In my alternative Michael Lewis story, the smart young whippersnappers build high-frequency trading firms that undercut big banks’ gut-instinct-driven market making with tighter spreads and cheaper trading costs. Big HFTs like Knight/Getco and Virtu trade vast volumes of stock while still taking in much less money than the traditional market makers: $688 million and $623 million in 2013 market-making revenue, respectively, for Knight and Virtu, versus $2.6 billion in equities revenue for Goldman Sachs and $4.8 billion forJ.P. Morgan. Even RBC made 594 million Canadian dollars trading equities last year. The high-frequency traders make money more consistently than the old-school traders, but they also make less of it.
Similarly, Lewis goes to great lengths to elide the distinction between small investors and big investors. As a rule, small investors are helped by HFT: they get filled immediately, at NBBO. (NBBO is National Best Bid/Offer: basically, the very best price in the market.) It’s big investors who get hurt by HFT: because they need more stock than is immediately available, the algobots can try to front-run their trades. But Lewis plays the “all investors are small investors” card: if a hedge fund is running money on behalf of a pension fund, and the pension fund is looking after the money of middle-class individuals, then, mutatis mutandis, the hedge fund is basically just the little guy. Which is how David Einhorn ended up appearing on 60 Minutes playing the part of the put-upon small investor. Ha!
Lewis is also cavalier in his declaration that intermediation has never been as profitable as it is today, in the hands of HFT shops. He does say that the entire history of Wall Street is one of scandals, “linked together trunk to tail like circus elephants”, and nearly always involving front-running of some description. And he also mentions that while you used to be able to drive a truck through the bid-offer prices on stocks, pre-decimalization, nowadays prices are much, much tighter — with the result that trading is much, much less expensive than it used to be. Given all that, it stands to reason that even if the HFT shops are making good money, they’re still making less than the big broker-dealers used to make back in the day. But that’s not a calculation Lewis seems to have any interest in.