction, you have never gotten such a visceral reaction in such a short time. What do you make of all this?

MICHAEL LEWIS, AUTHOR, “FLASH BOYS”: It does – I’ve had one experience kind of like this, and it was when I published “Moneyball,” but in that case they weren’t threatening to throw old baseball scouts in jail for what they did. But the disruption to the industry that that caused feels a lot like this.

And the instigator, there is a character kind of who has taken a different view of the industry and has kind of investigated it one way or another — the main character in this book, Brad Katsuyama — is got a similar feel to me to Billy Beane. And the reaction feels, it reminds me of that, that everybody has to have an opinion about the book right away, no matter whether they have read it or not. So that’s similar.

RUHLE: But is the opinion about the book or about the claim the market is rigged? That’s a big claim.

LEWIS: Yes. Well, it is rigged. So it’s not that big a – if you’ve read the book, I don’t think you could put it down and say the market’s not rigged. I really don’t think you – I mean, unless — we can parse the word rig.



LEWIS: Let me give you an analogy and I think is a very close analogy to the way the stock market is structured. It’s a casino analogy. So I have a casino and I want to start a poker game in the casino, so I get three card sharks and I tell them, go sit there and start the game. Make it look like a good game’s going on. There are no 4s, 9s, there are no queens in the deck. Only you will know that. And we will pay some tour group operators to bring like a bunch of dumb tourists in to pay with you. They won’t know. You’ll —

RUHLE: Hold on, a bunch of dumb tourists? So is David Einhorn is a dumb tourist?


RUHLE: Come on now.

LEWIS: In this analogy. Hold on. In this analogy, every investor — David Einhorn did not know; he did not understand. He understood that whenever he tried to do something in the market, the market moved like someone knew what he was up to. In the same way that big pension fund managers and mutual fund managers saw when they tried to execute big orders, oh my god, it’s like someone knows I want to buy before I buy. But he didn’t know why. He didn’t know – he didn’t understand that high-frequency traders were putting machines in exchanges to be closer to the exchange so that they could get price information in two milliseconds before him. And so on and so forth.

Let me — can I finish my analogy?

SCHATZKER: Absolutely.

LEWIS: So of course the tourists get fleeced all the time in the poker games, because they don’t know the deck is rigged. The poker players pay the casino a cut of what they make. The casinos, operators, pay the tour group – the tour group company money to bring in the tourists.

So in this case, casino’s the exchange, the poker players are the high-frequency traders, and the tour group operators are the banks and the brokers that handle the stock market orders. And I think the analogy is pretty close. So is that rigged? Is that a rigged game? I think it is a rigged game.

SCHATZKER: Well, it’s rigged only inasmuch as – rigged, so –


LEWIS: Why are you so invested in the idea this is fair? Why are you even arguing about this? It’s so clear.


LEWIS: Yes, you seem to be.

RUHLE: He’s barely even spoken.

LEWIS: No, no, no, I mean, it’s very interesting. But you seem to be – you can see, it’s very clear that people are being front run in the market. There’s plenty of evidence in the book. People making –

SCHATZKER: Their orders are being anticipated (inaudible).

LEWIS: Anticipated and run in front of, that’s right. And —

SCHATZKER: Well, no, there’s some people – in all fairness, I don’t have a stake in the proceedings here, certainly not like you because you’re the author of the book, Michael, but there are some people – you’ve probably met some of them — who would say in order to front run, you have to have a client. In order to front run, you have to have a client. And the HTF firms don’t have clients.

LEWIS: They buy the order flow. They buy – they pay –

SCHATZKER: They pay to see things.

LEWIS: No, they pay to execute the orders. They pay TD Ameritrade tens of million dollars a year. Schwab, they pay eTrade. So they pay for the right to execute the orders at a delayed price. So why would you – I mean, ask that question. Why would anybody pay for the right to execute someone else’s stock market order? That in itself is a little curious. I mean, I can understand why, if I’m a stock market investor, why I would pay a commission to a broker to handle my order. But why, on top of that, is the broker turn around and selling my order to some high-frequency trader for the right to execute? What is the value in that? The value in that is quite clear. It’s that that order for the high-frequency trader is an opportunity to exploit. And it’s an opportunity because he has advanced information about the pricing in the stock market. Is that fair?

SCHATZKER: He’s also getting paid by the exchange to print, right? To print the trades.

LEWIS: It depends. I mean, there you’re getting into a complicated discussion because exchange pricing, sometimes you pay and sometimes you get paid. But – so that is almost a separate issue. It is true that the exchanges create incentives to be on one side of the trade or the other.

And I think that basically when you look at it, at the bottom of this, it’s a bit like the financial crisis. At the bottom of this, is that the system is riddled with really bad incentives. It doesn’t make a lot of sense for brokers to be owning exchanges, I think. In fact, and the exchanges are for investors, not brokers, not for middlemen — when the brokers own the exchanges, the exchange is going to be essentially an instrument of the intermediary rather than the investor.

RUHLE: All right, then are the exchanges sort of the – like how the rating agencies – what the rating agencies were in “The Big Short”, is that with the exchanges are here? And if they were not for profit, would they be a better force, a force we could trust more?

LEWIS: It’s a similar sort of role. That analogy is probably – but, yes, it occurred to me that’s actually sort of the role. That they’re thought to be – their role is a kind of utility role. You need them to be an honest broker, you need them to create a fair experience for a customer that walks onto them. And if they, because they are for-profit, they are incentivized, and because of the way markets work, the way they work, they have to meet quarterly earnings and so on and so forth – it’s not a long term view they’re taking. It’s a very short-term view they’re taking. They are constantly subjected to temptation of taking money from one faction of their clientele to put the other faction in a bad place.

RUHLE: Would we like these HFTs more if they actually were putting money at risk, if they had positions? The fact that they are just taking a scrape here, is that why we dislike them so much?

LEWIS: The fact that they – they’re sort of set up not to take on market risk. It’s funny —

RUHLE: I want you to have skin the game. If you have skin in the game and you can lose, I like it more.

LEWIS: If you can have 4,000 trading days without a single day’s loss, something’s a little weird, right?

SCHATZKER: Yes, but let’s rewind the clock to pre-1975 when there weren’t really market makers the way there are now. Trading was largely an agency business. This was before Gus Levy and before the arbitrage (ph) desk at Goldman Sachs, and Robert Rubin — they didn’t lose any money either. You don’t lose any money as an agency trader.

LEWIS: It’s not true that they didn’t lose any money when you rewind the clock. I worked on Wall Street. The Salomon brothers, the traders would have down days and they would up days. And they would just hope that the up days were better than the down days.

SCHATZKER: But they were putting money at risk.

LEWIS: Right. The position they were taking — I’m not saying that that was pure and innocent and great either. But there were different problems in different days. But the role they were playing was a buffer the market. They were playing the role that Brad Katsuyama played at RBC, that someone needs to sell a million shares of something and the market won’t, isn’t ready —

SCHATZKER: But you know what? You’re actually – here’s one – I’ll phrase it s a question instead of making a statement. Would you knowledge that your critics perhaps have one fair point, which is that it’s hard to generalize? That much of what you’re talking about, the people whom you identify as the victims in the book, are by and large institutional traders. Some of them are mutual fund managers, like —

LEWIS: So could I stop you there? I’m sorry, but in the book, there’s a long interview with a guy who spent years selling the order flow for TD Ameritrade. I mean, that’s not institutional investors, that’s you and me. That’s mom and pop. And he says, what’s the most valuable order for a high-frequency trader to exploit? It’s a market order from an individual because the individual investor has such a slow feed, basically.

RUHLE: But –

LEWIS: No, it’s true. What is true, if the order is a 100-share order, that’s probably not that big a deal. It’s not that big a deal. That’s true.

SCHATZKER: Well, a lot of retail orders are 100 shares.

LEWIS: But who manages the savings a lot of people in America? It isn’t people trading 100-share allots on eTrade or Ameritrade, it is mutual funds, it’s pension funds —

SCHATZKER: True, but be careful of who you defend here. Actively managed mutual funds, we could talk about the passive ones separately, but actively managed mutual funds, on the whole, do a terrible job of overseeing Americans’ money. They fail to beat the market more than 50 percent of the time and they charge a fee on top of that. Are they really – I mean, here ,we were going to get down to this, but let’s do it now. How do you decide who to put the white hat on? Are these white hat guys?

LEWIS: I didn’t actually put a white hat on the mutual fund industry, I hope you don’t think that I just did that. But it doesn’t help that, in addition to the ineptitude of mutual fund managers, they have to pay tax. It’s all a cost to the ultimate investor. So I’m not an apologist for the mutual fund industry. That’s not the point. The point is, the people whose money who they’re managing is ultimately damaged by this are lots of little individual investors.

And so it’s to say that this doesn’t touch the individual investor is crazy. The second reason it’s crazy, and this gets to Goldman Sachs’ involvement, is that, in order to preserve essentially a stock market system that enables this sort of activity, the level of complexity has gone through the roof.

And the reason I wrote a book about this, nobody understands the stock market. This guy can walk in and describe a stock market that nobody understands. David Einhorn listens to it and says, oh my god, this I did not know.

The complexity is a source of instability. The people at Goldman Sachs that I talked to who have thrown their weight behind this exchange said the main reason they did it was that they — the outages of the exchanges, the flash crash, whatever it is – the various technical mishaps that seem to punctuate the life of the stock market these days, they see it all as symptomatic of a much bigger problem. There’s going to be a massive flash crash times ten and Goldman’s going to get blamed, so we go to get out of this before that happens. So that’s not good for the individual investor either.

RUHLE: But is this so material to the individual investors? Because, today, when I go to execute a stock, I definitely feel like, man, how did that get jacked right before my face? Every time, I do feel that way. But 15 years ago when I did a trade, I was paying significantly more to do it with a specialist because of what the fees were.

LEWIS: So you got to make a distinction here.

RUHLE: So it’s a different problem a different day. Is it really worse today than it was when specialists were on the floor?

LEWIS: I never said that.

RUHLE: And has the system always been rigged?

LEWIS: Yes, in different ways. Hold on. In different ways. The problems then were different from the problems today. And you’re not making a making a distinction I think is really important to make. Yes, technology has brought incredible benefits to the individual investor. It’s really good that trading is computerized. I’m not against computerized trading. It’s that it does not have to be computerized scalping going on with computerized trading. The two are not inextricably linked. They can be separate things.

What really should happen is that you get all the benefits of the computerized trading without someone running in front of you when you trade. That’s what should happen. And there’s no reason that can’t happen. And I think part of — this is a larger discussion about the state of Wall Street, but what has happened here is that technology has basically eliminated a role that Wall Street used to play. You used to need a human being to bring together a buyer and a seller. You couldn’t do it yourself. Now you hit a button on your computer and your stock market order goes into a box with everyone else’s stock market order.

RUHLE: And you don’t feel good about that?

LEWIS: That’s good. That is good.

RUHLE: That’s what I’m saying. I don’t want some guy jacking me.

LEWIS: The problem is – but some guy is still jacking you, and that’s the problem. Is you’ve got traders, all of this unnecessary financial intermediation happening. Wall Street’s found a way to insert itself into the stock market where it’s no longer necessary, and there’s all this trading happening between intermediaries and you and me that just don’t need to happen.

SCHATZKER: Michael, we’ve got to take a quick commercial break. We will be back in two short minutes with Michael Lewis, author of “Flash Boys.”




SCHATZKER: It has indeed become an extraordinary career for Michael Lewis and the man himself with us for the hour. Michael, people spend a lot of time figuring out or trying to figure out how you come up with the ideas for your books. If you go all the way back to “Liar’s Poker” and all the way forward to “Flash Boys” today, is there a single thread that you could draw through all of your books?

LEWIS: There is an element of accident in all of them. This one it comes up because I just want to write a magazine piece about the guy Goldman Sachs managed to get thrown in jail, the computer programmer, who was an HFT computer programmer. And I started asking people what on earth is HFT and they lead me to this subject. I didn’t think I was going to write a book about this. I didn’t go looking for this.

SCHATZKER: So had it not been for Sergey Aleynikov —

LEWIS: No, I got curious about — it always starts with some innocent curiosity that is usually small curiosity. It’s a magazine piece curiosity.

Oakland A’s, the way that started was, at some point in the early ‘90s, mid ‘90s, I started to pay attention to the salary differences between the right fielder and a left fielder on the Oakland A’s and I wondered how ticked off the left fielder was when the right fielder, who was making $10 million more, dropped a fly ball. And I wanted to do a thing bout class distinction in baseball, which ended up leading weirdly to “Moneyball”. So it always starts — it usually just starts with some question. And then it becomes a book when the idea is big enough and the characters are good enough, and it doesn’t fit into a magazine.

SCHATZKER: You always seem drawn to improbable heroes, right, people who by virtue of circumstance as much as anything else are thrust into the position of trying to destabilize, in some cases destroy the status quo, whether it’s Billy Beane, whether it’s Brad Katsuyama in this book. Even Michael Oher, his experience is kind of disruptive.

LEWIS: Totally disruptive, that’s right. So I think that’s because the people tend to be — the people who are disrupting their environments tend to be the best at describing the environment they’re disrupting. They have analyzed the anatomy of the environment because they’ve got to change it. So I think it’s they’re vehicles for describing the world around them. Those kinds of people end up being very good vehicles for describing the world around them.

RUHLE: So now that the world hates banks, hates bankers, hates finance, are you just waking up and doing an I told you so dance?

LEWIS: Now, it’s funny you say this because I don’t regard high-frequency traders as villains. I really don’t. It really is like blaming the lion for eating the antelope. They are wired that way. I think the system is screwed up.

RUHLE: They’re wired that way to do what?

LEWIS: To exploit opportunities, exploit glitches in the system. They’re not wired to say that this is moral or immoral; they aren’t wired to say is this good for the world. They don’t think that way.

So to answer your question, if you look at “Liar’s Poker,” that I guess is a little bit hostile to Wall Street, kind of, maybe, but more it’s just a funny book about what it was like to work on Wall Street. And a lot of my friends work on Wall Street. I don’t have like — there are a lot of great people on Wall Street. I do not have a problem with the type of person on Wall Street.

Broken systems bother me. You feel like, why does it have to be so inefficient?

SCHATZKER: Isn’t that part of the natural order, though? You talked earlier about perverse incentives. Wall Street is filled with perverse incentives. That’s how we ended up with a problem that you described in “The Big Short,” terrible incentives. But every effort to try and correct bad incentives creates more bad incentives.

LEWIS: So this is what I like about this story, is that it isn’t a story about demanding regulatory involvement or throwing people in jail. It is an entrepreneurial story in the middle of Wall Street. It’s really a Silicon Valley story happening on Wall Street. And so I think that’s the solution, is sort of like disruptive entrepreneurship in the financial sector is possibly a path to reform. Because the regulators are always going to have circles run around them. And if the SEC was — even if they were trying to do their job, even if they were really trying to make the stock market a level playing field, almost certainly they would introduce some regulation that someone would figure out how to game.

RUHLE: Somebody always finds an edge. So is the issue though that the David Einhorns of the world didn’t happen to be the ones who found the edge? Because there’s tons of examples where the Dan Loebs and Stan Druckenmillers do.

LEWIS: No, you keep referring to David Einhorn as if he’s like the only victim in this. That’s not — this is a case where all investors —

RUHLE: But is he a victim, or T. Rowe, or BlackRock? I mean, there are tons of examples, if you’re the big guy, you have great advantage.

LEWIS: So in this particular case, people who are investors, money managers like that, are being victimized. It’s partly — I think they are partly to blame in this sense.

RUHLE: Hold on, we’ve got to take a commercial. Hold the thought, we’re going to have more. We’re going to be back with more in two. Talk about Wall Street victims.



SCHATZKER: Welcome back, everyone. You are watching a special edition of MARKET MAKERS here on Bloomberg Television with author Michael Lewis. We’re talking about his latest book “Flash Boys” and the controversy it has brought us.

RUHLE: All right, I had to cut you off. We were talking edge. I’m saying here my issue is somewhat — it doesn’t matter of who has an edge, who’s the one who gets to exploit it? So people who maybe your sources, the drivers behind this, don’t like what’ going on at HFT because they’re not the ones winning.

LEWIS: No, sorry. What I was saying — I will finish the thought we were actually on, which was the thing — it is surprising that investors have not organized themselves more forcefully to take control of the stock market orders. That is a bit of a puzzle. And I think it is just that they are, investors, they’re spread out across the country, they’re not all in the same place, and they’re just not organized the way, say, Wall Street firms are organized. It sounds like have.

So it’s — but you could accuse investors — you were saying, aren’t the investors to blame in some way? Why are they victims? I mean, people who manage other people’s money aren’t as well organized as the people who are mishandling the money.

SCHATZKER: But let’s go back to the point that you were making earlier about how this is, as much as anything else, a systemic problem. And if it’s a systemic problem, then you could point the finger at either politicians or regulators.

So why don’t we take the opportunity to bring in congressman. He happens to be a Democratic Congressman who formerly worked for Goldman Sachs, his name is Jim Himes.




LEWIS: So if I could change the subject a little bit. They asked me to ask you a question, so I’m obliging. And what I would love to know is how is a former Goldman Sachs investment banker become a Congressman? And did you actually learn anything at Goldman Sachs that’s useful in Congress?

REP. JIM HIMES (D), CONN.: I’m trying to assemble the trifecta of low popularity vocations in my career.

RUHLE: Good answer.

LEWIS: What’s the third thing? After congressman, what were you going to do? Let me guess, pawnbroker.

HIMES: Mortician or, you know.


RUHLE: All right, I’m going to step in here. Michael, when you think about regulation, you said it earlier, the regulators are always going to get outsmarted here. But when we saw Reg M and S get put in place, can we not point the finger saying, “Hate the game, not the player?”

LEWIS: At? Yes, I’ve got no problem with that.

RUHLE: I’m saying that regulators are the ones putting this in place, and we’re saying, we’re looking for the villain here. It’s unclear to me who exactly the villain is.

LEWIS: I agree. It’s very complicated who the villain is. And the way I’ve written the story is without individual villains for that reason. It’s like — there’s systematic problems that need to be addressed. I’m totally with you on this.

RUHLE: Then can I ask what is your back-checking process? You’re an extraordinary storyteller, but this a heavy claim you’re making. When you look it, when you say the stock market is rigged, when you look at what the exchanges have done in the market — they are all getting crushed this week. One of the reasons, Virtu maybe saying they’re not bringing their deal, is because of valuations. You have made heavy claims. What exactly is the fact checking process? Because it’s what has people like Cliff Asness, huge investors with great reputations, up in arms?

LEWIS: So the first thing, this is a story about that man across the table. The beginning it’s a story about one man trying to figure out how the stock market works. So you can ask him if I got his story right. That’s what the story is about.

RUHLE: But you’re also talking —

LEWIS: Hold on, hold on. So I interview hundreds of people. What is my learning process is the question, really. So how do I learn what I know? I go and interview as many people as I can in different segments of the industry. I check what he tells me against three different people. Then when the book is done, it’s fact checked at the publisher, and it’s then fact checked again by the people who excerpt. “The New York Times” fact checks parts of the book; “Vanity Fair” fact checks on other parts of the book.

At some point, is that — I guess that’s a process, but I find that just generally in creating things, that the most important — it’s sense checking, not fact checking. The most important — all of that stuff happens in the research of the book, that it’s sort of like making sure that I talk to the right people who inform his story that I’m trying to tell so I get it right.

SCHATZKER: Let’s do some of that with a Congressman.




SCHATZKER: You are watching a special edition of MARKET MAKERS. I’m Erik Schatzker here with Stephanie Ruhle and Michael Lewis. Maybe you know Michael Lewis for “Liar’s Poker,” for “Moneyball” maybe, or “The Big Short”. His new book is “Flash Boys” and it’s fast becoming a controversial sensation. Brad Katsuyama is one of the heroes of “Flash Boys”, a former World Bank of Canada trader who in the spring of 2007 noticed that something was wrong with the way the U.S. stock markets were functioning. His mission to figure out what wasn’t right and then to fix it led Brad and his partners to build a stock market designed to neutralize the advantages of high frequency traders. It’s called IEX.

And also with us is Manoj Narang. Back in 2007, he was a hedge fund manager who also noticed exactly the same kind of market quirks as Brad Katsuyama. But his solution led him down a totally different path. Manoj now runs a high-frequency trading firm called Tradeworx.

Gentlemen, welcome. Thank you for joining us here. I am fascinated by the fact that both of you guys saw the same problems but ended up with totally different solutions.


SCHATZKER: I want to ask Michael a question that relates to both of you guys. So for a moment let’s suspend the debate. Michael, is it possible that both Brad and Manoj are right? That Brad can meet —

RUHLE: That is a great point.

SCHATZKER: Brad can meet the challenge of the market by slowing the trades down.

MANOJ NARANG, TRADEWORX: Only in a very post-modern view of the world (inaudible).


SCHATZKER: And Manoj can satisfy the need that the institutional investor has by playing the arms race to the max?

LEWIS: Do I think they’re both right? No.

SCHATZKER: Is it possible?

LEWIS: Is it possible? I think — no. Here’s what would be interesting. If you put Brad Katsuyama and a couple of people from IEX on one side of a stage and you put Manoj and a couple of people who want to argue the opposite —

NARANG: I assure you that would be a deterministic outcome.

LEWIS: You seem very confident, yes. And let them have a couple of hours with slides, with explanations — the problem is the forum in which this is trying to be understood, a few minutes on television, is very hard.

SCHATZKER: It’s, for the moment, the best we can do.

LEWIS: I know that. I know that, but I’m just saying you can throw out numbers and it’s very hard to check them in real time. It’s very hard, but also to make sense of what they mean.

SCHATZKER: Which is why I asked you a conceptual question. Is it possible that they could both be right?

LEWIS: I think it’s very unlikely.




SCHATZKER: Unfortunately, and I have to say this because we would continue for two hours if we could, we’re running out of time. I want to follow up on Stephanie’s question about Goldman Sachs to you, Michael. Is there a danger of taking Goldman Sachs at face value? If there’s one thing that I’ve learned observing this firm, it’s that Goldman’s true intentions never reveal themselves immediately. Sometimes it takes years. You discovered this when you were researching “The Big Short.”

LEWIS: No, I think there’s an argument going on inside of Goldman Sachs. I don’t think — it’s not a monolith. I think the supporters of IEX inside Goldman Sachs have opposition inside Goldman Sachs. So you’re right; they have a dark pool, and the dark pool is the antithesis of what they’re doing. So how long do they close their dark pool? I think there’s movement inside the place. I don’t know what it means completely. I admit as much in the book, I don’t know. It’s hard to know.

So let’s just wait, let’s wait and see.

SCHATZKER: Michael, let me take the opportunity to say thank you so much.

RUHLE: Who’s going to play Brad in the movie?

LEWIS: I think Manoj.


SCHATZKER: Well, listen, I want to thank all of you. Michael Lewis, author of “Flash Boys”, author of “The Big Short”, author of “Moneyball”. The list goes on. It’s been great to have you back. Please come again soon.

LEWIS: Thanks for having me. My pleasure.

Video for viewing here.

Bloomberg Television

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