Is the US stock market rigged?
“Keep regulators as honest as possible,” US journalist Michael Lewis says, “or else the financial industry will own the regulator.”
On March 31, 2015, my family and I attended the Invest Asean Conference 2015 in Singapore. (Disclosure: Thank you, John Reyes of ATR Kim Eng, for inviting us. We paid our own way to the conference.)
Asia is emerging as a superpower, with Asean a part of it. Asean now accounts for 10 percent of global gross domestic product, with trillions of dollars in investments. Companies, including family businesses, need to plan for engagement with Asean.
Organized by the Malayan Banking Bhd (Maybank), the conference featured public presentations and private meetings by top Asean businesses, but Lewis was the main draw.
After exposing the underside of industries such as baseball (“Moneyball”) and bond trading (“Liar’s Poker”), Lewis in his latest book “Flash Boys” targets stock exchange high-frequency traders (HFTs, hence the title).
Canadian banker Brad Katsuyama used to have faith that the US stock markets were transparent and fair. But soon he noticed that literally milliseconds after orders were placed in the systems, HFTs, armed with speedy algorithms and state-of-the-art infrastructure, somehow managed to get their hands on them before unwary brokerage firms could fulfill such orders.
The difference per transaction may be in fractions of a cent, but they add up to humongous sums, affecting the bottom line of regular financial firms, small and medium scale businesses, homegrown investors.
In 2013, Katsuyama set up IEX, the Investors’ Exchange, using technologies to prevent HFT algorithms from entering the exchange, to ensure that everyone plays fair. But after Lewis’ exposé, several businesses, media, even government went on the defensive. The former president of Bats Global Markets lambasted Katsuyama and Lewis publicly on CNBC, though shortly after that, he could not defend his group from grave charges, and had to leave his post.
The chair of the US Securities and Exchange Commission went on record, saying that “the markets are not rigged.” “Of course, she could not say that it was, because it would undermine confidence in the market,” says Lewis, “but a former SEC director of trading describes the US market as being like the Death Star (in Star Wars).”
Death Star, indeed, for whom can we trust? The regulators? “The people working for the [government] regulators were leaving to go work for the HFTs,” says Lewis. “After 237 people left, they stopped counting. This is an example of the industry owning the regulator. Wall Street is very good at responding to incentives. Who pays the most wins the day.”
Be careful of rules
Some Asian bankers said Asian stock markets, including those in the Philippines, do not have HFTs. They are fair. They are not rigged. But the audience at the conference was not reassured. The temptation to rig the markets is so tempting, it is naïve to believe that HFTs will forever remain in the Atlantic.
What can be done to ensure that what is happening in the US will not happen here?
Lewis does not have definite answers. But he is wary of knee-jerk rules from skittish governments. “Be careful of the rules you create,” he says, citing for instance a US SEC rule that backfired, giving rise to a slower market. Instead, Lewis believes that change should come from the market itself, in the form of conscientious financiers who will create a truly fair exchange.
We need our own Brad Katsuyama
Lewis is hopeful. Change is in the air. The US Justice Department, the New York Attorney General, even the FBI, are investigating HFTs in 60 stock exchanges. The Financial Industry Regulatory Authority has filed cases against “abusive algorithms”; the SEC against banks with dark pools (private in-house stock markets run deep inside). Bank of America shut down its HFT, Citigroup and Wells Fargo their dark pools.
“If this story has a soul, it is in the decisions made by its principal characters to resist the temptation of easy money and to pay special attention to the spirit in which they live their working lives,” Lewis wrote in “Vanity Fair” last month. “That some minority on Wall Street is getting rich by exploiting a screwed-up financial system is no longer news. That is the story of the last financial crisis, and probably the next one, too. What comes as news is that there is now a minority on Wall Street trying to fix the system… All they need is a little help from the silent majority.”
Next week: Family saga of Singapore’s top health business
Queena N. Lee-Chua is on the board of directors of Ateneo de Manila University’s Family Business Development Center. Get her book “Successful Family Businesses” at the University Press (e-mail [email protected]) E-mail the author at [email protected]
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