Fast money: the battle against the high frequency traders
A 'flash crash' can knock a trillion dollars off the stock market in minutes as elite traders fleece the little guys. So why aren't the regulators stepping in? We talk to the legendary lawyer preparing for an epic showdown
by Andrew Smith
A proud Mississippian, Lewis wears his intellect with quiet southern grace; he listens before speaking and never interrupts. In almost half a century of legal practice, he thought he'd seen everything, but over 14 years of retirement he watched the world lurch towards a new technology-driven feudalism, defined by disparities in wealth that were more keenly felt in his own state than most. He was feeling ready for another dragon to slay.
As is often the way, in the end the dragon found him. In April 2013, he was at a baseball game with his friend Professor Bonnie Van Ness, head of the University of Mississippi's school of business administration. Lewis asked after her professor husband, Robert, who was presenting a paper in Boston. What was the paper about?
This is the practice by which stock market players called high-frequency traders slam vast numbers of orders into the system, cancelling them before anyone can react, with the aim of slowing the transit of information to competitors, or of creating confusion from which they can profit – all in the space of milliseconds.
"I'm certain you must have that wrong, Bonnie," Lewis said, "because that would be quite illegal. It would be market manipulation."
No, she said, quote stuffing was as real as the teams on the field. The stock market was a new wild west running on rocket science: the stuff going on there was mind-blowing. The rest of the game passed in a haze.
Van Ness mailed Lewis the paper. Over the coming weeks, he read everything he could on this phenomenon. Here was a market beyond human control, dominated by super-fast machines running complex computer algorithms that jostled and fought each other at the level of milliseconds, microseconds – and with no meaningful oversight. The familiar cliche of gaudily dressed men waving arms on a stock market floor was history: trading now happened within black boxes housed in highly secure, unmarked "data farms".
Not only that, the algorithms at the heart of this world were run not by finance or programming people, but by "quants": quantum physicists, climate scientists, theoretical mathematicians. Some of the most formidable minds in the world were now employed in a technological arms race, a hidden war stalked by million-dollar predator algorithms that could swarm those of the larger, slower players – typically, pension and mutual funds – in the same way a shoal of piranhas might an ox, cutting them to shreds and pocketing the profits. The regulators couldn't keep up. If they tried, the algos simply mutated.
To Lewis, it looked as though the finance industry had found a new way to fleece the public – the ordinary savers and workers with pensions. Already, the system had caused several big scares, most notably the "Flash Crash" of May 2010, in which $1 trillion was wiped off the value of markets in the space of 10 minutes. Yet, the deeper he delved, the more forcefully a depressing truth emerged: that a fortress of legislation had been built around the stock exchanges and powerful traders (mostly banks and hedge funds) by lobbyists and politicians. Immoral as these practices might be, they were no more illegal than had been the packaging of sub-prime mortgages into tradable securities prior to the crash of 2008-2009.
Lewis pressed on, but his mood grew bleak. Then he met Eric Hunsader.
Eric Scott Hunsader has lived in Chicago for years, but he's never been to a place quite like this – the Chicago Executive Airport, whose Comfort Inn frontage belies a runway full of Learjets out back. It is 6 May 2014 and for the past four years, Hunsader, one of the most gifted programmers in the country, has felt like a lone voice in the woods after stumbling across high-frequency trading (HFT) and being shaken by what he saw. Finance insiders have branded him a conspiracy theorist or – absurdly – a luddite, but now the world seems to be waking up. Next to him at a rosewood conference table is not just the renowned Big Tobacco slayer Michael Lewis, but Lewis's "dream team" of class-action lawyers, whom he must convince of the evidence – a tough job, given the complexity of HFT. He can see some of the team struggling with the material, having doubts, but then one by one getting it.
Hunsader tries not to feel excited, knowing what the stock exchanges and banks will do to protect their interests against any lawsuit. It helps that since he and Lewis first met a year ago, the bestselling book Flash Boys (written by the other Michael Lewis) has opened up HFT to wider debate. Lewis smiles as he invokes the movie Star Wars and the metre-wide ventilation shaft Luke Skywalker uses to destroy the Death Star, hoping to have found its stock market equivalent. He's even taken to calling this strategy "the Hunsader torpedo", after the man who pointed it out.
If the torpedo works, Hunsader will be at the heart of one of the legal battles of the fledgling century – The People versus Big Finance. He looks about the room full of top lawyers and – not for the first time – wonders: how the fuck did I get here?
6 May 2010 opens like any other day on the markets. Asia is quiet, the US and Europe jittery as UK electors trudge to the polls, while Greeks hit the streets to protest austerity. Stock prices have been rising through the year, buoyed by waves of cheap credit, but now the mood is darkening, and every time Athens hits the TV screen, another few points drift from the Dow Jones Industrial Average like teargas. By 2.30pm, it is down 2.5%: hardly catastrophic, but worth a weather eye.
And then something unexpected appears – a flutter in the price of E-mini futures contracts, an investment vehicle traded on the Chicago Mercantile Exchange and regarded as a bellwether of wider sentiment. Almost no one notices, until the flutter becomes a shiver, then a spasm, amid whipsawing prices as the E-mini's vertigo spreads to other stocks and exchanges, and indices begin to plummet.
Within seconds, the Dow has lost 100 points. Finance workers turn back to their screens. But seconds later, another 100 has been shed and managers fly from their offices, yelling, "Pull everything!" as traders hit buttons and hammer keyboards, cancelling orders in an attempt to limit damage. In horror, they gather in communal spaces and watch price lines dive with eerie, implacable momentum, like lines scratched by an angry child.
300 points down…
At 600 down, the Dow has fallen further than it did on news of Lehman Brothers' collapse in 2008. But that crash took a day: this spans minutes. At 5% down and in apparent freefall, traders will report feeling nauseous, sick; a sense of staring into oblivion. Even 9/11 failed to rock the market like this – which implies that something catastrophic has happened. But what? The CNBC pundit Jim Cramer, an experienced former hedge fund manager, roars: "The machines broke – these are not real prices!" and wonders why no grown-up is stepping in to shut the show down. But the trouble is, nobody can: circuit breakers designed to halt trading after unnatural price swings work only until 2.30pm and it is now 2.47pm, with the Dow racing towards an unprecedented 1,000-point loss and almost $1tn wiped from balance sheets.
Then something even stranger happens as, with Armageddon approaching, the market turns tail and begins to rise, just as impossibly as it fell.
The traders breathe again. The whole episode, the most dramatic in stock market history, has occurred within 10 minutes. Welcome to the world of HFT and the Flash Crash.
Eric Hunsader never played the market himself: programming was his thing. At school he had been funnelled towards a career in medicine as a kind of smart kid default, but when he discovered coding, it was like falling in love. He adored the way you did "x" to make a computer do "y", and if it didn't, you knew you'd made a mistake; you got to the bottom of the glitch and fixed it. Beautifully simple, and certain.