Goldman Sachs and Flash Boys

In the City, they sell and buy. And nobody ever asks them why. But since it contents them to buy and sell, God forgive them, they might as well.

Humbert Wolfe, The Uncelestial City, 1940

Front-running in the name of ‘democratizing’ Wall Street

Unlike most trading platforms, it [Robinhood] does not charge a commission for letting users buy and sell shares. Instead it makes money by selling data on those deals to others before they go through.

— Elon Must grills Robinhood boss over GameStop row on Clubhouse, BBC

There is no such thing as a free lunch. Just as social media platforms like Facebook have been used to manipulate class grievances and spread falsehoods the claim that Robinhood is ‘democratizing’ Wall Street and putting the ‘little guy’ aka retail investors on an even playing field is another Big Lie. But to understand why requires a sophisticated understanding of how Wall Street trading of stocks really works and that nanoseconds matter. It is based on not just information but timing and we are talking about microseconds or perhaps even nanoseconds (think quantum computing).

‘High-frequency trading’ is undertaken by computers which are constantly offering to buy and sell securities. The interval for which these securities are held by their owner may—literally—be shorter than the blink of an eye. Spread Networks, a telecoms provider, has recently built a link through the Appalachian Mountains to reduce the time taken to transmit data between New York and Chicago by a little less than one millisecond. (Kay 2015, 2)

John Kay, Other People’s Money: The Real Business of Finance

What better way to manipulate the market than to aggregate the trades and sell the information before the trades are made to front-run the “little guy” so the platform doesn’t charge transaction fees but does let the “little guy” buy on “leverage” aka credit so they can lose their shirt, house, and everything else and then hold his trade long enough to sell the information to high-frequency traders who can then front-run them. We need to be asking “Who is Robinhood selling this information to? Who would profit from such information to a degree greater than Robinhood’s client trading costs and therefore be willing to pay for it? And what are they doing with it?” Epistemic Inequality is a dangerous thing. By holding its clients trades long enough to sell information about those trades to a third-party the cost of the ‘free lunch’ is a dystopian future of Surveillance Capitalism.

When you combine ignorance and leverage, you get some pretty interesting results.

Warren Buffett, on the global financial crisis, 2008

When Robinhood delays their retail-investor’s stock transactions in lieu of charging a commission this gives the illusion of something for nothing (i.e., ‘democratizing’ Wall Street with a ‘free lunch’) for its “retail investor” clients. But this is sham, a fraud, for Robinhood is collecting its commissions by selling its “retail investor” stock data information on trading positions while holding/delaying the trade going through so third-parties can profit on this information at the “retrial investors” expense. This trading data can then be used to front-run the positions of Robinhood’s “retail investors.” This is Surveillance Capitalism at its best!

Lucky fools do not bear the slightest suspicion that they may be lucky fools.

Nassim Nicholas Taleb, Fooled by Randomness, 2001

We the public have no idea at this time who the real people are profiting overall from this phenomena; it could even be outside foreign powers with a larger agenda such as destabilizing the US economy. As the SEC says, to find out who is really behind it you must follow the money; for those who profit most are most likely those who are behind this front-running market manipulation. The majority of actual “retail investors” who are being pumped up on Reddit to hold until the end will lose much depending on how leveraged they are. A few will make a killing, make the news, and further pump the dump. But in the end the one’s who really make a killing over the long haul are those who have the millisecond advantage and the cash to purchase Robinhood’s “retail client” positions and based upon this asymmetric (insider?) information take trading positions to win on the up-side and down-side (win-win) while the “retail investors” are left with win-some lose-many.

In the long haul the stock market cycle of creating bursting bubbles is a numbers game in which the only people really winning are Robinhood and its third-party clients who roll in the cash on the backs of the con of the retail investors. Only a fool thinks outside investors would drop 3.4 billion into Robinhood overnight if not for the fact that it was a win-win regardless of the fact that what wild speculation drives up based upon no intrinsic value inevitably will come crashing down. They have already banked (front-run) their profits and left many naïve retail investors qua speculative day traders who bought into this Ponzi scheme no chair to sit in when the music stops. This in the end is nothing but a massive transfer of wealth from the middle class to the wealthiest 1% in the world.

The goose that lays the golden eggs has been considered a most valuable possession. But even more profitable is the privilege of taking the golden eggs laid by somebody else’s goose. The investment bankers and their associates [aka financial services qua Robinhood] now enjoy that privilege. They control the people through the people’s own money.

Louis Brandeis, Other People’s Money, 1914

The junk merchant doesn’t sell his product to the consumer, he sells the consumer to his product.

William S. Burroughs, Letter from a Master Addict to Dangerous Drugs, 1956

Robinhood sells its retail customer’s trading data as its product. Robinhood’s real customers are those who pay for this time-delayed “retail investor” data. How convenient to misdirect the outrage at Robinhood’s halting trading when its clearing house demanded it put up 3 billion cash to back its positions. Like all misleading and/or disinformation, this directs the “retail investors” anger away from the real abuse of Robinhood, which is not stealing from the rich and giving to the poor but fleecing the not-so-poor out of their money by delaying their trade while selling their stock positions (data) to potential third-parties who can then trade to their own advantage based upon this information. What the retail investors should be angry about and asking for is absolute transparency as to why their trades are delayed while their data is sold to third-parties, who these third-parties are, and how is their time-delayed trade data being used by these third-parties?

Someone out there was using the fact that stock market orders arrived at different times at different exchanges to front-run orders from one market to another…. [He] explained … how his team had placed big trades to measure how much more cheaply they bought stock when they removed the ability of the machine to front-run them….

“It happens on such a granular level that even if you tried to line it up and figure it out you wouldn’t be able to do it. People are getting screwed because they can’t imagine a microsecond.”

When bids and offers for shares sent to these places arrived at precisely the same moment, the markets acted as markets should. If they arrived even a millisecond apart, the market vanished, and all bets were off. [He] knew that he was being front-run—that some other trader was, in effect, noticing his demand for stock on one exchange and buying it on others in anticipation of selling it to him at a higher price.

— Lewis, Michael. Flash Boys: A Wall Street Revolt . W. W. Norton & Company. Kindle Edition

It took only a few weeks for a consortium of high-frequency traders to marshal an army of lobbyists and publicists to make their case for them. These condottieri set about erecting lines of defense for their patrons. Here was the first: The only people who suffer from high-frequency traders are even richer hedge fund managers, when their large stock market orders are detected and front-run. It has nothing to do with ordinary Americans. Which is such a weird thing to say that you have to wonder what is going through the mind of anyone who says it. It’s true that among the early financial backers of IEX were three of the world’s most famous hedge fund managers (Bill Ackman, David Einhorn, and Daniel Loeb). But rich hedge fund managers aren’t the only investors who submit large orders to the stock market that can be detected and front-run by high-frequency traders. Mutual funds and pension funds and university endowments also submit large stock market orders, and these, too, can be detected and front-run by high-frequency traders. The vast majority of American middle-class savings are managed by such institutions.

Lewis, Michael. Flash Boys: A Wall Street Revolt . W. W. Norton & Company. Kindle Edition.

When angry class grievance mixed with greed and desire for a quick profit are joined with an army of “little guys” jumping into the market on a SPAC Jesus rumor and randomly running up the price of stocks based not on any intrinsic value in the underlying asset but only anger at the “big guy” aka hedge funds and greed for quick capital gains unaware of front-running because of their greed, anger, and mob psychology riled-up by Reddit social media posts the golden age of fraud has dawned and we have entered the era of the ‘democratization’ of Long-Term Front-Running and turned the entire American economy into the wrecking ball of casino capitalism.

“We’re living in a time of absolutely unprecedented uncertainty,” she said. “There really is no reason for anyone in their twenties to imagine that their 401(k) is going to pay off in 50, 60 years the way it did for their parents. And I’m not saying they shouldn’t believe it. I’m just saying they have good reason not to”. WallstreetBets Poster

Why should I care about posterity? What has posterity ever done for me?

Attributed to Groucho Marx, but also credited to various eighteenth-century English figures

There is a wide range of reasons used to justify jumping into day trading, running from just wanting to make a quick buck to a nihilistic desire to blow the system up. One thing is sure, what goes up must come crashing down. This house of cards will fall and with it potentially the American economy and middle class with it experiencing another Great Depression worse than 1929. This will be the prelude to the next American Demagogue, perhaps even Trump 2024, and the end of any of hope of progressive change in America. Unless this angry mob psychology is swiftly redirected to political activism, such as outlawing short-selling and leveraged speculation and bringing transparency, fairness, and robust regulation to the stock market which can only be done by the regulatory subpoena power of the SEC more economic destruction is likely to follow the destruction already wrought by the pandemic and four long years of Grifting Trumpism.

We are investment bankers [and financial services like Robinhood]. We don’t care what happens in five years.

Vincent Dahinden, head of global structured products, Royal Bank of Scotland, Institutional Investor, 12 February 2004

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object. (Keynes 1936, 97)

These tendencies are a scarcely avoidable outcome of our having successfully organised ‘liquid’ investment markets. It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of stock exchanges. That the sins of the London Stock Exchange are less than those of Wall Street may be due, not so much to differences in national character, as to the fact that to the average Englishman Throgmorton Street is, compared with Wall Street to the average American, inaccessible and very expensive. The jobber’s ‘turn’, the high brokerage charges and the heavy transfer tax payable to the Exchequer, which attend dealings on the London Stock Exchange, sufficiently diminish the liquidity of the market (although the practice of fortnightly accounts operates the other way) to rule out a large proportion of the transactions characteristic of Wall Street. The introduction of a substantial Government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise in the United States. (Keynes 1936, 97)

— J. M. Keynes, The General Theory of Employment, Interest and Money, 1936

~ ~ ~

I suppose this book started when I first heard the story of Sergey Aleynikov, the Russian computer programmer who had worked for Goldman Sachs and then, in the summer of 2009, after he’d quit his job, was arrested by the FBI and charged by the United States government with stealing Goldman Sachs’s computer code. I’d thought it strange, after the financial crisis, in which Goldman had played such an important role, that the only Goldman Sachs employee who had been charged with any sort of crime was the employee who had taken something from Goldman Sachs. I’d thought it even stranger that government prosecutors had argued that the Russian shouldn’t be freed on bail because the Goldman Sachs computer code, in the wrong hands, could be used to “manipulate markets in unfair ways.” (Goldman’s were the right hands? If Goldman Sachs was able to manipulate markets, could other banks do it, too?) But maybe the strangest aspect of the case was how difficult it appeared to be—for the few who attempted—to explain what the Russian had done. I don’t mean only what he had done wrong: I mean what he had done. His job. He was usually described as a “high-frequency trading programmer,” but that wasn’t an explanation. That was a term of art that, in the summer of 2009, most people, even on Wall Street, had never before heard. What was high-frequency trading? Why was the code that enabled Goldman Sachs to do it so important that, when it was discovered to have been copied by some employee, Goldman Sachs needed to call the FBI? If this code was at once so incredibly valuable and so dangerous to financial markets, how did a Russian who had worked for Goldman Sachs for a mere two years get his hands on it? (Lewis 2014, 40-53)

[I]n a room looking out at the World Trade Center site, at One Liberty Plaza … gathered a small army of shockingly well-informed people from every corner of Wall Street—big banks, the major stock exchanges, and high-frequency trading firms. Many of them had left high-paying jobs to declare war on Wall Street, which meant, among other things, attacking the very problem that the Russian computer programmer had been hired by Goldman Sachs to create. (Lewis 2014, 53-56)

(….) One moment all is well; the next, the value of the entire U.S. stock market has fallen 22.61 percent, and no one knows why. During the crash, some Wall Street brokers, to avoid the orders their customers wanted to place to sell stocks, simply declined to pick up their phones. It wasn’t the first time that Wall Street people had discredited themselves, but this time the authorities responded by changing the rules—making it easier for computers to do the jobs done by those imperfect people. The 1987 stock market crash set in motion a process—weak at first, stronger over the years—that has ended with computers entirely replacing the people. (Lewis 2014, 62-67)

Over the past decade, the financial markets have changed too rapidly for our mental picture of them to remain true to life. (Lewis 2014, 67)

(….) The U.S. stock market now trades inside black boxes, in heavily guarded buildings in New Jersey and Chicago. What goes on inside those black boxes is hard to say—the ticker tape that runs across the bottom of cable TV screens captures only the tiniest fraction of what occurs in the stock markets. The public reports of what happens inside the black boxes are fuzzy and unreliable—even an expert cannot say what exactly happens inside them, or when it happens, or why. The average investor has no hope of knowing, of course, even the little he needs to know. He logs onto his TD Ameritrade or E*Trade or Schwab account, enters a ticker symbol of some stock, and clicks an icon that says “Buy”: Then what? He may think he knows what happens after he presses the key on his computer keyboard, but, trust me, he does not. If he did, he’d think twice before he pressed it. (Lewis 2014, 72-78)

The world clings to its old mental picture of the stock market because it’s comforting; because it’s so hard to draw a picture of what has replaced it; and because the few people able to draw it for you have no [economic] interest in doing so. (Lewis 2014, 78-80)

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