Book Review

Review: Flash Boys

Note: The paperback edition of Flash Boys was released this week. This review is of the hardcover edition.

Flash Boys - Michael Lewis

The most remarkable thing about Michael Lewis’s tale of the rise of High-Frequency Trading (HFT) and the ‘fracking’ of the equity markets detailed in Flash Boys is not that it happened – after all, massive amounts of brain power are directed at financial markets to search for and exploit any available loophole – rather, the astounding realization you walk away with is that it happened under the noses of trained professionals who had just as much incentive to see that they were not being taken advantage of.

Anyone who has been licensed to sell or advise on securities has been tested on how markets function – the types of orders, the regulations surrounding disclosure of bids & offers, which orders take precedence, etc. – but, as Lewis explains, as far back as 2007, the world as traders knew it no longer functioned in a way they understood.

“The U.S. stock market now trades inside black boxes, in heavily guarded buildings in New Jersey and Chicago.” - Michael Lewis

The three historical exchanges, the New York, the American, and NASDAQ, and their trading floors in the case of the first two, had been joined (and in the case of the American, replaced) by rival exchanges and ‘dark pools’ – brokerage-owned proprietary exchanges – where computers replaced specialists and speed became king. From a world where a stock was listed on one of the traditional exchanges exclusively, shares could now trade on any of over three dozen platforms. And where there are multiple markets, there is opportunity for arbitrage – the simultaneous trading of the same stock at different prices.

As Lewis fascinatingly details, the High-Frequency Traders went a step further and induced markets to rig the game to create risk-free arbitrage through trading algorithms, co-location of computing power and trading fee structures that allowed the HFTs to predict the other side of the trade and race ahead to the next exchange to be waiting with the goods on the other side.

No Lewis book is complete without a hero and the narrative centers on two, Brad Katsuyama and Ronan Ryan, who put together the team that uncovered the changes to the financial markets that had taken place and built a brand new exchange from scratch to give traders a level playing field. Brad, a genial, soft-spoken, Canadian and Ronan, from Ireland and just as genial, but far from soft-spoken, have created IEX specifically to thwart the unfair advantage enjoyed by HFTs (though they are welcome to trade on IEX). From a standing start in October of 2013, IEX has grown steadily to where it represents just slightly over 1% of trading volume on the U.S. exchanges in early 2015.

How it got there is the story of the Flash Boys.

Book Review: Aftershock - Robert Reich

Robert Reich’s latest book, Aftershock, is the first I’ve seen post-Great Recession to offer an economic rather than a political argument for either fair or re- distribution of wealth, depending on your political leanings.

Reich explores the paradox of productivity: what does it profit a nation to produce if its citizens cannot afford the fruits of that production? According to Reich, it causes lots of trouble, both economically and socially.

This paradox was most famously identified, and solved, by Henry Ford in 1914 when he increased his workers’ wages to $5 a day, an unheard-of rate for factory workers at the time. Ford, in nearly doubling his workers’ wages, turned them into consumers, specifically consumers of the very Model Ts they were building. As Reich writes, “Ford understood the basic economic bargain that lay at the heart of a modern, highly productive economy. Workers are also consumers.”

But despite Ford’s early successes, the real hero of Reich’s book is Marriner Eccles, Federal Reserve Board Chairman under FDR. Eccles saw the inequality of wealth in American society as the chief culprit behind the Great Depression. Not surprisingly, Reich sees parallels with the run-up to the bursting housing bubble that signaled the Great Recession of 2007.

The concentration of wealth was such that, according to Reich’s sources, the share of total income commanded by the richest 1% more than doubled from its low in the mid-1970s to over 23% in 2007 (a figure not seen since 1928, just before the Great Depression). Reich (and Eccles before him) contends that this concentration of wealth artificially drives up prices and creates bubbles: stocks in 1928, tech stocks in 2000 (when the wealth concentration was again over 20%), and housing in 2007.

Reich contends that not only does such a concentration offend our sense of fairness and distort price signals, but encourages over-leveraging as the aspirational middle class runs out of coping mechanisms for keeping up with the wealthy. According to Reich, the middle class put off the day of reckoning by first moving women into the workforce and then working longer hours until these resources were exhausted, finally ‘borrowing to the hilt’ to consume at the same pace relative to the wealthy while relative incomes fell.

Reich fears an angry, populist, xenophobic backlash leading to protectionism and decline, but also offers remedies to restore the balance of income to the point where the nation will be able to afford to consume what it produces. Though explicitly swearing it is no “Robin Hood” scheme, Reich’s solutions do offer up a fair degree of income redistribution:


Reverse Income Tax – Essentially an expansion of the Earned Income Tax Credit, a reverse income tax credit would pay every full-time worker $1 for every $2 their salary fell below $50,000 (e.g. someone making $30,000 would get $10,000 from the federal government). Additionally, incomes between $50,000 and $90,000 would be taxed at 10%; between $90,000 and $160,000, 20%. The rate would apply regardless of the source: wage, dividend, or capital gain.

Higher Marginal Taxes on the Wealthy – Once we get above $160,000, the marginal rates go up; 40% between $160,000 and $260,000, 50% between $260,000 and $410,000, and 55% over $410,000. This last category represents the top 1% in wage distribution.

A Carbon Tax – Initially starting at $35 per metric ton of carbon dioxide (or its equivalent), the tax would rise to $115 per ton or an additional $1 per gallon of gas (approximately).

A Re-employment System – Designed to replace unemployment insurance, a reemployment system would pay workers 90% of the difference between their old & new (lower) salaries for two years in the event of a job loss or 90% of their former wage for one year for approved retraining.

School Vouchers Based on Family Income – Converts the average per child per year cost into a range of voucher amounts based on family income. School districts would compete for the voucher dollars.

College Loans Linked to Subsequent Earnings – 10% of a graduate’s income for the first ten years of full-time work, regardless of occupation, would be put into a fund to provide free tuition at public colleges and universities and federal loans for private colleges.

Medicare for All – A single-payer system with subsidies for low- and middle-income families.

Public Goods – Free public transportation, parks, recreational facilities, museums & libraries.

In the end though, Reich’s solutions replace one pricing paradox with another, namely: how is information about supply & demand and capital allocation transmitted to markets in such a manner as to provide for complex and competing desires efficiently & equitably when the signals that transmit that information (prices) are being distorted by political policy choices? Though each reader will have their own preference as to which paradox they are most comfortable with, the true test may be which regime can survive in a competitive, international environment.

Book Review: The Total Money Makeover - Dave Ramsey

Written by syndicated radio host and no-nonsense, no-debt guru Dave Ramsey, The Total Money Makeover book purports to offer a tried-and-true formula (the Baby Steps) for getting out of debt and building wealth. It’s not so much a ‘get-rich’ formula as it is a ‘stop-making-yourself poor’ formula.

Two points should be highlighted from the book: first, this is not a plan for optimizers. Ramsey’s focus is on the behavioral aspects of personal finance, not the math. For instance, he does not have you pay off your highest interest rate credit cards first, he has you pay off the smallest balance first. His premise is: personal finance is 80% behavior and 20% math. His goal is to teach you simple behaviors that you can apply that he has found to be successful.

The second point he makes is that this is not easy. “Live like no one else so later you can live like no one else”, is his motto. To get out of debt and begin growing your wealth requires sacrifice – from selling off expensive, debt-laden vehicles, to working extra jobs, to living on his metaphorical (and sometimes literal) ‘beans & rice, rice & beans’ – Ramsey expects short-term pain for long-term gain.

The Baby Steps:

1. Get a $1,000 emergency fund in the bank.
2. While remaining current on all debts, pay off your debts except your mortgage (and in some cases a HELOC or second mortgage), smallest to largest, rolling the payments you were making on the smaller debts into paying off the next debt in line (the Debt Snowball)
3. Build the emergency fund up to 3 – 6 months of expenses
4. Invest 15% of household income into Roth IRAs (if eligible) and pre-tax retirement accounts
5. Save for your children’s college education
6. Pay off your home
7. Build wealth and give

That’s it. If you have the persistence to work this plan, it will work for you. It may not be the best plan for everyone, but it is a good plan for most.

For the full plan see: http://www.daveramsey.com/new/baby-steps/