How a money manager realized High Frequency Traders were ripping him off

The book Flash Boys by Michael Lewis tells the story of how a mild-manner stock trader named Brad Katsuyama, while working at the milder-mannered Royal Bank of Canada (RBC), identified how High Frequency Trading (HFT) firms were stepping between buyers and sellers to make an unfair profit for themselves. How do they do this? The short and no-longer-a-secret answer is that they pay the stock exchanges enormous sums to give them information about what’s happening in the market before it is seen by ordinary investors.

Slipping one past mutual fund investors

In 2013, PBS Frontline released the documentary titled The Retirement Gamble. While the name is off target — it’s really about how Fund industry fees hamper nest egg growth —  the video takes key retirement issues head on.

In one scene, economist Robert Hiltonsmith is sitting at a computer scanning an on-line fund report as he explains the myriad fees levied by the industry. He points out the column heading shown in the screen shot below.

What I learned watching Inside Job 25 times

Despite the implication, I am not completely obsessed with Inside Job, a documentary post-mortem of the 2008 financial crisis. It’s just that I have five sections of my introductory investing class each year and we’ve been watching the movie as the culmination of the course since its release five years ago. Without further delay:

Most shocking moment   It’s a tie!

  • Larry Summers trying to intimidate CFTC Chairwoman Brooksley Born into silence by menacingly staring her down during her very public Congressional testimony (at 24:59), and
  • Harvard Professor Martin Feldstein, who, after being asked if he had any regrets in his role as a member of AIG’s Board of Directors (which presided over its implosion, necessitating a taxpayer bailout in excess of $150 billion), to which he replied “No.” This occurs at 1:23.55. Feldstein’s nonchalant answer is so stunning that the interviewer is left speechless.

Person who should be most embarrassed  Fred Mishkin, who showed himself to be a buffoon on so many levels. He acknowledged that everything he said about Iceland in his paper defending its deregulated financial system was incorrect. He had no idea that many top financial institutions such as Lehman Brothers, Fannie Mae and Freddie Mac had AA or even AAA ratings until just a few days before they imploded. He acknowledged attending meetings where consumer advocate Greenlining presented evidence of abusive and predatory mortgages being offered to unsuspecting borrowers, to which his response was “So, what do you do?” Here’s an idea: immediately prohibit those types of mortgages.

A strong runner-up is John Campbell, Chairman of Harvard’s Economics Department. He saw no conflict of interest in his professors becoming wealthy by cashing in on the prestige of their positions at Harvard. It took the interviewer using a scenario of a doctor prescribing a medicine that he or she has an ownership interest in to get Campbell to understand what conflict of interest means. Upon achieving this “aha” moment, Campbell froze and could only utter “um” and “ah” for the next several seconds.

Biggest revelation   That the tentacles of the financial industry are so far-reaching they’ve corrupted the study of economics itself. Basically, professors traffic in the prestige of their universities by providing cover to Wall Street firms that want a highly reputable third party (like only an Ivy League institution can be) to assure Congress, the public and critics that its latest financial innovation is perfectly safe (and couldn’t possibly blow up the world).

Students reflect on Inside Job – Overall reaction and what it says about America

As discussed in What I learned watching Inside Job 25 times, I show this movie at the end of my introductory investing course. I then ask students to reflect on it. One of the questions they’re asked:

What is your overall reaction to the Inside Job movie and what it says about America? Think: democracy, society, leadership, capitalism, fairness, corruption, opportunity, freedom, the American dream, etc.

Sophomore Z.A.  Before I watched “Inside Job” I was under the impression that the implosion of the stock market was natural, and was simply “meant to happen.” However, I now understand the extent of the corruption of Wall Street, and how it creates a negative image of the United States of America. More specifically, the fact that members of the United States government, such as Federal Reserve Chairman, Ben Bernanke, arguably knew the situation, makes us understand how unloyal our leaders are. Moreover, if this is truly the definition of capitalism, it is clear that there is need for reformation! Clearly, ideas such as “opportunity” and the “American dream” are now less and less freedom-like, mainly because our own leaders have proven themselves to be content with lying and deceiving us, both as traders and as citizens. I am simply appalled with the lack of orderliness or even straight-forward trusthworthiness that Wall Street has shown. The most tragic aspect of the situation is that the people involved do not admit their wrong doing and also, walk away with their fortunes! Looking back, I’ve simply learned that there is another layer to the onion which resembles America, and it is not pretty.

Students reflect on Inside Job – The 1% vs. the 99%

As discussed in What I learned watching Inside Job 25 times, I show this movie at the end of my introductory investing course. I then ask students to reflect on it. One of the questions they’re asked:

“The movie talked about how income disparity is growing between the top 1% of income earners and the other 99%. The 1%ers continue to separate themselves from other 99%. An example: a Manhattan apartment can now sell for over $100 million. But, over half of Americans have no wealth and are having trouble affording the house or apartment they live in! How do you view this? Is it a concern to you or something that’s not important, and why? Make sure to address how this could play out in the medium and long-term future, as in:  Where will this lead?”

Sophomore M.K.  I believe that compensation should be about value added towards the company, so in the case of the disparity between a CEO and a minimum wage worker, the CEO is potentially making million dollar deals, while a wage worker is doing a non-specialized task. The debate over income disparity that is occurring should not be focused on executive pay; rather, raising minimum wage to allow hourly workers to make a real living instead of living paycheck to paycheck. If something like this is not done, there will be real societal issues to follow, with hourly workers possibly going on strike or worse, leaving the economy in the lurch. This is a major issue that can and should be solved by the government, requiring companies to pay their hourly workers fair pay and benefits. After watching the documentary on Walmart earlier in the year in class, that documentary made the point that the bottom line of the company would not be reduced by such as margin where they couldn’t make money. Rather, the movie showed that with higher pay came worker satisfaction which in turn led to more efficient working. This would led to large companies making even more money, with their workforce even more efficient.