Flash Boys: A Wall Street Revolt

In the early 2000s, high demand for housing in the United States and a corresponding rise in prices helped drive substantial economic growth. In 2007, the real estate “bubble” burst and the decline in prices contributed to a recession that marked the worst conditions for the US economy since the Great Depression (1929-1939). Wall Street giants Bear Sterns and Lehman Brothers both collapsed, leading to a financial crisis that wiped out trillions of dollars and jeopardized the entire global economy. To avert the worst-case scenario, the US Congress passed a massive relief package to shore up financial institutions deemed “too big to fail.” In the aftermath, it became apparent that large Wall Street firms played a significant role in exacerbating the housing crisis. When the housing boom peaked years earlier, the Federal Reserve drastically raised interest rates to deter buyers who might otherwise oversaturate the market. Wall Street firms turned to so-called “subprime mortgages” to maintain their growing profits, which expanded the pool of potential homeowners by targeting people who could in many cases afford interest-only payments. These interest-only payments caused the principal amounts of the loans to skyrocket and snowball out of control as the bundles of loans passed between banks. Wall Street firms sold bundles of such mortgages to one another for profit and ignored the growing threat caused by the inability of homeowners to pay money toward the principal amount of their loans.

Congress received immense criticism for spending so much money to bail out the very agencies that bore responsibility for the crisis. To recover their reputation, Congress passed a series of measures to reduce the risk of another crisis. The most significant of these was the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which set liquidity requirements for large banks, establishing the Consumer Financial Protection Bureau, and making it easier for whistleblowers to call attention to malfeasance on Wall Street. Michael Lewis argues in Flash Boys that these reforms were not enough, on the basis that Wall Street reforms tend to be piecemeal and focused on very specific activities, such as subprime mortgages, while leaving the incentives and structures that caused these problems intact. These piecemeal reforms have two glaring limitations: Every effort to clarify acceptable behavior creates new gray areas that canny investors can exploit and limited reform accepts the basic structures of Wall Street as they are. Even if there is never another subprime mortgage crisis, Wall Street is constantly developing new and risky techniques that exacerbate the risk of different kinds of crises with the same root causes. Katsuyama’s quest to curtail HFT is an attempt to reform the system from within rather than from without.