I liked The Big Short a lot, but Flash Boys was so bad that I found myself wondering how trustworthy The Big Short was.
You can see part of what's problematic about the latter book just from this Guardian summary of it. The summary would have us believe that HFT is a trick employed by giant Wall Street banks to screw over smaller players. But Katsuyama, the protagonist of Lewis' book, was a big-bank trader, paid exorbitant amounts of money to tax large block orders by pension and hedge funds, and outraged by his inability to compete with algorithms that were bidding that tax down.
I'm uncomfortable calling any giant financial firm "trustworthy", but if you were going to pick one firm that has come close to earning that label, it's Vanguard. Vanguard's chief investment officer has repeatedly and unequivocally stated that HFT firms have lowered Vanguard's costs and improve outcomes for its investors.
Here's Matt Levine writing entertainingly about how the "Flash Boys" in Lewis' book ought to have been, based on his previous books, the protagonists, and Katsuyama the villain:
I mean, I understand (and even slightly sympathise with) the way big hedge funds and banks hate the way HFT are competing with them and driving their margins down.
...what I'm confused by is why so many journalists and authors are taking the side of the hedge funds over the interests of retail investors. With apologies to Goldman, but when you have Goldman on one side and Vanguard on the other, my default assumption is that the Goldman side is probably doing something shady. Which is, to be sure, a rebuttable presumption, but not one I've seen rebutted.
I am a big fan of Lewis & I have read multiple accounts / variations of the sub-prime crisis. The Big Short tells only half the story but nevertheless a very important one especially by covering Michael Burry as patient zero for identifying the problem. However, the book does a big dis-service by not writing more extensively about John Paulson. He made the most amount ($15BN) shorting sub-prime mortgages & when you have a book called the Big Short but don't cover the biggest short, it seems incomplete. Gregory Zuckerman's "Greatest Trade Ever" should be read along with "Big Short" to get a more complete view of the crisis.
What I found most curious about "The Big Short" was its (almost exclusive, IIRC) focus on telling the story of the folks who were short these ultimately toxic derivatives: Why they thought this was a smart move, the finacial engineering and negotiation done so they could actually make the move, the usual Michael Lewis quirky portraiture.
What it was missing was any explanation of the folks who were long. Presumably many of them were at least almost as smart as the shorts, but I got no sense from "The Big Short" why they bet in the other direction.
Genuinely curious if there's a mirror of "The Big Short" out there that could fill in that gap.
It does explain it. They were long because they thought the housing market could never crash. It doesn't really matter how bad someone's credit is, if the value of homes keeps going up the banks will not lose money. They might put nothing down and then pay their mortgage for 5 years, then default, but the home's gone up 15 or 20% in value so the bank will resell it and be made whole.
For a longer (and fairly technical) answer, see "Slapped by the Invisible Hand".
Essentially, a subprime mortgage had the price-will-rise-forever view baked in, as a way for the borrower to passively increase equity in the house while making very low payments. When the prices stopped rising, these borrowers went underwater fast and could not refinance when they needed to.
There isn't but that is largely because the [general points] are popularly known:
1) Politically, at the Federal level, steps were taken to regularly increase subsidies to the housing market. It was a populist position in both parties so it seemed safe from serious intervention that would depress prices.
2) Housing had been increasing for some time and this upward momentum "seemed" safe in the general case where the borrowers were credit worthy. In the long term, housing has always gone up decade-over-decade at least as fast as inflation.
3) Housing demand is rock solid, even in times of crisis, so the fluctuations would be less severe than the surrounding environment. In other words, they had always assumed they could find buyers for housing in any market environment so the hits they took in a recession would be small.
4) Subprime being a vector for a contagion that would affect middle class homeowners and cripple the economy didn't occur to them. As such, risk was effectively mispriced even tho the banks [frankly] were and still are aware that the Credit Agencies are really captured by the large financial institutions. They had assumed that "AAA" would remain relatively safe.
5) The institutions themselves didn't really understand that the grading mechanisms for credit were so badly corroded by corruption to be essentially worthless in the housing market until the damage was so severe that all they could do was unload the toxic assets before other people realized they were toxic. The only people who could buy these at scale were other banks and financial institutions...
Parts of that is right, but I think you mis-state a lot of the ratings stuff.
The fundamental idea behind the ratings is (simplifying a lot) that you could take a lot of crap mortgages and then slice them into tranches, assigning losses to the lowest tranches first, and to the highest tranches last. So if you have 1000 mortgages, and you slice it into 10 tranches of 100 each, and 250 mortgages go bad, then the lowest two tranches lose 100%, the next tranche loses 50%, and the top 7 tranches lose 0%. What the ratings agencies were doing by assigning AAA grades to the top tranches was estimating the likelihood that EVERYTHING would go bad was very low.
And what I think a lot of people miss about the financial crisis is that this was not wrong. Not only was it correct in principle, but actual losses on AAA rated securities was extremely low because even among subprime a lot kept on being serviced. So the ratings agencies said "hell, we could have a massive crisis and these top tranches will still mostly pay out", and then we did have a massive crisis, and those top tranches still mostly paid out.
There were a lot of issues and problems and corners cut and bad paperwork and robosigning and a hundred and one other scandals, some quite significant. However when you say:
> They had assumed that "AAA" would remain relatively safe.
It's worth remembering that this assumption was shown to be correct! From the financial crisis inquiry report:
"Overall, for 2005 to 2007 vintage tranches of mortgage-backed securities originally rated triple-A, despite the mass downgrades, only [...] 4% of subprime securities had [...] losses imminent or had already been suffered by the end of 2009."
On the other hand, something like 95% of lower rated tranches ended up suffering losses. The tranches were a mechanism for concentrating credit risk in the lower tranches; the problem isn't that it didn't work, but that 1) it worked really well and 2) everyone was badly underestimating the total about of credit risk in the system. AAA was mostly fine; everything short of AAA was absolute toast.
(Also, I think you're missing how huge the decline in home prices was, both as cause and vector of the crisis. A vast amount of paper wealth nominally owned by the middle class vanished in a puff of smoke; most of the crisis was the result of that. But the impacts of an asset price bubble should properly be attributed to its inflation, not it's popping.)
> "Overall, for 2005 to 2007 vintage tranches of mortgage-backed securities originally rated triple-A, despite the mass downgrades, only [...] 4% of subprime securities had [...] losses imminent or had already been suffered by the end of 2009."
> (Also, I think you're missing how huge the decline in home prices was, both as cause and vector of the crisis. A vast amount of paper wealth nominally owned by the middle class vanished in a puff of smoke; most of the crisis was the result of that. But the impacts of an asset price bubble should properly be attributed to its inflation, not it's popping.)
Its inflation exists because of how corroded the mortgage ratings were. None of them were correct except relative to each other within the mortgage bond market. You don't rate things AAA when they are really BBB. I understand you might feel that is correct but I sure as hell do not.
That is the expected cumulative default rate for a AAA corporate bond. The mean is .10% with standard deviations of .07%. So when you say "4%" that is absurdly high in comparison yet they were marketed and sold as if they were equivalent risks.
> The extent and speed of rating downgrades of asset-backed
securities. Investors have learned to their cost that the credit
ratings of structured credit securities are more likely to suffer
rapid and severe downgrades than are corporate bonds (see
chart). Not only have downgrades occurred more frequently
to subprime securities, they have often been reduced several
notches at once because of the sensitivity of such securities’
ratings to increases in assumed credit losses. As a result,
investors’ faith in rating agency opinions has been shaken—
credit spreads on AAA-rated U.S. residential MBSs have been
priced at about the same level as BBB-rated corporate bonds
since August 2007.
The real value of the AAA-rated residential MBSs were the equivalent of BBB for other securities and had been for years preceding the event. The majority of the market was blinded by the assurances of the credit bureaus which were valuing BBB assets as AAA assets.
A credit bureau that doesn't consistently and accurately estimate risk across securities is in many ways worse than useless because it gives a false sense of security where none exists.
Similarly, captured referees / regulators / credit bureaus cannot be trusted if you are not the sole organization in control.
However, I can see how this is likely more in the realm of opinion so I'll just leave it here but I think the comparison to corporate bonds is relevant.
1) It's worth reiterating that there was a huge housing bubble and a massive devaluation. You say 4% losses is terrible for AAA rated securities (which is true), but you could also say it's pretty amazing for subprime mortgages during a massive housing bubble popping. It's like building a levee that's meant to stand up to all but the most massive floods, and then having a massive flood; the fact that the levee failed it not itself proof that it wasn't engineered correctly.
2) The point I was originally trying to make and got sidetracked from is that if (and seems likely to me) there was an extremely widespread systematic belief that there was no housing bubble and that a coordinated, nationwide drop in housing prices was effectively impossible, then you would see the exact outcomes we saw without the corruption or "corrosion" you posit.
In short, you're suggesting that people knew the loans were going to go bad, and put high grades on it knowing there was a real risk of default. I would put it to you that actually no one inside the system believed the loans were going to go bad, and the high grades were put on it in the incorrect belief that there was no real risk of default.
There's been a lot of research on this subject, but to me the most compelling is research showing that "insiders" did not diversify away from the crap they were selling. See facts 9 and 10 from this paper[1] for example, which notes that Lehman, for example, was using internal models which estimated the odds of a bursting bubble at 5%, whereas they assigned 30% odds to scenarios that assumed absolutely impossible and historically unprecedented house price growth. Bear Stearns executives invested heavily in their own bank's funds which in turn were invested in MBS. Similarly, many loan originators got into trouble not because they bundled the loans up and sold them on (as their risk models required them to do), but because they kept too many of them, thinking they were great investments. If Lehman and Bear Stearns and Bank of America were the suckers, who was doing the exploiting? (And the biggest winners were people like John Paulson, who had no clue how the mortgage market worked, and had never traded mortgages before.)
From where I stand, there is a compelling, coherent story of people being idiots, but the cynical, blatant corruption seems missing. If your model says there's a 5% chance of housing prices dropping, then your model is wrong, but your conclusion about the risk of impairment of AAA tranches makes a lot of sense. So the next question is, well, did you really believe that there was a 5% chance of housing prices dropping? And the people involved bet their careers and personal fortunes on that, so...apparently they did?
Edit: I highly recommend the entire paper, and in particular you may find "fact 12" of interest, as it gets into the weeds on how the ratings were actually calculated, why the ratings on MBSs ended up being mostly accurate, why the ratings on CDOs ended up being completely wrong, and why there was a difference.
> From where I stand, there is a compelling, coherent story of people being idiots, but the cynical, blatant corruption seems missing.
Yeah, like I said, its closer to opinion than verifiable fact.
However, the paper basically admits the facts I use to conclude that are correct but draws the opposite conclusion by comparing incestuously rather than across verticals.
Yes, relative to other mortgage related things, the ratings were correct but such ratings are published as absolute probabilities and not as relative assurances that AAA > AA > A > BBB. The fact the absolutes were in error for a single portion of a single vertical among multiple firms implies its an incentive problem which the paper agrees. It just draws the line in a different place because its analyzing a different question [Insiders vs. Outsiders rather than Insiders vs. Insiders].
> The answer may well involve the information and incentive structures present inside Wall Street firms. Employees who could recognize the iceberg looming in front of the ship may not have been listened to, or they may not have had the right incentives to speak up. If so, then the information and incentive problems giving rise to the crisis would not have existed between mortgage industry insiders and outsiders, as the inside job story suggests. Rather, these problems would have existed between different floors of the same Wall Street firm.
The paper believes its internal to the firms but the uniformity of the problem between firms implies it was the culture of all the large firms and likely exported to the credit bureaus due to heavy competition in a single vertical. The difference between what the paper is arguing vs. what I'm arguing is likely impossible to determine because of the incestuous movements between those firms and even the credit bureaus of the human capital involved.
Discussing the merits of HFT is similar to discussing the merits of different approaches to cryptography. Because there's such a vast amount of prerequisite knowledge required for analysis, one either has to slog through the learning curve or look for expert opinions.
So who are these experts in HFT that should be referenced? Certainly not me or Michael Lewis.
One source I like to follow is
Eric Hunsader. One of his claims to fame is catching a leak in FOMC data that led to a policy change by the Federal Reserve [1].
My own take on the HFT debate: HFT is here to stay; the method of trading is not the problem, the danger is that no regulator can monitor the massive stream of quotes and trades and accurately sift out bad actors. What's the solution -- I have no clue, but arbitrarily slowing down trades is not useful.
Apparently no true Scotsman would follow Nanex as a source. Duly noted. :) I'd be interested to hear of other sources that at least attempt in depth analysis like Nanex.
Because there's such a vast amount of prerequisite knowledge required for analysis, one either has to slog through the learning curve or look for expert opinions.
Thomas, Erin, and I possess voluminous experimental evidence that suggests generalist engineers can know more about market making than Michael Lewis (and, if one assumes Lewis is not committing malpractice with regards to framing quotes, Brad Katsuyama) in under two hours.
This is not a commandingly high bar. An order book is just a data structure. It tends to have a lot of money associated with it, but that is also true of at least some hash tables, and you understand hash tables.
I am frustrated with HN discussion of HFT occasionally for the same reason I get frustrated with HN discussions of some privacy technologies: there exists a political valence to the discussion and some participants treat that political valence as carte blanche for just ignoring that we are talking about actual codebases which have actual rules which can be described in words, including words which definitively falsify some claims about them which feel right to people due to political valence.
> Thomas, Erin, and I possess voluminous experimental evidence that suggests generalist engineers can know more about market making than Michael Lewis (and, if one assumes Lewis is not committing malpractice with regards to framing quotes, Brad Katsuyama) in under two hours.
After which level in Stockfighter is it likely that I know more about HFT than Lewis?
Depending on how exactly you decide to solve it and how good of a mental model you have about what your code is doing, level three. Again, a high bar Lewis' level of understanding is not.
I know it feels like this is an abrasively combatative statement from me, and it's quite uncharacteristic about any topic other than Bitcoin, but if you've coded a trading system and then read Flash Boys it's like several hundred pages of "I used a GUI to query optimize the traceroute with MongoDB and a red/black tree." Those words, individually they have meaning, but in that configuration it is resoundingly unclear that the speaker understands what is going on. It is resoundingly unclear that Lewis understands what an order book is, what order types are (other than (paraphrase) a mechanism by which sophisticated operators cheat mom-and-pop hedge funds out of their hard-earned 2 and 20), etc.
If you'd like this critique at literally book length, read Flash Boys: Not So Fast. It's brutal. It's a point-by-point and page-by-page refutation which brings in lots of crunchy detail (which Lewis scrupulously avoids), quotes extensively from experts (including ones who would be incentivized to say the opposite thing except for a respect for the truth), comports with the understanding of our informal advisors, and does not require me to suspend belief in core principles of math, physics, or computer science, which Flash Boys does multiple times.
Pretty much any of them. He interviewed zero HFTs for his book and seems to repeatedly misunderstand how the basic concepts of order books work, or things like "someone trying to sell a million shares is going to drop the price of the stock", which you learn on level 3 at the very latest.
The second order problem is how to select which "experts" to believe. In my opinion, Hunsader sees conspiracies where none exist and interprets all unusual or hard-to-explain behavior as evidence for his existing beliefs. (Not to say he's never right, of course). But you have no reason to believe me, some random guy on the internet, and in general most experts on the subject are going to have some kind of conflict of interest.
Yeah....most people in the know think Hunsader is full of crap.
He certainly sounds smart to people outside of the business of HFT, but he's not quite the droid everyone seems to think he is. His opinions of HFT and the various market microstructures that evolve are quite hilarious to anyone with a trading background.
After reading The Big Short and discussing its contents with people who know a lot more about the financial industry than I do, I was surprised to find how much the book stood up under their scrutiny. So many popular books seem to lead me down a deceptive rabbit-hole of semi truths and poetic license given for the sake of sensationalism whereas Michael Lewis just seems to have a knack for telling the facts as a compelling story.
Also, this quote from the article struck a chord with a lot of the internal dialogue I have about doing what I know is important as opposed to doing what is profitable:
>> "They had been so transformed by the rates of pay and the needs it had created in them, they couldn’t escape from it. “
I have found the exact opposite with Flash Boys (and, to a certain extent, with Big Short - although that is less my area of expertise) If you have read Flash Boys and you are interested in the other side of the story I suggest reading a very well edited point-by-point rebuttal:
http://www.amazon.com/Flash-Boys-Insiders-Perspective-High-F...
So, I'm a nerd, and I found "Not So Far" more interesting than Lewis's book. I don't think you need to read Lewis' book to get value out of the rebuttal.
I've had a couple people who work in high frequency trading say that Flash Boys is extremely inaccurate, but they still recommend The Big Short. I've not really heard anything significantly negative about TBS though I'm sure there are probably disputed opinions about it out there. And while the character narratives in TBS could be entirely fabricated (I mean, I'm sure they aren't totally false), the underlying issues and events line up with my previous understanding of the crisis.
I'd probably be such a person (former HFT). But here's the thing - I know fuck all about mortgages.
I know a bit more than the average person, e.g. I know the actual mechanics of a CMO. Certainly I can see past the "evil vampire squids pooping toxic waste onto innocent homeowners" story the media pushes. But if Michael Lewis wanted to fool HFTs giving the Big Short a casual read, he could.
In much the same way, I'm sure mortgage people could potentially see through BS in the Big Short (if such exists) but couldn't spot it in Flash Boys. I also suspect that HFTs (read: computer geeks, the sort of folks who read HN) are far more vocal on the internet than mortgage guys.
Not much in the way of bs in the big short tbh. A little dramatisation of the characters probably but hey, gotta sell a book right? Facts were pretty spot on. The book atleast; no clue about the movie.
My father worked at one of the Hedge Funds referenced in The Big Short for about 15 years, and was there during the collapse. I've talked to him ad nauseam about these books and the only one he didn't like was Flash Boys, but calls The Big Short "sort of scary" in how accurate it was.
In reference to Flash Boys he said that the technical aspects of how HFT works were so poorly illustrated that he couldn't really take the book serious and felt that it would limit his ability to further consider future Michael Lewis books. Wish I understood more of that, but his point was, I think, that it's not as nefarious as it's often made out to be.
Look, HFT as a concept is already black magic to people who trade.
It's a fundamentally simple idea but when you actually try to apply it to a real living breathing market, it becomes indistinguishable from electronic warfare because that's what it is!
A lot of the shenanigans that people point to are just different techniques to try and suss out the market microstructure and are in effect no different from trading techniques that evolved in the 1920s.
The best HFT book I ever read was "Reminiscences of a Stock Operator" because if you look at what he's saying and then replace the people in the book with electronic agents, you end up right where we are with HFT.
Interestingly, I did a brief detour from algorithmic trading/HFT to work on the exotic derivatives desk (which traded CDS, CDOs, etc) at GS in 2007 for a year. I didn't like GS very much, I felt like I gave them 130%, and they gave me shit- I was suckered into a bad role that was clearly considered a cost center. I was also almost autistically focused on the housing market, wondering how I was making good money but couldn't afford a house by traditional standards and reading tons of data and blogs to figure out who was mad (me or everyone else). But anyway...
The Big Short was a lot more accurate. Moreso because Lewis's thing is to tell a story from one side, usually with some kind of reluctant or unlikely hero, and the Big Short fit that structure a lot better. Everyone, and I mean EVERYONE, as in 99+% of the US population, was all in on the housing market. I mean everyone was chugging the kool-aid. Insurance companies (IE AIG), pension funds, cities, all looked at these securities as a way to get safe returns with an attractive yield. Where things really started to get off the rails with them is that they weren't looking at the underlying loans themselves- they trusted the rubber stamped AAA rating that the ratings companies were putting on them. What's worse, is that the first line of defense against this sort of thing is supposed to be the loan officers- but they looked the other way as they pushed NINJA (No Income, Job, Assets) loans through the system. And while "Wall St" gets yelled at for being greedy, there were maybe a few thousand people on Wall St who got rich. The number of mortgage brokers and loan officers who were making deep in the 6 figures, often with just a year out of school was in the hundreds of thousands, if not millions- I know because many of my classmates made me extremely jealous. Anyway, my point being is that the Big short was quite accurate.
So why was Flash Boys less so? Well, the number of players involved is a lot higher, and its not so easy when you really look at it to paint a clear picture of good vs bad when you really understand the stuff. First off, he only seemed to talk to people at IEX- Katsyuma and his crew, who clearly had a vested interest in making themselves look like heroes. IEX actually launching was a more or less non-event, they were merely one of 37 venues to trade at that point, and in Oct' 13, they barely registered as a blip until Flash Boys came out. Also, HFT is an ever-changing game, the Thor strategy was widely known by mid 2009 and every major sell-side algo had it implemented by then or shortly after. My firm happened to call it "sync-take" (IE synchronized "taking" of liquidity).
My problem with Flash Boys is that it just told so little of the story, and clearly wanted to make Katsyuna a hero figure protecting the little guy from the big bad HFT's. But there are two huge parts of the story that I think he should have at least mentioned. The first part is that the desire for speed and great lengths to get it are nothing new on wall st. CGuys using phones to get ahead of bucket shops at the turn of the 19th century, the whole reason guys paid big bucks to become floor traders, SOES bandits on Nasdaq in the 80s, are all just a part of the very long story of people trying to get a speed advantage to trade on the stock market. It just became a lot scarier because its on computers (many HFT strategies are actually fairly simple- the whole point is to be simple as they just want to use their speed to ensure as close to a risk-free profit as they can.
The second major part of the story that they don't talk about it is how corrupt the markets used to be. Floor traders were shady and would literally front-run orders. That is more or less impossible now, there is a clear audit trail. But even aside from that, which did happen, but was relatively small potatoes, is the fact that the "spread" you would pay when buying and selling stocks used to be huge. Transaction costs used to be a huge part of trading, from your broker charging $50 just to make a trade, to the huge bid/ask spread that went in the pockets of market makers. There used to be armies of "traders" in the 80s and 90s that brought home 6 figure salaries when that really meant something that were just automated out of a job in the 00's. Your typical spread on IBM is now maybe a few cents, where it used to be over a dollar in the 90s. Your typical brokerage now charges about $7 a trade, with some as low as $1 (Interactive Brokers- which I use).
This is a topic I tend to ramble about, which I have done here, but hopefully that paints more of a picture. If you have questions or want me to expand on any particular area, let me know.
While Big Short doesn't seem as factually challenged as Flash Boys, it is over-simplified. Either Michael Lewis falls short of his goal of producing an unbiased representation complex issues in a "pop non-fiction" form, or his goal is different and he is a biased observer forming a cohesive story from a cherry-picked selection of facts.
Every Lewis book I've read has been great. He does a fantastic job exposing any number of things that are likely desired to be kept secret. Also does a great job making things understandable, while not dumbing it down too much to the point of inaccurate.
"The Great HFT Debate" is a must-watch, following the release of 'Flashboys' just seeing how defensive the market players got.
I'm a (or at least was) a huge Michael Lewis fan. Until he wrote a book about the industry I was in (HFT). Regardless of where you stand on HFT, Flashboys does a very bad job explaining the technical aspects that are occurring. Further it presents a completely 1 sided look at the industry, without ever quoting someone knowledgeable about the technical aspects.
I don't dislike Flashboys because of its conclusions, I dislike it because of its inaccuracy. It called inot question every other book of his. Which was really disappointing as I had enjoyed them all so much.
> I think this is the crux of this story: according to Michael Lewis and Katsuyama, we’re supposed to trust people like Einhorn who have been convicted of insider trading, people who are suspected of insider trading (buy side is by definition rife with this; particularly firms that do merger arb and special events), J.P. Morgan, Goldman and Morgan Stanley: we’re supposed to trust these guys more than we’re supposed to trust a bunch of tiny little market making firms who had been inconveniencing them by taking away some of their flow. Lewis tries to make this seem like a battle between the underdog “good guys” and the evil establishment. To believe this, you’d have to believe that Goldman Sachs and people like Einhorn are underdogs, rather than the actual establishment. To believe this, you’d have to believe the tiny industry of HFT traders actually rules the world and buys off congressmen and the SEC more than … J.P. Morgan and Goldman. [...]
Yeah, I might believe that. I might believe that if I were a dribbling retard.
Still this is all just Ad-Hominem attack on the characters in Flash Boys and seems a bit over the top "Yeah, I might believe that. I might believe that if I were a dribbling retard."
doesn't really answer why Flash Boys does such a terrible job of explaining HFT
Yes, it does. You didn't read it carefully enough.
The whole premise of the David and Goliath story Lewis wants to tell is that HFT is a device used by the Wall Street establishment to screw over the rest of the market.
But in fact it's more the opposite: HFT firms are upstart prop trading and market making shops that are pissing off giant banks like Goldman and JPMC by making it harder for them to skim profits off block trades for pension and hedge funds.
Also: the use of rhetoric like "dribbling retard" isn't what makes an argument "ad hominem". An ad hominem argument is one whose logic rests on a claim about its opponent and doesn't account for its opponent's argument. The logic behind the quote you're commenting on doesn't do that.
i said that comment is a bit over the top. i was talking about "either Lewis is a credulous idiot who is not competent as a journalist, or Katsuyama is an idiot who was not competent as a trader" it seems Locklin's goal is to say Michael Lewis is an idiot, which is ad-hominem attack. The need to call him an idiot, combined with the "retard" comment is really not needed and doesn't add anything.
i do appreciate your explanation for how the goal of Lewis's book is based on a fallacy
The argument being made here is about Katsuyama's complaint that the prices he'd see in his terminal would suddenly move away from him if he tried to trade large blocks of stock at that price.
What makes Katsuyama sound incompetent is his apparent lack of understanding of the price pressure his own large block trades put on the market. Lewis makes Katsuyama out to sound as if he can reasonably expect that if FCOJ is quoted 29.78-29.80, he can sell 100,000 shares at the quoted price. Of course, not only can he not expect to do that, but the influence that large trade has on the market is the whole reason Katsuyama is paid by RBC to trade for its clients.
Hence: either Lewis doesn't understand his subject well enough to report on it, or Katsuyama doesn't understand the basic function of his job.
In any case: not an ad-hominem, sorry. There's a popular Internet fallacy that says any argument that uses insulting language must be an ad-hominem. Insults aren't usually productive, but they don't automatically produce flawed arguments.
How about him saying "looking a little scaly, bub" for a caption for lewis. Surely what Lewis looks like has no relevance on the argument. Seems Lacklin has it out for Lewis.
I guess calling him an idiot is not ad-hominem in that he's arguing he doesn't understand what he's talking about.
If you're on a mission to spot all the unproductive rhetoric in a substantive criticism of the book, that's fine, but I'm not interested. It takes a couple minutes to think out and write up an explanation of what these criticisms are about, and when you respond to one of those explanations by changing the subject to a snarky caption on a photo, I'm made to feel like I wasted my time.
B) was just pointing out that the snarkyness comes across strong in the blog post. So it's possible that frame of mind affects the writing and it affects the reader, argument aside.
I think that is a fair criticism. You can read my blog post to be "Flash Boys, Not So Fast is the rebuttal I would have written if I had the time and was a good writer".
Maybe I should change the post to be more explicit about that.
If there was a way you could have worded this comment without implying that Kasey was just making things up, it would have been a better comment. As it stands, I think you can take the time to use the search bar at the bottom of the page to find what he's written about the book on the site before.
in no way was i implying he was "making things up" but he has said that Flash Boys did a "bad job of explaining HFT" and on that website he links to it says its "dreadful". He also says he "answers this question so often" he made that site. but the site just lists books, but doesn't really answer any questions. Just pointing to other peoples books is not really answering a question. and i think if Flash Boys is "dreadful" he could point to a few concrete examples
Back in the day I worked for financial traders on early automated trading systems, and I think your summary is fantastically poor.
First, people have long had questions about the societal effects and costs of trading, even when humans did it. Second, the automation of trading isn't merely replicating what humans do at a lower cost. I'd call it a fundamentally different activity. Third, one of the things that has become more and more attenuated is any sense of moral responsibility. Traders were never known for attacks of the warm fuzzies, but algorithms not only don't give a shit about how the affect humans, they can't. And fourth, instead of saving everybody money, finance eats up an ever-increasing share of the economy, and I think automation is part of that.
Automation isn't universally good. Sometimes it makes things better, sometimes worse. As technologists our job isn't just to automate everything. It's to use our professional skills and experience to improve the world, to improve human lives.
I feel like you're side stepping the point of his argument. Maybe I'm misreading you both. It read (to me at least) more of a "why isn't hn this hard on other automation stories" and less of an indictment of the (fashionable) distaste for HFT.
I suppose one could read it either way. But a) most engineers are pro-automation, b) he works for a financial company, and c) computers haven't really replaced people in finance, so absent other evidence, I am going to stick with my reading of his comment for now.
You don't have to assume zero sum in general. Just that some interactions can be zero or negative sum. The simple example is monopoly rents: monopolists can increase their share of total profits without increasing value delivered.
By a lot of measures, the financial industry captures a lot more money than they did in previous decades. But it's far from clear that they're delivering a lot more value, and given that computers have drastically reduced their costs, it's reasonable to expect them to be smaller, not larger. As a start, this has some good graphs:
Yes it was. Even stipulating your use of the term "front running"†, it's not hard to see how. When humans intermediated trades, spreads were denominated in dimes and quarters (and even higher as you go back further in time). Now they're pennies.
Google "odd eighths scandal" for a good starting point.
† "Front running" has a specific technical meaning, which very few people who throw the term around seem to know about: a front-runner violates a fiduciary duty they have to a client, trading against their clients for their own benefit. Market makers and prop trading firms aren't generally brokers for other people and don't have that duty; they can't "front-run" the people they out-trade.
Your real estate agent would "front run" you if they knew you wanted to buy a particular house, knew your maximum price, bought the same house for less than that price and then sold it to you at a profit. Same with your stock broker and, say, IBM stock; they have a duty of best execution to you.
I only know as much as I read in Flash Boys, and it sounds like front-running is generally the right name for this, but the difference is that it is not your broker but 3rd parties who are fishing for info on potential trades that are front-running.
By your analogy, the real estate agent knows you want to buy 5 houses, and suddenly after closing the first one, the price of the remaining 4 goes up.
No. Your real estate agent has a duty to you and cannot trade against your interests. A prop trading firm (or "3rd party firm") has no such duty, and thus can't "front-run" you.
If your own real estate agent bought a bunch of houses to resell them to you at a profit, they would be front running you. If another real estate firm noticed that you seemed intent on buying 5 houses and bought a bunch of them to resell to you, that would not be front-running; in fact, that would basically be a description of how the real estate market works.
I'm not saying it's your own broker or agent that is biding up the remainder of the lots you are intending to buy. It is "observers" who are manipulating the system in a way to make you reveal to them your intentions and price, so they can "front run" you for the next transaction a millisecond later at the next exchange.
And the reason I quoted observers was becuase in my limited understanding (if i had the book in front of me I would re-read this), the HFT traders would put up some token offers up on all the stocks for the purpose of exposing potential activity that they could abuse. A quick google of this suggests that this is called "Pinging".
basically be a description of how the real estate market works.
For example: a commercial real estate developer may be putting together "an assemblage", which takes a bunch of disparate properties and tetris-style assembles them into a contiguous landmass to hold e.g. a larger commercial property with a signed anchor tenant and the plans for more. The developer has important, market-moving knowledge about the near-term prospects for properties composing that assemblage: they are all about to become sharply more valuable precisely because the developer has a use for them. The developer will send out someone who is isomorphic to my dad to discuss with the owners of each property, partially in serial and partially in parallel, to get them to sell to the developer. Their goal is to get the properties as cheap as possible and they are under no obligation to tip their hand as to why they want them.
It is highly, highly in the developer's interest to conclude all purchases before either a) the property owners or b) anyone else realizes what is going on. This is complicated by many factors, including e.g. planning commission approvals required in some places which are public records. A fairly common strategy among savvy local real estate investors is to a) identify assemblages before they are assembled and b) race the people putting them together.
"They bought the corner gas station? It's useless without Milly's house. Have they closed Milly yet? Quick way to check. calls Milly Milly, I was wondering, haven't you considered being closer to your children? Where did they live again, Florida? Yeah, yeah. Interested in selling your house if I give you a fair offer? Well, we can talk it over any time, but $300k cash and I can close immediately. Sure sure, let's chat."
Real estate developers hate, hate, hate when it happens, because sometimes the market maker here has correctly intuited "This deal doesn't happen without the property which was previously occupied by Milly, right? Man, that would be a shame. $700k." "That's an outrage. It's worth $250k." "You were certainly going to tell Milly that,which is why I gave her $300k. But, between businessmen, it's not worth $250k or $300k. It's worth whatever number your client is willing to authorize to get the assemblage done." "$600k you dirty dog." "$650" "DONE." "Pleasure doing business with you."
Now naturally, sometimes the market maker guesses wrong. He now is holding a house. That's the nature of the business.
This maps fairly directly to financial markets, except the "assemblages" are called "block trades", they're composed of fungible units rather than individually distinguishable properties, and this happens much faster and much cheaper because market makers are very, very good at their jobs.
You can imagine that the neighbor next door to Milly might notice the fact of Milly's transaction (e.g. via hearing directly) or the market maker's transaction (e.g. via public records). This is analogous to the tape being painted in a lit exchange. "Ooh spiffy, my property is more valuable than I thought it was!" The real estate developer hates this as much as Brad Katsuyama hates when someone spills the beans that he's putting a 100k trade together by painting the tapes with buy orders.
The real estate developer, and Katsuyama, should learn to deal with their disappointments or get better at executing on their only job.
That's splitting hairs. Do you have a better term for when someone sniffs your trades on the wire and uses their advantaged position to buy up the market and then relist it at a higher price?
Arbitrage doesn't really cover it because people were buying at the original price and may not buy at the marked up price.
As I understand it, "sniffs your trades on the wire" is an inaccurate description of what is going on. HFT is responding to information about trades that have already happened (possibily at a different exchange).
Where it really is wire tapping, I would say the right term might be (high speed) industrial espionage.
> HFT is responding to information about trades that have already happened (possibily at a different exchange).
And that they were likely a party to. They would place small orders on all the stocks so that they could detect activity that they could exploit at the next exchange a millisecond down the wire.
That implies popularity, but I've never heard of any of the alliterative characters mentioned in Wikipedia:
> In 1849, a "very different" English version was published under the title "The Story of Chicken-Licken" by Joseph Orchard Halliwell.[15] In this Chicken-licken was startled when "an acorn fell on her bald pate" and encounters the characters Hen-len, Cock-lock, Duck-luck, Drake-lake, Goose-loose, Gander-lander, Turkey-lurkey and Fox-lox.
> In the United States, the most common name for the story is "Chicken Little", as attested by illustrated books for children dating from the early 19th century. In Britain and its other former colonies, it is best known as "Henny Penny" and "Chicken Licken", titles by which it also went in the United States.[note 1]
Lewis's books are ideologically driven, not a search for truth. People don't read them critically because of confrmation bias -- everyone hates Wall Street, so everyone assumes take-downs of Wall Street must be correct.
It is extremely difficult to write any kind of book or movie about finance which is a) accurate b) comprehensive (covers more than a tiny slice) and c) NOT boring as hell and extremely confusing to the lay audience.
Lewis does as good a job as is possible, given the subject matter. Mostly accurate, fairly comprehensive, and not boring.
You can see part of what's problematic about the latter book just from this Guardian summary of it. The summary would have us believe that HFT is a trick employed by giant Wall Street banks to screw over smaller players. But Katsuyama, the protagonist of Lewis' book, was a big-bank trader, paid exorbitant amounts of money to tax large block orders by pension and hedge funds, and outraged by his inability to compete with algorithms that were bidding that tax down.
I'm uncomfortable calling any giant financial firm "trustworthy", but if you were going to pick one firm that has come close to earning that label, it's Vanguard. Vanguard's chief investment officer has repeatedly and unequivocally stated that HFT firms have lowered Vanguard's costs and improve outcomes for its investors.
Here's Matt Levine writing entertainingly about how the "Flash Boys" in Lewis' book ought to have been, based on his previous books, the protagonists, and Katsuyama the villain:
http://www.bloombergview.com/articles/2014-03-31/michael-lew...