Flash Boys: A Wall Street Revolt (2 page)

What Spivey had realized, by 2008, was that there was a big difference between the trading speed that was available between these exchanges and the trading speed that was theoretically possible. Given the speed of light in fiber, it should have been possible for a trader who needed to trade in both places at once to send his order from Chicago to New York and back in roughly 12 milliseconds, or roughly a tenth of the time it takes you to blink your eyes, if you blink as fast as you can. (A millisecond is one thousandth of a second.) The routes offered by the various telecom carriers—Verizon, AT&T, Level 3, and so on—were slower than that, and inconsistent. One day it took them 17 milliseconds to send an order to both data centers; the next, it took them 16 milliseconds. By accident, some traders had stumbled across a route controlled by Verizon that took 14.65 milliseconds. “The Gold Route,” the traders called it, because on the occasions you happened to find yourself on it you were the first to exploit the discrepancies between prices in Chicago and prices in New York. Incredibly to Spivey, the telecom carriers were not set up to understand the new demand for speed. Not only did Verizon fail to see that it could sell its special route to traders for a fortune; Verizon didn’t even seem aware it owned anything of special value. “You would have to order up several lines and hope that you got it,” says Spivey. “They didn’t know what they had.” As late as 2008, major telecom carriers were unaware that the financial markets had changed, radically, the value of a millisecond.

Upon closer investigation, Spivey saw why. He went to Washington, DC, and got his hands on the maps of the existing fiber cable routes running from Chicago to New York. They mostly followed the railroads and traveled from big city to big city. Leaving New York and Chicago, they ran fairly straight toward each other, but when they reached Pennsylvania they began to wiggle and bend. Spivey studied a map of Pennsylvania and saw the main problem: the Allegheny Mountains. The only straight line running through the Alleghenies was the interstate highway, and there was a law against laying fiber along the interstate highway. The other roads and railroads zigzagged across the state as the landscape permitted. Spivey found a more detailed map of Pennsylvania and drew his own line across it. “The straightest path allowed by law,” he liked to call it. By using small paved roads and dirt roads and bridges and railroads, along with the occasional private parking lot or front yard or cornfield, he could cut more than a hundred miles off the distance traveled by the telecom carriers. What was to become Spivey’s plan, then his obsession, began with an innocent thought: I’d like to see how much faster someone would be if they did this.

In late 2008, with the global financial system in turmoil, Spivey traveled to Pennsylvania and found a construction guy to drive him the length of his idealized route. For two days they rose together at five in the morning and drove until seven at night. “What you see when you do this,” says Spivey, “is very small towns, and very tiny roads with cliffs on one side and a sheer rock wall on the other.” The railroads traveling east to west tended to tack north and south to avoid the mountains: They were of limited use. “Anything that wasn’t absolutely east-west that had any kind of curve in it I didn’t like,” Spivey said. Small country roads were better for his purposes, but so tightly squeezed into the rough terrain that there was no place to lay the fiber but under the road. “You’d have to close the road to dig up the road,” he said.

The construction guy with him clearly suspected he might be out of his mind. Yet when Spivey pressed him, even he couldn’t come up with a reason why the plan wasn’t at least theoretically possible. That’s what Spivey had been after: a reason not to do it. “I was just trying to find the reason no [telecom] carrier had done it,” he says. “I was thinking: Surely I’ll see some roadblock.” Aside from the construction engineer’s opinion that no one in his right mind wanted to cut through the hard Allegheny rock, he couldn’t find one.

That’s when, as he puts it, “I decided to cross the line.” The line separated Wall Street guys who traded options on Chicago exchanges from people who worked in the county agencies and Department of Transportation offices that controlled public rights-of-way through which a private citizen might dig a secret tunnel. He sought answers to questions: What were the rules about laying fiber-optic cable? Whose permission did you need? The line also separated Wall Street people from people who knew how to dig holes and lay fiber. How long would it take? How many yards a day might a crew with the right equipment tunnel through rock? What kind of equipment was required? What might it cost?

Soon a construction engineer named Steve Williams, who lived in Austin, Texas, received an unexpected call. As Williams recalls, “It was from a friend of mine. He said, ‘I have an old friend whose cousin is in trouble, and he has some construction questions he needs answers to.’ ” Spivey himself then called. “This guy gets on the phone,” recalls Williams, “and is asking questions about case sizes, and what kind of fiber you use, and how would you dig in this ground and under this river.” A few months later Spivey called him again—to ask him if he would supervise the laying of a fifty-mile stretch of fiber, starting in Cleveland. “I didn’t know what I was getting into,” said Williams. Spivey told him nothing more about the project than what he needed to know to lay a single fifty-mile stretch of cable. In between, Spivey had persuaded Jim Barskdale, the former CEO of Netscape Communications and a fellow native of Jackson, to fund what Spivey estimated to be a $300 million tunnel. They named the company Spread Networks, though they disguised the construction behind shell companies with dull names like Northeastern ITS and Job 8. Jim Barksdale’s son, David Barksdale, came on board—to cut, as quietly as possible, the four hundred or so deals they needed to cut with townships and counties in order to be able to tunnel through them. Williams then proved so adept at getting the line into the ground that Spivey and Barksdale called and asked him to take over the entire project. “That’s when they said, ‘Hey, this is going all the way to New Jersey,’ ” Williams said.

Leaving Chicago, the crews had raced across Indiana and Ohio. On a good day they were able to lay two to three miles of the line in the ground. When they arrived in western Pennsylvania they hit the rock and the pace slowed, sometimes to a few hundred feet a day. “They call it blue rock,” says Williams. “It’s hard limestone. And it’s a challenge to get through.” He found himself having the same conversation, over and over again, with Pennsylvania construction crews. “I’d explain to them that we need to go through some mountain, and one after another they would say, ‘That’s crazy.’ And I would say, ‘I know that’s crazy, but that’s how we’re doing it.’ And they would ask, ‘Why?’ And I’d say, ‘It’s more of a customized route to the owner’s wishes.’ ” To which they really didn’t have much to say except, “Oh.” His other problem was Spivey, who was all over him about the slightest detours. For instance, every so often the right-of-way crossed over from one side of the road to the other, and the line needed to cross the road within its boundaries. These constant road crossings irritated Spivey—Williams was making sharp right and left turns. “Steve, you’re costing me a hundred nanoseconds,” he’d say. (A nanosecond is one billionth of one second.) And: “Can you at least cross it
diagonally
?”

Spivey was a worrier. He thought that when a person took risks, the thing that went wrong was usually a thing the person hadn’t thought about, and so he tried to think about the things he wouldn’t naturally think about. The Chicago Mercantile Exchange might close and move to New Jersey. The Calumet River might prove impassable. Some company with deep pockets—a big Wall Street bank, a telecom carrier—might discover what he was doing and do it themselves. That last fear—that someone else was already out there, digging his own straight tunnel—consumed him. Every construction person he talked to thought he was out of his mind, and yet he was sure the Alleghenies were crawling with people who shared his obsession. “When something becomes obvious to you,” he said, “you immediately think surely someone else is doing this.”

What never crossed his mind was that, once his line was finished, Wall Street would not want to buy the line. Just the reverse: He assumed that the line would be the site of a gold rush. Maybe for that reason, he and his backers hadn’t thought much about how to sell the line until the time came to do it. It was complicated. What they were selling—speed—was only valuable to the extent that it was scarce. What they did not know was the degree of scarcity that would maximize the line’s market value. How much was it worth to a single player in the U.S. stock market to have an advantage in speed over everyone else? How much to twenty-five different players—to share the same advantage over the rest of the market? To answer these sorts of questions, it helps to know how much money traders can make purely from speed in the U.S. stock market, and how, exactly, they make it. “No one knew this market,” says Spivey. “It was opaque.”

They considered holding a Dutch auction—that is, start at some high reserve price and lower it until the line was bought by a single Wall Street firm, which would then enjoy a monopoly. They weren’t confident that any one bank or hedge fund would fork over the many billions of dollars they assumed the monopoly was worth, and they didn’t like the sound of the inevitable headlines in the newspapers: Barksdale Makes Billions Selling Out Ordinary American Investor. They hired an industry consultant named Larry Tabb, who had caught Jim Barksdale’s attention with a paper he’d written called “The Value of a Millisecond.” One way to price access to the line, Tabb thought, was to figure out how much money might be made from it, from the so-called spread trade between New York and Chicago—the simple arbitrage between cash and futures. Tabb estimated that if a single Wall Street bank were to exploit the countless minuscule discrepancies in price between Thing A in Chicago and Thing A in New York, they’d make profits of $20 billion a year. He further estimated that there were as many as four hundred firms then vying to capture the $20 billion. All of them would need to be on the fastest line between the two cities—and there were only places for two hundred of them on the line.

Both estimates happily coincided with Spivey’s sense of the market, and he took to saying, with obvious pleasure, “We have two hundred shovels for four hundred ditch diggers.” But what to charge for each shovel? “It was really a total wet finger in the air,” says Brennan Carley, who had worked closely with a lot of high-speed traders, and who had been hired by Spivey to sell his network to them. “All of us were just guessing.” The number they came up with was $300,000 a month, roughly ten times the price of the existing telecom lines. The first two hundred stock market players willing to pay in advance and sign a five-year lease would get a deal: $10.6 million for five years. The traders who leased Spread’s line would also need to buy and maintain their own signal amplifiers, housed in thirteen amp sites along Spread’s route. All-in, the up-front cost to each of the two hundred traders would come to about $14 million, or a grand total of $2.8 billion.

By early 2010 Spread Networks still hadn’t informed a single prospective customer of their existence. A year after the workers had started digging, the line was, incredibly, still a secret. To maximize the line’s shock value and minimize the chance that someone else would seek to replicate what they had done, or even announce their intention to do so, they decided to wait until March 2010, three months before the line was due to be completed, before they tried to sell it. How to approach the rich and powerful men whose businesses they were about to disrupt? “The general modus operandi was to find someone at one of these firms one of us knew,” says Brennan Carley. “We’d say, ‘You know me. You know of Jim Barksdale. We have something we want to come over and talk to you about. We can’t tell you what it is until we get there. And, by the way, we want you to sign an NDA [non-disclosure agreement] before we come in.’ ”

That’s how they went to Wall Street—in stealth. “There were CEOs at every meeting,” says Spivey. The men with whom they met were among the most highly paid people in the financial markets. The first reaction of most of them was total disbelief. “People told me later that they thought, Surely not, but let’s talk to him anyway,” says Spivey. Anticipating their skepticism, he carried with him a map, four feet by eight feet. He finger-walked them through his cross-country tunnel. Even then people still demanded proof. You couldn’t actually see a fiber-optic line buried three feet under the ground, but the amp sites were highly visible thousand-square-foot concrete bunkers. Light fades as it travels; the fainter it becomes, the less capable it is of transmitting data. The signals transmitted from Chicago to New Jersey needed to be amplified every fifty to seventy-five miles, and for the amplifiers that did the work, Spread had built these maximum-security bunkers along the route. “I know you guys are straight shooters,” one trader said to them. “But I never heard of you before. I want to see a
picture
of this place.” Every day for the next three months, Spivey emailed this man a photograph of the most recent amp site under construction to show him that it was actually being built.

Once their disbelief faded, most of the Wall Street guys were just in awe. Of course they all still asked the usual questions.
What do I get for my $14 million in assorted fees and expenses?
(Two glass fibers, one for each direction.)
What happens if the line’s cut by a backhoe
? (We have people on the line who will have it up and running in eight hours.)
Where is the backup if your line goes down?
(Sorry, there isn’t one.)
When can you supply us with the
five years of audited financial statements that we require before we do business with any firm?
(Um, in five years.) But even as they asked their questions and ticked their boxes, they failed to disguise their wonder. Spivey’s favorite meeting was with a trader who sat stone-faced listening to him for fifteen minutes on the other side of a long conference table, then leapt to his feet and shouted, “SHIT, THIS IS COOL!”