Motley Fool Hidden Gems Investing - Motley Fool Money: 08.29.2014

Episode Date: August 27, 2014

Is high-speed trading a big problem for investors?  On this week's show, we revisit our interview with Michael Lewis, author of Flash Boys: A Wall Street Revolt. Learn more about your ad choices. Visit megaphone.fm/adchoices

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You want more? I'll give you more! Mobland, new season hits September 18th on Paramount+. everybody needs money that's why they call it money from fool global headquarters this is motley fool money it's the motley fool money radio show i'm chris hill this week we revisit one of our most popular interviews earlier this year motley fool CEO Tom Gardner sat down with best-selling author Michael Lewis to talk about his book Flash Boys, A Wall Street Revolt. In it, Lewis explores the secretive world of high-speed trading, and they begin by talking about a big problem with the stock market.

Can I just start? Yeah. Are you ready? Yeah. All right. Rather than you ask me a question. Great. This is great. Because before we went on camera, you just said, and a fool is a good thing. And you just triggered a thought that the experience of writing this book has sort of hammered

home. And it's that a big part of the problem in the stock market right now, or has been, that investors did not want to acknowledge their ignorance about how the stock market worked. So they're willing to believe the noise that came out of brokers' mouths about how electronic trading worked. And everybody is still, to this moment... And not just investors, like small investors, but like the CEOs of large mutual fund companies. The heads of mutual funds, the heads of pension funds, the big hedge fund managers, that the thing that they get quickly offended by, coming out of my mouth, say, is the idea that the hero of my book explains to them how the stock market now works, even though that's what happened. That two or three years ago, they had no idea how they were being front-run by high-frequency traders. This guy comes and explains.

They respond by saying, oh, my God, I can't believe this is happening. Flash forward to now, and when they tell the story, oh, I knew most of what was happening. He helped me round out my understanding. And it's funny that this is, it's a problem in finance. And I don't know quite why it's a particular problem in finance. The idea that ignorance is a sin, and so everybody's terrified about not knowing. When it's such an unhealthy... I'm not defending finance by asking this, but what industry is ignorance not a sin?

I mean, obviously, it's maybe the greatest sin in finance where you're essentially, in many cases in finance, acting as a salesperson. I have an answer for you. Yeah. My industry. Journalism. It's great. Being a detective. Columbo.

You know, that not knowing is an excuse to learn. That not pretending, not being a know-it-all is a huge advantage in being a journalist. It's better to seem to know less than you know. Have you read the book The Outsiders by Will Thorndike? I have not. He points out eight CEOs that performed incredibly well over 20-plus year periods as CEOs. And he looks for the patterns across them. Right.

And what he finds is that virtually all of these CEOs came from outside their industry. So they acted as detectives. They had to figure out what was really happening. They brought fresh eyes to it. And they didn't have any convention to protect. And there was no stigma associated with not knowing. Right. And there's a stigma associated with not knowing things in a rapidly changing environment, which is finance.

So things are always not known. There's all this innovation going on, much of it malign. And, I mean, nobody knows what a subprime CDO really is or whether it's really AAA. Nobody asks. I mean, so that's – I don't know why this is particularly a problem. I think it is a particular problem. It's very noticeable in finance. And it may be because in finance it's filled with people who are rich

and they're used to people thinking they know everything and they like that pose of I know everything. Well, it creates an incredibly interesting dynamic now. the technology is coming front and center into finance and, of course, into every industry. Automation algorithms and what 61-year-old CEO of a large financial firm should know thinks about that going in. And so they're seriously hurt by the fact that they can't willingly admit that they don't understand how the tech works. So I'll tell you a quick story I heard. I didn't put it in the book while I was working

on it. So a guy who I met who kind of experimented in designing high-frequency trading strategies, but never really put him into practice. He was a professorial type. Collided with an old trader who ran a money management firm who said, this was five or six years ago, let's try your algo. Let's go trade with the thing you dreamed up. And so the guy says, I've never done it before,

but let's do it. So they hook it up, so they're hooked up to doing trades. And they hit the button, enter, to go. And the thing starts doing maniacal things. I mean, it's like losing, boom, losing money. It's like an IBM commercial right now. And the 61-year-old CEO, the money manager, first, turn it off, turn it off. And they're hitting buttons and they can't turn it off.

He goes on and he yanks the plug out of the wall to shut the machine down. But it was just, you know, there is the, I mean, it is sort of like the mark of the Wall Street man, overconfidence. I mean, male overconfidence is responsible for so much trouble in the financial system. And when it collides with technology, it's particularly toxic. Let's go with some of the basic themes of the book, just for those of us who aren't familiar with them. And I was saying to you off camera that high-frequency trading, dark pools, the whole dynamic between the two, flash trades. I've heard the terms, but I've never really spent much time digging into them because I'm buying stocks and holding them for five-plus years. So there's no particular reason for you to know.

Nonetheless, it would be good for me to know. For one reason. You know what the reason is? You're talking about the structure of the market you're operating in. So while you just sitting on stocks may not be getting scalped that often, the market is becoming increasingly unstable in the service, just to serve the high-frequency traders. Flash crash. Flash crash is just one symptom. Outages at NASDAQ, BATS IPO going crazy, Facebook IPO.

It's one thing after another. So at some point, you shouldn't have to, you shouldn't have to, but it probably behooves you to pay attention to, is this market stable? So what is high-frequency trading? It's a term of art that really didn't hit the newspapers or the public consciousness until maybe 2009 when a Goldman Sachs programmer was labeled a Goldman Sachs high-frequency trading programmer and was arrested by the FBI for taking Goldman's code.

And it's not easy to define. I guess you could say, if you want to be the loose definition, it would be trading by computer algorithm at very high speeds. Microseconds. What's a microsecond? I mean, right? I mean, it's milliseconds. I mean, in fact, at this moment, the cutting-edge high-frequency trading firms are talking about picoseconds, which is worse than nanoseconds. So to put that in context, I'm told that a blink of an eye takes between 100 and 200 milliseconds.

And a millisecond is 1,000 microseconds in a millisecond, 1,000 nanoseconds in a microsecond, and 1,000 picoseconds in a – right. So it gives you an idea. I like to think I can blink my eye faster than that. See? I did it. You are ready to trade. You are ready to trade. I'm ready to go.

So talk about spread networks. And essentially, in a way, as I was reading, I was thinking this is like the very first oil pipelines. I mean, maybe not necessarily the first. I was thinking the railroads. Yeah, I was, yeah. The railroads. So can I frame this just by saying? Please.

All right. So the book, it's a very simple structure. It's about one guy who's a trader on Wall Street figuring out how the stock market actually works. Even though he's in the stock market, he realizes around 2008, something's changed and I don't know. What is it? And Spread Networks enters in the story, even though it opens the story, as an important data point for him in what's happened. So what Spread Networks is, is there was a trader on the Chicago Mercantile Exchange who realized that people were willing to pay for speed, incredible speed, but without totally knowing what it was for. His name was Dan Spivey.

And Spivey in 2009 looks at the fiber optic line that runs from the Chicago Mercantile Exchange to the New Jersey Stock Exchange is where the actual stocks are traded. Futures are in Chicago, individual stocks in New Jersey. And he sees that the fastest line goes like this from one place to the other. It's a Verizon line. It takes like 16 milliseconds. We go back and forth, which is not much time. But nevertheless, he realizes if you just laid a straight line fiber from the exchange in Chicago to the exchange in New Jersey, you could get it down to 11 milliseconds. And that whoever was faster was going to – winning by a microsecond was enough.

And people were already trying to capture good areas of the Verizon line. That's right. And Verizon didn't even know what they had. They didn't realize that people were using it to trade. They didn't realize just how valuable very small increments of speed had become to stock market traders. And he did. He didn't know exactly how either. In fact, he was flying blind in a lot of ways.

But he persuades Jim Barksdale, who is the former CEO of Netscape, and some other investors, but mainly Barksdale, to give him 300-plus million dollars to dig a hole, to dig a tunnel from Chicago to New Jersey on a straight line to lay this fiber, completely in stealth. He is able to string this line through. Pennsylvania turns out to be the problem. It's pretty easy to run a straight line through Ohio, but when you get to Pennsylvania, mountains are the problem.

And the mountains run kind of diagonally. So he blasts holes through mountains. He goes through farmer's fields. He goes through parking lots. He buys rights away. What year is this? 2009, 2010. So not that long ago, right?

He finishes it in the summer of 2010. And he's able to do it without anybody, anybody asking him what exactly is the line for, or at least not having to answer the question. That people just, well, it's just some fiber. And the sole purpose of the line is to speed up stock market trades. And what it's really supposed to do, I mean, I don't think even he completely got this, because he thought he was building a line that enabled people to do the arbitrage between the futures and the cash. But the way the high-frequency traders work is they're making lots of little markets in small amounts of shares in all the stocks in New Jersey.

They don't actually want to own these things. They're trying to tease out information. They're making the markets to tease out information about what investors are doing so they can react to it. So they're listing 100 shares available when an order is coming for 10,000 shares. Right, so they find it, ah, so I want to get on the other side of that. I want to get in front of that. But the risk, the big risk for them is that the whole market goes down, and they're sitting here dangling out 100 share orders in 4,000 different stocks, and they get hit.

And they own a bunch of, they own, you know, all that stock. So they are very sensitive to overall market movements. They need to know, market pop and market not. And the market popping and the market going down first registers in the futures in Chicago. So they get the market direction, the directional signal from Chicago to New Jersey. It says get out of the market. You know what happened to Flashcrest? My guess is it's not been well explained.

But my guess is that's how it starts. It's someone that it does start in the futures market. And then the next thing is all the people who are supposedly the intermediaries in the stock market just pull out. and this line gets the signal in the fastest possible way from the Chicago exchange to the New Jersey exchange so Spivey the great thing

I mean there's several great things about this story because he does it completely in secret he doesn't tell any it's also great that he's doing it in secret and he doesn't really fully know why he's doing it he doesn't he thinks he knows why and he thinks he knows the market he thinks there are 400 people out there who will pay he's guessing

10 million dollars a pop to be on the line uh but they're guessing i mean there's this wonderful business school case study that someone will do about this one day but so they start to go out into the market to tell high frequency traders that if they want the fastest line he's got it just flipping it on a week you better pay for it or you're out a bit or you're or you're not you're going to be last to know whether the market moved um and the high frequency traders when he goes to see them they're like who the hell are you you know they don't know what did you just do 10 million dollars you out of your mind we have basically like a costless line already from verizon and then nobody knows how

valuable is and so they really want to like throw him out of the office but then they realize he's right we got to have it and they're but it isn't 400 of them it's 27 of them it's not that many but but in a funny way they also begin to resent him they hate him yeah they all like they all hate him my system is working now i'm gonna have to pay 10 million and now the game is on to go faster and faster to beat the other firms right they hate him and he loves it that they hate him He doesn't care. He's like the salesman who doesn't matter what his customers think about him. And he says this to me, actually.

It was kind of fun to see how angry they got. One of the customers, when they walk in, gets angry, calms down, says, let us think about it. And then comes back and says, can you double the price? Because they wanted to price everybody else off the line. The bank's response is riveting. So he goes into the banks. The banks are trying, at that point in their lives, think they're competing. I think they think they're going to compete in high-frequency trading.

That turns out not to be so, I think. But he goes into Goldman Sachs, and he goes into Credit Suisse, and Credit Suisse says, and he says, you can lease, for $10 million, you can be on the line, but you can't let your customers use it. You can't let anybody else use it. It's just for your own proprietary trading. To which they say, screw you. You're trying to screw our customers. We won't do that.

you want us to trade against our customers at a faster speed than the customers can trade. We're not going to do that. He goes to Goldman Sachs and says, ship it in. We'll take it. And I also like the Morgan Stanley. The Morgan Stanley, they say, could you change the language? In case we're called out. Yes, in case we're called out.

So the optics aren't good. But he starts to develop the first picture of what this market looks like. No one knows this market. No one knows who these high-frequency traders are. He's finding their names in kind of obscure SEC documents and calling them up out of the blue and saying, you don't know this, but you have to meet with me. Coming up, why Flash Boys is the new money ball. This is Motley Fool Money.

Welcome back to Motley Fool Money. I'm Chris Hill. Let's get back to Motley Fool CEO Tom Gardner's interview with Michael Lewis about his latest bestseller, Flash Boys, A Wall Street Revolt. In a funny way, Dan Spivey is similar to Brad and Ronan in that when they went to present what they were developing, they were, it's Moneyball. They were laughed out of the executive suite at every baseball team stadium. It's very funny. My brother David, initially, he wanted to go into baseball.

He thought there was no path for him having read Bill James so early on. I don't know when Bill James first started writing, maybe in the early 80s or something. But Dave was there reading Bill James in the late 80s and really wanting to go into baseball and felt he would never have the ability to do it, so he went into investing. Because it was a meritocracy where, hey, people can laugh at me. They can say that my strategy doesn't work, but the merit will out. Yeah, we'll see what the results are. And so you have these characters who are stepping in to, yeah, the executive suite and convention

and being sort of initially laughed at before they explain why it is what they're doing and what it will mean. So here's also how it's very similar to Moneyball. So the Oakland A's go and find, basically, with their actions, say, to the rest of baseball, you don't know how to value baseball players and you don't understand the value of baseball strategies because we found inefficiencies in them and we're exploiting them. That's how we're succeeding. And the book describes that process. And in the bargain, embarrasses everybody who's not doing it their way

and creates this uproar and this anger. Brad Katsuyama and IEX come out and say, we have created the only fair exchange where investors actually are on equal footing and there aren't people exploiting each other just in the structure of the exchange, thereby embarrassing and humiliating and shaming all the other, the 13 public stock exchanges and 46 dark pools are out there, and basically everybody is involved in the stock market, and creating a very similar sort of uproar.

And this book feels, in the experience of publishing it, very similar to Moneyball. You know, it's interesting because there are so many other things I want to cover. I know we have limited time, but Dan Spivey, there's almost a little Moneyball in that. I mean, he's seeing something that others aren't seeing. It's an unbelievable act of entrepreneurial nerve to say, I'm going to lay a straight line from Chicago. I'm going to dig a tunnel. I'm going to blast through the Allegheny Mountains.

I'm going to blast through the Allegheny Mountains, and I'm going to do it completely in stealth. No one's going to know, and I'm going to spring it on a market I don't even know. But then what it creates is bad actions. That use of the technology, that great new insight in active entrepreneurialism leads to something that you certainly, I think, from the tone of the book, don't favor. So here's why. And Brad then counters it. So let me tell you this. I have a thing I've got to kind of square in my head, and it's this.

So I think Spivey's entrepreneurial act was incredible. I mean, it's like this is what makes America great, that someone's willing to go do that. And at the same time, the use to which this thing is put is not great. But I would say this, that the high-frequency traders were always going to have the fastest line. They were going to be doing this. I don't think he increased the take that high-frequency traders have in the market. He just taxed them. It's almost a pure tax.

So in a way, it was kind of charming. He was bleeding the profits of high-frequency traders. It's like someone who sneaks onto the pirate ship and steals the pirate's stolen gold. That's what it feels like. Coming up, Tom and Michael discuss a can't-lose business. This is Motley Fool Money. Welcome back to Motley Fool Money. I'm Chris Hill.

This week, we're sharing a recent interview that Motley Fool CEO Tom Gardner did with Michael Lewis about Lewis's new book, Flash Boys, A Wall Street Revolt. You know, I think a lot of people, myself included, initially thought high-frequency trading was profitable because of speed, and that was it. That they had some, they had some, they had some. Why would speed be valuable all by itself? Well, I was going to combine it with that they had their beliefs about where the market was going based on their fundamental research. Right? Yeah. Yeah, so I'm a fool.

I don't feel uncomfortable when you laugh at that. That's very sweet. This is why this book was so valuable to me, Michael. It's very good. I didn't know what the high-frequency trader advantage was. They have speed. They're there first, but what if they're wrong? So a couple of this.

So two things. One is their obsession is with speed, right, with microseconds advantages. And two, the fact that what we know of them, they never experience a day of trading losses, that every day is profitable. 1,000 days of no trading losses. Mathematically impossible. Unless you're basically gaming a market. You can't be taking market risk.

You can't be making judgments about stocks. No matter how good you are as a money manager, you will have stocks that go down some days, right? Of course. Of course. So they're doing something different. Well, this is why this book was so valuable to me. And what they're doing is explain dark pools and what is happening with the various firms. So one of the things the book tries to do through the journey of Brad Katsuyama is divine the different predatory strategies.

I don't pretend to have gotten them all. He finds four big ones. So one is, I'll give you an example. The one that's easiest to sort of get your mind around is the first one he discovers. He's sitting at his desk, at his trading desk in southern Manhattan in 2008. And previously, before he starts to know something is wrong, when he would look at his trading screens, he'd see however many stock markets there were at the time. He'd look across them. He'd say, well, altogether in all the markets, there's 20,000 shares of Microsoft offered at $25 a share.

I can buy. And if I want to buy 20,000, he hits a button. I'll buy 20,000. He gets them at 25. He would just get them. One day he wakes up and he hits the button and he only gets a couple thousand. Like everything else disappears and Microsoft stock goes up. And he realizes that from then on, every time he hits a button to buy or sell, it's like the market knows what he's trying to do.

and runs out in front of him and either jacks the price up or sends it down, depending on what he's buying or selling. It takes him a year and a half to figure out what is happening. By the way, how much do you think it's moving up? Let's say 25 pennies. He's putting his buy at 2,501 and the shares disappear. But over the course of a year in his trading desk, it's tens of millions of dollars. So it takes an incredible act of detective ingenuity for him to figure out what actually is happening.

And what actually is happening is one of the HFT strategies is the buy signal from his desk goes up the side of the West Side Highway in fiber optics, goes out the Lincoln Tunnel in the fiber optics that are on the side of the Lincoln Tunnel, and arrives first at the BATS stock exchange, which is planted right on the other side of the Lincoln Tunnel. I don't know why it was built there, but it's interesting that it was built there. The other exchanges are further away. It takes his buy signal longer to get to those exchanges. So on the BATS exchange, high-frequency traders are making small markets in Microsoft to divine the intentions of brokers who are sending in orders. They divine his intention to buy Microsoft, and they race him and beat him to the other exchanges, buy up the Microsoft, and then sell it back to him at a higher price.

So that's what happens in that case. And every time he— It's parasitic. It's parasitic. No matter what exchange he landed in first, they would beat him to the other exchanges to get whatever stock was there. So the fragmentation of the market created this opportunity for people to race back and forth between the markets. And the dark pools add even more fragmentation. So one way to generalize what's happening is that sort of like there's 60 places now where you can buy and sell the stock of Apple.

For investors, let's say, for large investors who don't want the market to know what investment they're making. So they send their order into a dark pool. Which ends up not being a dark pool. It's like, by the way, we put a couple of flashlights in the dark pool and we've given bathing suits. That's exactly right. So they give flashlights to high-frequency traders in the dark pool. They've given them special access, sold them access to the dark pool. And then what they do is the way the big banks tend to route the orders is they tend,

it's like they want their order to be executed in their dark pool. So they do everything possible to prevent it from being executed outside the dark pool. So they hoard the orders. So they keep big orders that might cross away from each other. So buyers, this system of intermediation has evolved to prevent buyers and sellers from coming together too easily because otherwise you don't need the intermediary. So people are saying, I'm sure it's happened in some of your interviews, I know that I've read online.

Some people are saying, well, this is just great. I don't know why Michael Lewis is raising an alarm here. This is creating a tremendous amount of liquidity in the market. It's allowing investors to be down penny to penny rather than back in the day in 1989 when I was buying shares. It was like you could buy it at 35 and an eighth. It's 35 and an eighth to 35 and seven eighths. I mean, we're not talking pennies. So we're out of fractions.

We're into decimals. So people are saying this. People are saying this. Let me see if I can explain this. So technology has brought wonderful gains to many industries. When I was living in London when I was 24 years old, it cost me like $2 a minute to make a phone call to my parents. It now costs me whatever, pennies a minute, right? And that's because of gains in technology.

Now imagine if some gremlin in the middle of the telephone system, in the process of that declining price, instead of letting it go down to two or three pennies a minute, wedge its way in and charge me 10 cents a minute or a nickel a minute. I'd say, wow, the phone system is still so much better. Why am I upset with the gremlins? And they were the first ones to go out publicly and say, we're creating phone calls. We're creating voice sound at a lower price with technology. So let me give you another explanation to couple with that explanation. If you take any market, take a stock market.

If the government waved a wand over and said, so you now have to be front run. Here's the government entity that will front run. Scalper Zinc. Scalper Zinc will front run every trade. What is the effect on this market? It will double the volume in the market because every trade gets front run. So all of a sudden, the scalper zinc creates twice the volume. And if you think liquidity is volume, yes, you increase liquidity.

And you can start to say you can't get rid of scalper zinc because otherwise the market would be half the size. That's what's happened. So you have to define liquidity. What is liquidity? Liquidity is your ability to turn your stock into cash. They're not there to do that. They're not there taking risks. They go home every night without positions.

Without them, technology and decimalization, the spreads would be narrower. That's true. The actual spread will be narrower. I mean, the stated spread is often a penny, right? It's tiny. But it's an illusion. The minute you go to act on that spread, it widens with any volume. So what has this changed for you in your active day trading?

I don't... Well, that's my question. What impact does this have on your approach to investment and molecule approach? Can I just tell what my reaction was? So my reaction was, first, unbelievable story that this has happened and that these guys wouldn't figure it out. So that was my first reaction. But how it affects me personally as an individual investor, I am the most passive investor there

is. I take very little interest in it. I don't trade and I hold long term. And so the scalping side of things matters very little to me. I mean, I'm not losing that much money. However, this is a system-wide tax on investment capital. And I don't know what it is. It's $20 billion or $30 billion, whatever it is a year.

It's a significant sum of money. So that's bad for the economy. Productive enterprise pays more for capital because of this. Now, that's in a way trivial compared to the instability caused in the system by the complexity required by high-frequency traders and demanded of the exchanges by high-frequency traders. So what is the instability? What if flash crashes and NASDAQ outages and all this lead to?

It leads to mistrust in the investment public. Why on earth are fewer Americans, is there a decline of individual American investment in the stock market during one of the greatest bull markets in history? It's because people don't trust it. I mean, there is understandable mistrust of this market. It's an unstable market. So what's the cost of the mistrust?

Well, here's a funny time. You tell me. I mean, I don't want to put you in the position of being incredibly selfish, but I'm going to for the fun of it. Doesn't all of that actually benefit you as a passive long-term investor? I mean, I don't want to make it all about each of us as an individual, but if so much of the financial machinery and the people that are behind it, which are becoming fewer and fewer as the machines take over, is focused on trying to slice down the time and the frequency that they can activate trades

and the information they can get to just nibble and be a parasite on every transaction, There's so much attention there. Doesn't that open up? And if the rest of the marketplace is therefore distrustful, doesn't that create a great long-term opportunity for a long-term passive investor like you? Think about that one. I mean, I think that my – I'm not saying it's a good thing. So my reaction, my basic reaction is probably not because what I'm thinking is I'm a long-term passive investor.

What am I actually doing as a long-term passive investor? I'm making an investment in the future profits of American corporations, or the corporations in my portfolio. And those future profits are going to be badly affected by an unstable market, if they're operating in an unstable market. I mean, it's just not good. But as a stock picker, if I was a long-term stock picker, maybe it creates more. If fewer people want to be in the marketplace, maybe it creates a bargain or two for me. I don't know. I just don't know.

But the overall instability and loss of trust in the market system. So can I add one more thing as a cost? And I don't think it's trivial. So if you create an industry on Wall Street that sucks in the brightest, best in the brightest, whose job is basically to game the system and scalp investors, and you create that as a model for success in this country, and that's what people, kids who graduate from Princeton, Harvard, and Yale think is successful, what is the effect of that instead of doing something actually useful?

I love the description in the book of, I think it's John Schwal, his first name John? Yes. And he's assembling the LinkedIn networks to understand what's happening with high frequency trading businesses because none of the executives will go on record and they'll fire anyone if they speak in the media. But so many of the developers, the software developers, the technology are going on to LinkedIn and posting what they do. And he's able to connect those networks and read what they're doing. And he comes to the conclusion that all of these very bright, presumably very bright developers don't know. They don't have any idea what they're doing. They're building the

whole technology platform. They have no idea how it's being used. It's being used to parasitically nibble off trades across the market. Right. That's right. It's amazing. And they found this, the people at IEX found this over and over, that the technologists tended, not always, but tended to be so narrow, so specialized, that they didn't have a sense of how their work fit into the big overall picture. That's a real misuse of talent resources. So that's disturbing. I have a potential solution. I'd like to have you shoot it down because I can't shoot it down in my mind right now, but I'm sure it can be. Maybe you can't shoot it down because it's your solution and you really don't want to. I'm so egotistically. So here's what it is.

Why don't we apply capital gains tax rates tied to the length of your holding period? We do in a very broad way. You're saying if it's a millisecond. Yes, it's 98% capital gains tax. And basically, if it's 10 years, it's 0% capital gains. So here's the thing. I mean, this is going to sound crazy coming from my mouth right now, but I have no doubt that there's some useful high-frequency trading.

And if you start mucking around in the markets that way, I think what we need is more transparency about what's going on. I think there are other ways to solve the problem. That seems like, I don't know what the consequences are. It seems so great to me that everyone now needs to be in New York. I love the firm. I can't remember in the brilliant story that you've told here, the firm that feels like it's fine to be in Kansas. Yes.

And then they're waking up to the reality. Well, you remember, you probably remember. There's a ton of people saying that the great thing about now, technology means it doesn't matter where you are. But if everyone needs to converge closer and closer right in the center of New York City, and New York City has, like, the highest tax rates, why don't we tax that high-frequency trading? They really have to be in New York. Well, they have to be in New Jersey, which is even worse.

They have to have their machines next to the stock exchange. That's the thing. Wall Street is no longer Wall Street. It's in New Jersey. How that happened, I don't know. Coming up, what's the real cost of high-frequency trading? Stay right here. This is Motley Fool Money.

Welcome back to Motley Fool Money. I'm Chris Hill, and we're wrapping up Motley Fool CEO Tom Gardner's interview with best-selling author Michael Lewis. Michael, what do you think broadly is happening with technology and, like, algorithms, robots? Does this interest you, or do you just happen to have gotten deeply into the story because it's in the world of finance, which you have spent so much of your life? I'm probably not as interested as I should be, but you can't help but notice that the technologist is displacing the trader on Wall Street. I mean, that's what's been happening, is machines have replaced people. So the people who control the machines are the people who have increasingly power, people who understand the machines. So the Russian technologist who's in jail rightly or wrongly now.

They let him out, but yes. Okay, he said, oh, they let him out. His conviction was overturned after he spent a year in jail. Okay, okay. But those technologists, you're saying, they are the future of Wall Street. Like Pixar is the future of Hollywood in some way. I mean, technology that may be a backroom basement tool that has been used by investment firms is becoming much more front and center and ultimately will be the leader of those firms.

So I think one of the reasons the high-frequency trading industry, this shadowy, very small firm kind of industry, has flourished is that the big banks did not confer enough status on the technologists who could create high-frequency trading platforms, and so that they went and did it outside the banks. They don't respect the technologists. So I think that's probably changing, but slowly. uh and i do think that i mean the geek effect the geekification of wall street started when i was

there i mean that all of a sudden the solomon brothers trading floor the guy who used to be the guy who ran the thing was big and hairy and you know ape like kind of thing and uh and and he got replaced by these weedy mit guys who had no hair anywhere does this cause you to be a long term optimist about the markets and market stability and do you believe that the book has the potential to have a major impact i mean i presume that's part of the reason you spent probably a very intense period given how recently this happened to actually sit down and write this book. Are you an optimist that things are going to be, transparency will win and that the market will be more stable for investors? I think it's going to be a war. I really think that it's going

to be an ugly, long war. And I think that Brad Katsuyama and IEX, I think Brad Katsuyama is Frodo Baggins in Lord of the Rings, I think he's created, he's sort of like, he has antagonized Mordor and the orcs are rising on Wall Street. And on the other side, he's got this Fellowship of the Ring thing with investors, big investors who are supporting him. And there's a, the war is between ultimately big investors who manage little people's money and the system that is exploiting the money. And I don't know where it ends up. I don't actually know where it ends up. I do think it's not going to just go away quietly. The book's not going to be published and then people are going to forget about it because it's got all these investigations going

on. And I do think also that if the world changes, it won't be because of the book. It will be the people. But IEX could be the lever, that you create this fair exchange. And it's really a fair exchange and you're committed to restoring trust in the financial markets, what you do is you give people a choice. And so all of a sudden they're making, it's not one dark pool versus another or one exchange that's sold out to HFT versus another exchange that's sold out to HFT. You actually have a fair place that's operating in the interest of investors that you force a choice onto the world that hasn't existed before. And that's very seditious. It's already an opportunity to have a purely transparent and fair market.

Yes, and there's no reason it can't be. So I do think, actually, I think they're going to win. I don't know how, but I do think. I mean, I can imagine several paths to change. I mean, I can tell you what I think the most likely is. The most likely is one of the public exchanges, possibly the New York Stock Exchange, says it's actually, this thing is turning fast. The old business model of deriving our revenues from high-frequency traders is going to collapse. Let's buy IEX and make them the New York Stock Exchange.

Let's look at the reputational win. Huge reputational win. So Goldman Sachs has been the first mover in the banks to get behind IEX and no one else has followed? I love that part of the reason that could be true is because they realize they can't catch up technologically. That's right. So they're like, that's your point. Let's play the reputational side. Let's play the reputational side.

Let's win with what we have. So there's no reason an exchange, one of the exchanges, won't do the same thing. And the natural one to do it is a New York Stock Exchange. Michael, I know, by the way, so in that scenario, you are our J.R.R. Tolkien. We hope you're safe out there writing about this. I thought I was Gandalf. Okay, you're Gandalf. I love that, but you're such a youthful Gandalf.

Okay, I'll be one of the humans, you know, one of those guys. I'll be Viggo. Okay, perfect. You're Viggo. So I know you're not going to share this with us. This is the final question I'm getting from Mac, our producer, that you have to go. You've got another variety of interviews here in New York, so thank you for spending time with us. Federal Communications Commission License Number 1215095.

I Googled it. I need to dig deeper. You do. There's a clue. Has someone figured the mystery of the final page of your book out? Not someone who's going to put it in print, but an investor got to the bottom of it very quickly. Okay, got it. So do you have any additional clue or hint for us?

Or no, we're on our own. There's enough there. There's enough there. That investor did it. You can figure out who did it. There's a puzzle at the end of this great book, and we're going to figure it out together in the Motley Fool 1 community. Why not? Michael.

Thank you. Thank you. It was fun. Interviews with business leaders and CEOs is one of the many features in Motley Fool 1, our premier all-access service headed up by Motley Fool CEO Tom Gardner. To learn more about Motley Fool 1, just visit fool1.com. That's fool1.com. That does it for this week's edition of Motley Fool Money.

We'll see you next week.