On this Flashback Friday episode, Jason Hartman talks to Scott Patterson about A.I. Bandits, a term he uses to describe electronic high-frequency trading. His book Dark Pools explains the use of robot systems to trade in milliseconds, which poses a threat to firms not using high-frequency trading. He also talks about the history of quantitative strategies based on his book The Quants.
Announcer 0:00
This show is produced by the Hartman media company. For more information and links to all our great podcasts, visit Hartman media.com.
Jason Hartman 0:10
Hey, this is Jason Hartman, thank you so much for joining me. Do you know what day it is? Yes, it is flashback Friday, or you hear the best of the creating wealth show and you hear some good prior episodes, some good review. Remember, we’ve got almost 500 episodes out. And you know what? iTunes doesn’t even hold them all if you’re an iTunes listener, if you are listening on Stitcher thank you for joining us. So we want to bring you some good review stuff now. What’s interesting about flashback Friday it’s a little scary for me I gotta I gotta be very very candid with you on that. Because you the listener, you get the chance to hold my feet to the fire. Did I make any predictions? Was I right? Was I wrong? I’ve been I’ve been right about a lot of things, but I’ve been wrong about a few. But it’s flashback Friday and we will give you the uncensored Best of the creating wealth show with a prior episode. So let’s dive in. Here we go. Remember, this is not current, it’s flashback Friday.
Announcer 1:20
Welcome to the creating wealth show with Jason Hartman. You’re about to learn a new slant on investing some exciting techniques and fresh new approaches to the world’s most historically proven asset class that will enable you to create more wealth and freedom than you ever thought possible. Jason is a genuine self made multi millionaire who’s actually been there and done it. He’s a successful investor, lender, developer and entrepreneur who’s owned properties in 11 states had hundreds of tenants and been involved in thousands of real estate transactions. This program will help you follow in Jason’s footsteps on the road to your financial industry. In a day, you really can do it on Now, here’s your host, Jason Hartman with the complete solution for real estate investors.
Jason Hartman 2:10
This is your host, Jason Hartman. Thanks so much for joining me today. Well, thank you so much for all of you who have registered to join us for our creating wealth boot camp in Atlanta, along with our Atlanta distressed property tour. We’re getting lots and lots of registrations for that. And we usually get one or two every day. So it’s just plugging along nicely. And I’m glad to see a lot of you taking advantage of the early bird discount. So that’s fantastic. So on this show today, we’re going to have a caller from Australia. And we are also going to talk about the quants and dark pools. And what that is all about is that is about high frequency trading and all of the stuff that goes on in Wall Street that continues to amaze me, and I hope it continues to amaze you as well because it really is incredible. And I think you’ll find that guest today to be very, very insightful. So we’ll have that in just a moment. But on the last episode on episode number 271, you know, I talked to you a little bit about organizing your income property portfolio. And I promised after talking about the acquisition file, that legal size file, now we’re talking about good old paper files here. But we also, of course, use software in our real estate investing business. But we’re just talking about good old fashioned paper files here. And today, I’d like to just talk to you for a moment about the operations file. Now the operations file is the file you’ll use often so you want to keep this in a physical drawer somewhat near you. Of course, you can scan it and you can use it within the property tracker software, which I highly recommend. Or you know, some people just like a good old physical file and I gotta say, I consider myself to be fairly techie. But for some things, I just like good old fashioned paper that tends to work well. Bye So with this physical file, and this is your operations folder, this is the one that is letter size, so eight and a half by 11. And it is a classification folder. So it’s got six tabs to it. And the way you organize those tabs, very simple. And this is a continuation again of last episode where I talked about the other file that goes with it, and that is the acquisitions file. So in this one, tab one, you’ll have your HUD one closing statement, a description of the property of many photos of the property, copies of maybe a plot plan of the property and a change of address receipt from the US Postal Service. Now, I always recommend that you do those change of addresses for your properties. Because if statements get sent to the properties, and of course you don’t occupy the properties, right, you live somewhere else, because you’re following my advice to invest in properties that make sense So you can afford to live in a property that doesn’t make any sense. In other words, a nice high end property for yourself. But lots of bread and butter properties that you rent to other people whether they be single family homes or apartment buildings or for plexes or whatever.
Remember, you’re listening to flashback Friday. Our new episodes are published every Monday and Wednesday.
So you do that change of address so that mail is forwarded to your either p o box or the place where you live so you get the mail for that property tab number two mortgage statements on the first loan on the property. Tab number three is your warranty on the property and any property tax information tab number four mortgage statements for the second loan on the property or and or your insurance information. Homeowners Association statements if you have a homeowner’s association utility bills. And then tab. Number five is your monthly property manager statements that you get from your property manager. Or if you’re self managing your property, any records you use to keep track of that. And tab number six are your contracts with your property manager if you have one, and your tenant leases and maybe the tenant application as well. So there you go, there you have it, your operations folder, the one you’ll reference probably at least once a month, and that acquisitions folder is sitting in a bottom drawer. You know, those gold bugs, they’re always bugging me those gold bugs and I don’t know why I just have a thing for them. I guess they just bug me because they are so illogical. And the lack of logic in the gold bug world never ever ceases to amaze me.
And I want to remind you that Peter Schiff I’m I’m a fan of Peter Schiff. But no, I also want to hold him accountable to something Peter Schiff said, By the end of Obama’s first term gold would be $5,000 an ounce. And better hurry up Peter, because we’re not even close to $5,000. Gold has got a triple what’s got a more than triple to be at $5,000 an ounce in every gold bug you talk to, if you ask them the question, is the price of gold going up? Or the value of the currency? In this case, the dollar? Is it going down? They will unanimously say, and this is a trick question. By the way, on my part, they will unanimously say that it’s the dollar that’s going down. In other words, the metal, the silver, the gold, whatever the commodity is, for that matter, but usually silver and gold we’re talking about that is simply keeping pace with inflation. They will say that to you every single time so I asked you this. Now I don’t think Peter Schiff is gonna Right. But even if he is, if gold goes up to $5,000 by November, the end of Obama’s first term and I hope hope the end of Obama’s presidency in general, but if it goes to $5,000, what will happen to the value of your debt on your income properties? Hmm, let’s see gold. Let’s just say gold triples in price. That means the destruction of your debt if the gold bug argument is correct, and I actually believe it is it’s, it’s not gold that’s going up. It’s the dollar that’s going down. That means your debt will be decimated by two thirds. That means you’ll have a huge 66% reduction in your debt.
Wow, amazing. If you owe a million dollars, against your income property, you will after gold triples in price, not In value just in price in in nominal dollars, not real dollars, because there hasn’t been any real gain. That’s what the gold bugs will tell you. Right? After it triples, your debt will decline massively. Okay, so you will owe far less than what it says you owe in real dollars in nominal dollars. Of course, it’ll still say the same thing. And I just got to point that out. I want to remind you, let’s see if Peter Schiff is right. See if by November gold is $5,000 an ounce. I don’t think it’s gonna happen. But if it does, our debt is going to be dramatically reduced against our income properties. and the value of the commodities attached to that debt will have kept pace just like the gold with inflation with the devaluation of the dollar. So that’s that, okay. Hey, let’s take a caller from Australia. And thank you so much for calling into the show. By the way, be sure To do this, and I want to just tell you, I know some of you are kind of shy out there. And you may not want to call into the show, but remember, it’s edited in post production. So if you say anything silly or you know you got too many ohms and ahhs in there, our editor will fix that up for you. Okay, so it’s not like calling into a live radio show. That’s one of the other beauties of it. I hope that takes away a little bit of your reluctance to call into the show. It’s easy. Do it, call into the show, we want to have you calling in and asking questions and participating and contributing to the show. So please be sure to do that.
Anyway, let’s take a caller here, and I’ll be back with you for just a moment before our guest. Hey, it’s my pleasure to welcome Stephen to the show. He’s calling from Australia. How are you Stephen?
Stephen 10:51
Yeah, hi, Jason. Good. I thought I would just take you up on your opportunity to call in on Skype well, and,
Jason Hartman 10:57
And thank you so much for calling. We’d love to get a lot more calls. I haven’t really pushed that yet. But you’re one of the early few callers. So how are you doing?
Stephen 11:04
Guy? Yeah, I’m good. I’m calling you from the Sunshine Coast in Australia. And I listen to your podcasts and find them very helpful. I had a question you had a guest on a little while ago, and he was talking, I think he was one of your investor clients who was talking about being in an advantageous position. If the banks to go into hyperinflation by owning multiple multiple rental income earning properties, and you’re not being too financially intelligent. I wasn’t really clear as to why it is advantageous to own multiple rental income properties if we go into a state of hyperinflation and was seeking some clarification on that.
Jason Hartman 11:44
Yeah, actually, great question. Well, there are two main reasons and really, there are three. So the first thing I would say is what are the options out there? Most people would say in an inflationary environment, you know, you want to own gold. Precious metals. And, and you know, like you’ve heard me say on many episodes, I think those are okay, I think they’re just okay. They’re better than dollars or any currency out there, but they’re not better than income property. And the reason for income property is that it performs so well in an inflationary environment is really twofold. One is of course, just like gold and silver, any commodity generally does very well as a hedge against inflation. So whether it be soy beans, coffee, beans, lumber, petroleum products, gold, silver, any form of commodity item does does pretty well it usually keeps pace and in hedges inflation pretty well. Okay, so that’s the first part. So of course when you own these income properties, you own a lot of commodities. I always talk about packaged commodities investing or assembled commodities investing, you’ve got concrete lumber, labor, products, glass, steel, all the ingredients for a house. So you know, we all would agree on that the commodities that’s the first part. But the part that really, really, really makes it special is what I call inflation and do step destruction, where when you have inflation, inflation basically pays your debts for you. So for example, if you borrow $1 million, and you buy real estate with it, and let’s assume it doesn’t produce any income, it’s not even as good as income property. It’s just a property, say, for example, you live in it or it’s a property you just keep vacant. And if you got a $1 million interest only loan on these properties, then in one year, if there’s just 10% inflation, the value of that dollar of that money you owe declines, just like the value of the money you have declines. So the money in your savings account would go down by 10%. If there’s 10 percent inflation, because it would be it would have 10% less purchasing power, but also the value of the debt you owe against the properties would decline as well. Because that is that is also being destroyed by inflation just like our savings are stocks or bonds show equity in real estate. That’s that’s inflation induced destruction. So we like it when our debt gets destroyed.
Just a reminder, you’re listening to flashback Friday, our new episodes are published every Monday and every Wednesday.
Stephen 14:37
But doesn’t that mean like you’ve got tenants that are paying rent on your property, and they are in effect paying the devalued mortgage, but the amount that the tenants can afford and what they’re actually paying is also devalued as well.
Jason Hartman 14:51
Well, the amount of their rent if you say, for example, you have a one year lease on the property. Now you know, it’s We had hyperinflation within that year, that would that would hurt you because you could probably charge more if you were to kick that tenant out, or they were to move, and you were to lease it to a new tenant because rent rents are indexed to inflation very well. In fact, historically speaking, at least in the States, rents typically outperform inflation. But remember, here’s the thing, okay, the mortgage payment doesn’t go up. And the cost of running the property really don’t go up except maybe very nominally, but the mortgage certainly won’t because it’s a it’s a 30 are fixed alone, even if you could get a higher rent from somebody else. In relation to the property. If you can’t raise the rent for free, you have to wait a whole year to raise the rent for example. So what that’s not really gonna hurt you that much because it’s tied to the the property’s functioning. And so that’s, that’s not going to hurt you too bad. No, no, here’s another question that you May be thinking of because you almost alluded to it in the last question when you talk about how we’ve always got to think about our tenants and how inflation affects them, not just how it affects us because we’re not investing in a vacuum, right? We’re subject to market forces to if our, if our tenants have problems, we have problems potentially, right?
Stephen 16:19
Exactly. Yeah.
Jason Hartman 16:20
Well, okay. So let’s look at how inflation will affect them. They may get a raise that is tied to say the cost of living, but that always understates inflation. So what you’ll see there is the tenant will suffer, okay? And say, for example, that one year lease comes up and you raise their rent, and you raise that a lot, because there’s been a lot of inflation in that year. So rents are skyrocketing, with everything else with the cost of gas and coffee and food at the supermarket and everything is going up. Right. But the question is, because that’s a pretty a pretty grim scenario. It’s pretty gloomy. scenario if everybody’s hurt by inflation Well, so what I say will happen is the standard of living will just decline. That’s where the pain will be felt. So, maybe now that tenant rents a nice four bedroom, two and a half or three bath house from you and say that houses 2000 square feet, well, if inflation comes along, they might have to move out of that house and move into a an 1100 square foot home with, you know, with three little tiny bedrooms and just one and a half baths. So their standard of living will decline, but there will still be a renter, that’s the person that moved down from the 3000 square foot house that moved into your 2000 square foot house. So you know, it’s just a ladder, you’re always moving up and down the ladder. And I think it is a gloomy scenario for most people except us because we don’t have to how to beat the inflation.
Stephen 18:02
So is there any any implication of of the hyperinflation of the banks then adjusting sort of what the value of currency becomes? Because let’s say you have a 30 year mortgage on a property and let’s say you owe the bank $200,000. And then the value of the currency increases or sorry, decreases, but the amount that you owe the bank is still 200,000, isn’t it? The bank can’t say, Well, now don’t 1000 is not worth 200,000. You actually I was
Jason Hartman 18:34
800,000. Right? Well, you know, I suppose they could pass some kind of law and basically revalue all the money out there, but that would be extremely difficult to do. The fact is no, under current law, they can’t do that. I mean, the bank cannot rewrite your loan. And and think about it. The inflation game is only benefits the government and the central bank Like the Federal Reserve and other central banks around the world, they actually benefit from it. Because all of the all of the money they owe, see the government is quite familiar with inflation induced at destruction, okay, even though they don’t use that term. But you know, if we owe China a trillion dollars worth of our bonds and treasury bills, and we have 10% inflation, well, then we owe them 10% less in the next year, right. So it’s a great deal for the government. So the government wouldn’t want to revalue. They wouldn’t want every bank to revalue their loan, because that would that would dramatically hurt the economy. They’d rather they’d rather let the bank suffer and let the government benefit. That’s extremely unlikely. But hey, when you control the laws and the military, you can do anything you want, you know? So I never say never, but I can’t imagine it happening. I’ll put it that way. Yeah.
Stephen 19:54
So your strategy is to get into as much debt as you possibly can and have the mortgage Have the rental income, cover the mortgages and then wait for the hyperinflation. Tie the lines off in effect. Yeah,
Jason Hartman 20:06
you know, that’s not the only strategy, but it’s definitely a major part of it. I mean, I don’t want to say debt in general, of course, I want to say only long term fixed rate debt tied to income properties that produce income that pay for themselves. Yeah, you have the opportunity to outsource the debt to a tenant where the tenant becomes responsible for the debt and that that’s not consumer debt. It’s good debt. It’s not bad debt. Right. Okay.
Stephen 20:34
Yeah. And then that’s helpful.
Jason Hartman 20:36
No, no, a good question to ask Stephen is say it doesn’t happen. Say that the hype say hyperinflation never come say somehow, we defy the laws of gravity and physics, through this whole explosion of money printing, you know, just under Obama, we’ve had another $5 trillion of money created out of thin air that didn’t exist three and a half years ago. That’s an incredible thought, Oh, I see dollars, right? And so if if that doesn’t happen, and if we just sort of plot along the way we did it, you know, in the 80s, and the 90s, and the first decade of the 2000s, I mean, heck, still gonna be great. It’s gonna be as great as it was for all of the millions of people who owned income property through the last three decades. But if we get that provider in and have the tenants covering the mortgage on that, Oh, absolutely. And every property we have nowadays, is positive cash flow from day one.
Stephen 21:36
And say we don’t really having those sort of properties in Australia at the moment because we haven’t really sort of bottomed out most of our properties are still a fair way off from being positively geared at the outset. We’re still paying sort of six and 7% interest rate on on the mortgages and the tenants. rental return, the rental income from the tenants is is probably only about half of what the mortgage repayments are. Oh, yeah,
Jason Hartman 22:04
that’s
Stephen 22:04
negotiated, maybe a 10% reduction on the price, because the mark is slow. But it hasn’t, you know, there’s a lot of optimism and a lot of hope with the mining industries and the resources boom in Australia, that we’re going through it. So people are sort of thinking we’re not gonna see, you know, Detroit, and Miami’s sort of fall over here. Yeah,
Jason Hartman 22:26
yeah, I am. I have the connection, either. Jason is Yeah, I’m here. Can you hear me? Yes, I can. Yeah, the connection got bad there for a moment. So yeah, I think that that is definitely not going to work. Because whenever you have a situation where you’re you’re, your mortgage cannot be covered by the rent and your other expenses can’t be covered by the rent. You know, that’s a great sign that you’re in a bubble that things have to adjust. And there’s only two ways they can adjust either. Either the rents have to go up radically, or the prices have to go down radically. Where the interest rates have to go down radically? In other words, the cost of owning that property has to go down. Exactly. Probably it’s not going to be a matter of interest rates. What are your mortgages like they’re nowadays
Stephen 23:12
yet? They’re about 25 to 30 years at about 7%. So it’s very it’s very high. Very high.
Jason Hartman 23:18
Well, historically, it’s not that high but yeah, it’s high tide compared to the UFC. The US is just defying gravity with with the way its Federal Reserve System was it’s a it’s a it’s a scam. So it’s a it’s a sort of a Ponzi scheme. It’s not exactly a Ponzi scheme, the way that’s played out, but the point is benefit from, I mean, use that to your advantage.
Stephen 23:40
Yeah. Now, that’s very helpful. Thanks, Jason. I was wondering that because I was listening to you talking to one of your clients, and they were sort of going on about how they want to, they want to get locked in as many loans as possible with with the tenants paying the mortgage. And I thought, if we go into hyperinflation isn’t that bad. So but you’ve explained that so it’s helpful
Jason Hartman 23:59
Good, good. Well, hey, yeah, just before you go, do you mind sharing your investing experience with the listeners? Are you new to investing or experienced?
Stephen 24:07
Yeah, I’m filling you. I’m 40 years old. And I’ve done a couple of little places, one in Sydney, little subdivision and one in the Sunshine Coast, to actually on the Sunshine Coast, and then my own place. And the most sort of effective one that I found is a place that I renovated the downstairs area to add four bedrooms. So this is a house sort of in the middle of a town area where it’s great walking distance to the beaches and the shops and everything. And I bought a two story brick place that was old and rundown, renovated upstairs added four bedrooms downstairs. So I’ve now got eight unrelated people, renting individual rooms from me, and I cover the utilities and I provide a wireless internet facility through the house. And that seems to work very well that property is actually positively good, but that’s It was an interesting lesson because when I bought it, what I could have rented it out for would have been substantially negatively geared. But by spending another hundred thousand dollars on the renovation and heading the extra rooms, and then getting the four additional rental incomes in, it bumped it up. So I spend a little bit more, but the returns were a lot more, if that makes sense. Right? So that that property’s sitting there and it’s in a fantastic location. And it’ll it’ll, it’ll, I’m sure it’ll get some capital growth sooner or later. But um, like a lot of people, I’m not sure what’s happening with the economy and whether things are actually going to go up or just play it out for 10 years or so. But in either in either case, it’s just ticking along paying for itself. It’s not going ahead, but it’s not going backwards.
Jason Hartman 25:46
What are you interested in us investing and how long have you been listening to my podcast?
Stephen 25:50
I’ve only been listening to the US for about three months. It’s and I did live in the states for a while about Probably 10 years ago, I won a green card in the visa lottery pop up internet ads, they just aren’t when you’re online, these ads pop up and they say, you know, the American government is giving away a certain amount of green card. So I applied for that years ago and I actually want a green card. So I went up to the states and, and enjoyed it. And I particularly like Miami and sort of being interested in the property there and reading some forums on Miami investing and in time to come. I think I’ll probably look at buying a property over in Miami somewhere and
Jason Hartman 26:26
let me just tell you, it’s too early for Miami. It’s I just think it’s too early still. We have people asking us about Miami many times a week. And the other one they always seem to ask about is Las Vegas Of course. Yeah. And I it’s just yeah, just just wait, Miami is one of those high.
Stephen 26:45
These are all the Latin Latin. Yeah, it seems all the Latin Americans have just moved into Miami and they’re spending all their equity that they’ve you know, Venezuelans and Brazilians this stuff, but once they have once I had problems then I think really slowly I’m sort of holding out a little bit.
Jason Hartman 27:02
Yeah, I would be very careful of areas like Miami. And if you’re in them, don’t do condos just do this good old fashioned single family homes. Because once you once you add that condo complex and that
Stephen 27:15
homeowners association to the mix, it just has so many new problems that are created that weren’t there even University districts because I hear that you can get it you can get a condo apartment for 40,000 or 30,000. And it’ll you’ve got good rental income from university students and low homeowners fees.
Jason Hartman 27:35
Right, right. Well, you’re generally against condos a few times, we’ll make an exception. We did make an exception in Dallas, where we’ve got these really inexpensive condos that you can almost treat like apartment buildings, or you can buy several of them right next to each other. And, and you know, those are kind of interesting. They’re especially interesting, by the way for foreign nationals, because they’re very inexpensive and they have really good cash flow. But a lot of the a lot of the miami condos, I see investors buying them all the time and I just think Gosh, what are they doing? I wish I could stop them and and get some knock some sense into them. Yeah, you know where they’re they’re expensive, really nice condos. And they just it just doesn’t work. It’s just so risky. I mean, thousands of people have been burned from things like that. So yeah, really, really be careful. Yeah.
Stephen 28:24
What are your thoughts on the single family homes sort of on Miami Beach up in the northeast Kanye and Surfside you can pick them up for sort of low to hundreds.
Jason Hartman 28:33
I think they’re too expensive. Look at my general philosophy is it’s the opposite of everything I like. Okay. I like sexy and swanky and cool I live in a gorgeous penthouse myself, but to invest in I like milk and cookies, meat and potatoes, whatever you want the
Stephen 28:52
middle of the Belka, yeah, just
Jason Hartman 28:54
really simple suburban single family homes. That has always just been Really nice, stable type of deal. So
Stephen 29:04
yeah, I agree when you type in the bell curve of the population, you’re more likely to, to hit the nail on the head than if you go for the extremes either too high or too low.
Jason Hartman 29:14
No, no question. So today, now this is, you know, this is a moving target. But today, that number means a property that say $130,000. somewhere around there not above, you might be 90 to $130,000. And that price is going up a bit. So, you know, you talk to me, and in six months, it might be 110 to 150,000. But the nice thing about that section on the bell curve, is that you can catch the people moving up, and you can catch the people moving down. And I say, if we have this hyperinflation, there’s gonna be a lot of people moving down. And those are still respectable enough houses, that people can live a happy life in them. And also batten down the hatches during an inflationary environment or a bad economy of any kind. There are other types of bad economies that aren’t inflationary, you know, can just be depression airy in general, well, inflationary depression or recession, but I just think that’s a really good stable bet.
Stephen 30:17
Yeah, me too.
Jason Hartman 30:18
And the other thing I would say is spread them around geographically. You have a couple in this city a couple amount city a couple in another city. You know, just in case hedge your bets. Yeah.
Stephen 30:27
Okay. Yeah, I like the city investing because you’ve got the, and you always will have the concentration of the population in the larger areas. And, and if you if you need to turn it over, or if you need to get more tenants, you want to be in an area where you’ve got a lot of employment for people and, and that sort of thing. You know, I’m in a regional area, but it’s something with 320,000 people here on the coast, but it’s a high tourist area, probably sort of similar to to Fort Lauderdale or somewhere like that.
Jason Hartman 30:58
Well, like I mentioned, I’ve been to New And Surfers Paradise in Australia, and Sydney as well. And I Love New so I thought that was a great, great little town. Yeah, it is. And you’re right. You’re right near there. You’re about a half hour away from Noosa. Right? Yeah.
Stephen 31:12
Yeah. Well, look, I’ll probably 45 minutes if you are if you’re down here again. Yeah, let me know. I’d love to catch up.
Jason Hartman 31:17
Oh, I’ll definitely look you up. Thanks so much for calling into the show. It’s like 10 minutes after 11pm here, but I just happened to catch your call. And I was talking to investors.
Stephen 31:29
I gotta get back to work,
Jason Hartman 31:30
essentially, from down under what time is it there? It’s quarter past four in the afternoon. All right. Well, you get back to work and we’ll talk to you soon. Thanks for calling in.
Stephen 31:38
Okay, thanks, Jason.
Jason Hartman 31:45
So another great call, please be sure to call into the show. We’d love to have you participate. Now. Let’s go to our guest in just a moment here, but I just want to remind you if you haven’t registered already, for our Atlanta creating wealth, boot camp and prosper. tour, be sure to do that as soon as possible at Jason Hartman comm slash events. All right, we will be back with our guest today in just a moment.
Announcer 32:14
You know, sometimes I think of Jason Hartman as a walking encyclopedia of the subject of creating wealth. Well, you’re probably not far off from the truth Penny because Jason actually has a three books set on creating wealth that comes with 60 digital download audios. Yes, Jason has that unique ability to make you understand investing the way it should be? It’s a world where anything less than 26% annual return is disappointing. I love how he actually shows us how we can be excited about these scary times and exploit the incredible opportunities this present economy has afforded us. We can pick local markets untouched by the economic downturn, exploit packaged commodities investing and achieve exceptional returns. And securely. I also like how he teaches you to protect the equity in your home before it disappears and how to outsource your debt obligations to the government. And the entire set of advanced strategies for wealth creation is being offered at a savings of $94. That’s right and to get your creating wealth encyclopedia series complete with over 60 hours of audio and three books, just go to Jason hartman.com forward slash store. If you want to be able to sit back and collect checks every month, just like a banker. Jason’s creating wealth encyclopedia series is for you.
Jason Hartman 33:47
My pleasure to welcome Scott Patterson to the show. He is a writer for The Wall Street Journal. He is the author of a few different books including the quants and dark pools and we’re going to talk about how this affects Wall Street and High Speed trading and all of the stuff related to those things. Scott, welcome. How are you?
Scott Patterson 34:04
I’m great. Thanks for having me.
Jason Hartman 34:06
My pleasure. are you located in New York, by the way today?
Scott Patterson 34:08
No, I’m actually in Washington, DC I used to work at in New York, for the journal. But now I cover financial regulation for the journal. And this is where else regulators are being drawn to the government is helpful, right?
Scott Patterson 34:24
Yeah, yeah. Just just down the street here. Well,
Jason Hartman 34:28
your latest book is dark pools. Right, right, to start with that one and tell us about it.
Scott Patterson 34:33
Right. So, you know, this book is about the shift to automated trading and computer driven trading on Wall Street that’s really exploded on the scene in the past 10 years or so. When I was when I was in New York, working into the wall street journal. A couple years ago, after I’d written the quants. We started hearing more and more about this, this trading style called high frequency trading, and I wrote a piece that’s said that it was estimated to account for about 70% of all the volume on the markets. And that was just sort of a jaw dropping number for all of us at the paper who cover this stuff. So I dive more and more into it and and basically learn a whole lot about the industry.
Jason Hartman 35:17
In other words, 70% of the trading on Wall Street 70% of the market is controlled by computers, then
Scott Patterson 35:24
it’s probably more like 95% is controlled by Oh, even worse, wow. 70% is specifically high frequency trading. So most of the trading that goes on today is is driven by computers. You know, if you’re investing in a mutual fund, your fund manager is using computers to implement those orders into the market, but he’s often interacting with a high frequency trader.
Jason Hartman 35:49
And you know, it just begs the question Can the little guy the middle class investor, just the regular everyday investor out there? Can they beat the system I mean, So many people are are kind of sold on the idea that they can somehow match the the computers, the algorithms, the quants, it’s really part of the same equation because the quants make the algorithms that run the computers. Right,
Scott Patterson 36:13
right. Yeah. And, you know, is it even possible for the little guy to compete with us? In a word? No. You know, after seeing how sophisticated these firms are, they hire PhD physicist and, you know, electrical engineers, and, you know, people from the top universities in the country, MIT and University of Chicago to design these systems. And, you know, so I mean, just day trading is just a bad idea. Now, it’s just not, it takes so much firepower, so much speed. And I think that that’s not really the problem that I’m concerned about, though. I mean, if people want to try their, you know, luck and play in the market, that’s, you know, that’s their decision, but what I’m really worried about That even the trade execution experts for the mutual funds are getting outgunned by these HFT firms, which are, you know, there’s really just a few of them that are very, very good. And from what I can tell they’re constantly winning the race, on the exchanges. And, you know, you could say in a way that it’s a tax on the individual investor who’s investing in 401, K’s and mutual funds.
Jason Hartman 37:25
You said HFT. firms. What does that mean?
Scott Patterson 37:27
Right. That’s the sorry, that’s short for high frequency trade. Oh, okay. Thank you. Yeah. Okay.
Jason Hartman 37:33
So so it’s not just that high frequency trading is something that firms on Wall Street do. There are firms that call themselves HFT firms there. That’s a that’s an actual category of business. This is what do you do? Well, I have a high frequency trading business. Right. Yeah, that’s sort of
Scott Patterson 37:51
Yeah, these are private companies, largely the best ones. Kind of like a family office. They’re run by just a few owners. And they employ, you know, teams and teams of quantum computer programmers and they’re just wildly successful. You know, one of the biggest is called get codes based out of Chicago. That’s short for a global electronic trading company, I believe, and they’re just wildly successful get go accounts for something in the order of 20% of the volume of some of the biggest stocks in the United States. That’s just one firm unbelievable.
Jason Hartman 38:31
So we’re gonna do they get their money to invest with are these just wealthy families that set up an HFT firm, or they started
Scott Patterson 38:38
off really small. And, you know, this is one of the stories I tell in my book dark pools is, you know, how they rose up in the late 90s and early 2000s. Very small firms trading on these new electronic communication networks that were trying to compete with the big stock exchanges like the New York Stock Exchange or NASDAQ, these are completely computer driven networks. The high frequency firms started using them because they could handle the automated trading that they were very good at. But they’re very small. They didn’t have a lot of money. But over the decades, they got bigger and bigger and bigger. And as the market shifted towards automated trading, and you know, the New York Stock Exchange and NASDAQ incorporated those trail computer driven trading networks, they came to dominate the market and explode and profitability. So it’s really only been in the past five years or so that they’ve gotten to be as big as they are and as dominant as they are.
Jason Hartman 39:42
So so then high frequency trading definitely works, right.
Scott Patterson 39:47
Oh, yes. It’s, it’s very effective. It’s a it’s a brilliant strategy. You know, they basically flood the market with buy and sell orders and only trade one They, their systems predict that they’ll be profitable. Or at least that’s what they try to do. So they cancel most of their orders. So they’ll put in tons and buy and sell orders. But they’ll they’ll cancel something in the order of 99% of those orders. And only trade when they when they really want to. So so they’re just really clogging up the system too, right? I mean, they’re keeping people from getting their orders executed, other people can’t get their orders executed, because they’re just flooding the system with with noise. It sounds like Well, that’s a big concern now is that the amount of data that the exchanges and other trading networks are forced to handle because this is just clogging up the system? And could we be you know, some outages? Another problem is that they’re able to jump in front of other firms. That’s part of the strategy is they can they can see you know, they have directly Links to all these different venues across the markets. And they can they can see how the market is moving by, you know, detecting like, you know, when a stock moves on the New York Stock Exchange, When is that going to also move on a on a dark pool say? So they’re able to constantly jump in front of other firms in the order book and be at the front. And that’s really essential to their strategy is being in the front and getting the order when it when it happens.
Jason Hartman 41:30
So explain to the listeners, what is a dark pool? I mean, that’s the title of your book.
Scott Patterson 41:34
What is the dark, right? Yeah, so the technical term for dark pool is a sort of a private, secretive, trading venue where stocks are bought and sold away from the public markets. The buy and sell orders are not made public. The order only is made public after there’s an execution. So the supply and demand that’s in the dark pool is is invisible, but the Larger argument that I’m making in this book is that the entire market is shifting towards darkness. The lack of transparency, even the public markets, like a New York Stock Exchange is becoming increasingly opaque. And we just saw yesterday that the SEC approved and ignored stock exchange’s proposal to create their own sort of hybrid dark pool. So that’s just a symbol of the shift or just a symbol of the shift towards opacity in the stock market,
Jason Hartman 42:30
so even the exchange is going to have or has a dark pool in another try its own. I mean, the exchanges that is the clearing house, and they have a dark pool too.
Scott Patterson 42:46
Yeah, yeah. It’s surprising but it shows you you know, where how the market is changing. And you know, one of the reasons why these dark pools have become so popular is because the big investment firms have been running away from the public markets because they’re worried that the high frequency firms that can see their buy and sell orders, they can see that supply and demand can use that information to front run them. So to escape from that they’re going into dark pools. So in a way that the dark pools are a symptom of the disease that is infecting the exchanges right now.
Jason Hartman 43:24
And again, there’s nothing illegal about this is there?
Scott Patterson 43:28
No, there is not anything illegal about it, although there are suspicious activities that go on and the SEC is looking into some of these activities. The SEC, as we’ve reported in the pages of the Wall Street Journal is looking at whether the exchanges has provided benefits to these high frequency trading firms that allow them to have an advantage over other regular investors. This is an ongoing probe. We don’t know what you’re going to find yet. So you know, Another problem is that the regulators can’t really surveil the market at all, because they don’t have the technology to track all of this trading. So, you know, if there was something going on, we wouldn’t even know it unless they just got lucky or there’s a whistleblower or something. Right. Right. Right. You got to wonder, I mean, do you think there’s any inkling of whether even the SEC, the regulatory body has been,
Jason Hartman 44:23
to some extent or any extent bought off by wall street itself by the people it’s supposedly regulating? Because it seems there are so many things that are so unfair to the average investor and so favorable to institutional investors?
Scott Patterson 44:37
Yeah. Well, you know, I think bought off is a strong word. Okay. You may not be able to
Jason Hartman 44:43
totally answer that in your position.
Scott Patterson 44:44
Yeah. You know, I think the the regulators in terms of the stock market and the you know, a lot of the markets today have just been completely left behind by the technology that’s that’s overtaking the market in the past. 10 or 15 years, they haven’t kept up with the the sophistication. And that’s allowed these firms to do things that the regulator doesn’t understand. And I think we saw this with a lot of the derivatives that blew up in the financial crisis. So these, you know, the credit default swaps and synthetic CDO, that just Visser ated the balance sheets of all these banks around the world. The regulator’s just were, you know, totally asleep at the switch. They couldn’t understand it. And I think something very similar is going on in the stock market. And other markets too, like the futures markets or options markets were very sophisticated trading strategies are taking place. exchanges are helping those strategies succeed. And the regulator is just completely in the dark about it.
Jason Hartman 45:51
You know What amazed me I think it was the 60 minutes expos a on high frequency traders. It amazed me is that Literally these firms, these, these HFT firms, the speed is so important to them, that at the speed of light 186,000 miles per second, it makes a difference, whether you’re a few blocks away, or you’re right next door to the exchange in terms of how fast you can execute these trades, and it blows my mind that people actually think they’re going to outwit that system.
Scott Patterson 46:30
Yeah, well, you know, that kind of tells you where we’re at right now. And, and that is the game being in front of another firm by microseconds, which is a millionth of a second so these firms are fighting to beat each other by microseconds. In my book, dark pools, I tell the story of a company called spread networks that built a fiber optic cable between Chicago and New York. It costs them $300 million to build this cable, the cable allowed firms to gain a three millisecond advantage over firms using the current system. And that’s 3,000th of a second. And they spent $300 million to do that. And it was probably a good investment. Right. And they, they believe that there was going to be demand for the cable. Unfortunately, for this company, innovation is moving so fast that other firms realize that they could use microwaves signals to send orders between Chicago and New York faster than this cable. So the demand wasn’t as robust as they’d hoped, because innovation is moving so quickly. And everybody is trying to get in front of everybody else so ardently, that as soon as you build something, it’s already out of date. So it’s just an endless cycle of innovation. The question is, what is what advantage does that bring to regular investors and it’s really hard to argue that That it’s bringing any advantage. You know, you could see why, you know, when it used to take an average of 20 or 30 seconds to get an order executed in the floor of the New York Stock Exchange, you know, now it’s less than a second, you can see how that that that’s an advantage that helps the market become more efficient. But when you’re talking about an order being executed 10 microseconds faster, you really start to wonder whether the efficiency that we’re gaining has any impact or improvement and if it actually could be detrimental to the market if that’s that’s what the races now and it is where the races now
Jason Hartman 48:35
just out of curiosity, is there any access to either high frequency trading or dark pools because they both seem very beneficial to the people that run them and the investors in them that the middle class day to day investor can can get involved? For example, can I buy a share of a mutual fund that runs a dark pool and a high frequency trading firm and make some of their money Now granted, I know they’re gonna, I know they’re gonna pay the management and the board of directors a lot more than me.
Scott Patterson 49:06
But at least it could be part of the whole thing. You know, I mean, I, one of these days, we’re going to see a mutual fund that’s, you know, a high frequency trading firm. I think the closest that investors can get now is hedge funds. And there are plenty of hedge funds that have high frequency trading operations. One of the biggest is Citadel investment group. They have a very successful high frequency trading firm that is called tactical trading. And in 2008, it made a billion dollars. So I you know, the average investor though not really and, you know, this is still something that’s, you know, there for the wealthy and the insiders on Wall Street,
Jason Hartman 49:48
right, right. It’s way out of their league. Let’s just kind of back up maybe we should have started the interview with this, but let’s talk about quants. For a minute. Your book is entitled quants and you have probably seen I was fascinated by it the movie margin call, right?
Scott Patterson 50:02
Yeah, I didn’t see that as a good movie.
Jason Hartman 50:05
It was a great movie. And you know, what totally impacted me about that movie is remember the scene where Peter Sullivan character gets called in at three in the morning, you know, and then the head of the firm is flown in from Europe or something and, and wants to see him. And he says, and you know, the Peter Sullivan characters like 26 years old and the head of the client, yeah, but he’s a quad and the head of the firm says, Hey, kid across the table, you know, what, what’s your background? What’s your degree and and he says something like, you know, I went to MIT and my thesis, my PhD dissertation was on the way our rocket propulsion impacts resistance or some crazy thing like that, right? Yeah. And, and the head of the firm says, So basically, you’re a rocket scientist. And he says, right, and he says, Yeah, but there’s more money on Wall Street. Yeah, that that’s really what these quotes are. They’re just They’re just mathematical geniuses. And they would normally be I think that’s kind of like, you know, not to go too far afield. But it’s kind of a sad statement in a way for, you know, American Enterprise that these people aren’t in the sciences. They’re just in the moving money game. Your thoughts?
Scott Patterson 51:18
Yeah. Well, that’s the story I tell in the quants is how Wall Street starting in, I go all the way back to the early 60s, became increasingly mathematical. And, you know, these guys were able to figure out in efficiencies and prices between between all these different asset classes and design arbitrage strategies. They’re also frequently good computer programmers. So that would help them crunch the numbers. And it just got bigger and bigger. And, you know, basically was, you know, by the early 2000s running Wall Street, you know, I think that it was the machine behind You know, everything, and then it blew up. But you know, it’s kind of a quat bubble, and all sorts of different ways. And I try to show that in the book is, you know how there were stock trading strategies that blew up in 2007. These derivatives that were behind the the asset bubble and mortgage industry blew up. And all of these things were designed by these mathematicians who have taken over Wall Street. You know, a lot of them are well intentioned, but yeah, it was the money. I mean, you know, see will old stories, you know, what drives Wall Street’s greed? earlier?
Jason Hartman 52:37
Sure. There was that what was the name of that firm? Forgive me, you know, I’m not a wall street guy. So I just, this is not top of mind to me. But there was that firm about 12 years ago that blew up that their whole thing was, they said me long term capital. Yes, yeah, long term capital management. Thank you. And their basic their basic stance was we have figured out the markets, we know how to math magically beat the market and we’re sure of it. And you know that of course, they lost a bunch of money and then the whole thing blew up. Yeah.
Scott Patterson 53:06
Any any background on long term capital management? Yeah, well, that definitely was a Kwan driven firm. Their strategies were entirely based on these mathematical arbitrage is that they had figured out, they had a couple Nobel Prize winning economist on their staff. So I think that they’re, you know, like you say, they said they thought they’d figured it out. And this is one of the big temptations of the quants mentality is that you think you’ve managed risk so much that you can leverage up more. So long term capital believe that it had hedged out all of the possibilities, all the negative events that could go on and, you know, that’s a big part of these strategies is hedging out a negative event. And if you have all the negatives under control, then you can take more leverage. So they ended up becoming leveraged something like 100 to one at one point. And it even rose to something like infinity when they were losing all their money. So it’s a it’s hubris, you know, I mean, they were, it’s a classic tale of hubris. And I think it just long term wasn’t a warning, ironically, to Wall Street, that there’s something dangerous in the strategy. I think Wall Street looked at and said, Hmm, well, that’s a good idea. We can just do it better.
Jason Hartman 54:24
What advice would you have for the average investor? That’s that’s the vast majority of the world out there in terms of numbers, it may not be in terms of dollars, but or it may still be actually in terms of dollars just because there are so many of them. But you know, what, what should they do? I mean, should they just buy an index fund and follow the the random walk advice or not be on Wall Street at all and buy some rental properties? What should they do?
Scott Patterson 54:50
Yeah, it’s it’s a tough question. I mean, everybody wants to know now with interest rates, so low fixed income is Seems like a terrible place to be. But the market seems really risky. And I think it’s probably riskier than people realize given, you know, how everything running it now is these computers that are susceptible to systemic events. But there have been so many studies showing that active investing is is a huge waste of time, you you pay more fees, these fund managers are often hugging the index as much as they can, because they’re, they’re just trying to beat it just a little bit. So why not just put your money in a low fee index fund, and hope for the best?
Jason Hartman 55:35
Well, and that was really the foundation of a huge company Vanguard, you know, you’re great. I mean, their whole thing was just by the index and call it a day. And you know, just Just wait.
Scott Patterson 55:46
Yeah, I that seems like a pretty smart strategy to me, and especially the active managers tend to trade too much. And given how you know what I’ve seen with these high frequency firms for a while Yeah, the market more efficient and it became cheaper to trade, but I think they’re just getting their clocks clean these days. So the more you trade, the more money you’re gonna lose.
Jason Hartman 56:08
I love how in the dark pools book you talk about, and you’re probably kind of branded this term AI bandits, artificial intelligence, bandits, and the threat to the global financial system. I mean, we’ve talked today a bit about, you know, individual investors, but But what is the threat to the overall system is the systemic risk here? Well, they just trade against each other, and the software will become better, the algorithms will become better, and the elites and the insiders will make all the money. And basically, the market will eventually go back to I mean, really, that’s the way the stock market was, in the old days, you know, the little guy didn’t access the stock market very much. And Merrill Lynch was really one of the big promoters that brought it into the, you know, more public sphere. Maybe it’ll just go back to the elites, and they’ll just be trading against each other.
Scott Patterson 56:58
Yeah, I don’t think They would like that very much because they like to feed off the little guy. I’d like that the fish food, you know, the feeds the sharks in the pool. But in terms of the systemic threat that I’m talking about, you know, that partly comes from my experience covering the flash crash for the Wall Street Journal. I really got to see how the the system is fragile. It’s it’s highly complex. And it’s very fragile, you know, kind of like, you know, the space shuttle is an example of a tiny thing went wrong with the space shuttle, shuttle Challenger and an O ring and the whole thing blew up. And there’s two there’s theories that say that if the more complex a system is, the more vulnerable it is to some kind of systemic event like that, that can lead to a huge sort of Black Swan like event flash crashes like that it was a 10% decline in the US stock market in a matter of minutes. It did bounce back, but You know, we don’t know if it happens again, if it could be 20%, if it will bounce back. There’s also concerns that because these, these firms are trading many different asset classes at a single time, like futures and options and currencies, that if you get a big move in one, it can spill over to another asset class. And they call that the splash crash. Some people much smarter than me have come up with this. He’s experts in artificial intelligence, and risk management. And, you know, these are concerns that people need to be aware of, it’s not just fear mongering. And people say that, you know, I’m, I’m trying to scare people, and that’s going to hurt them because they’re really afraid of the market, you know, but I’m trying to draw attention to this problem that we have, because the market has shifted to being very computer driven and these computers are, they’re trading so quickly that they can do things they can do things so rapidly, they can We can pull out of the market in the blink of an eye. And that’s what happens is these strategies, they don’t really like it when the market becomes too chaotic. They’re risking too much money. So they just pull out. And that’s what we saw on May 6 2010. The Flash Crash, you’re right, they’ll they’ll just
Jason Hartman 59:15
they’ll just yank the money out and cause a sudden dive in prices. Yeah, that’s right. It’s scary when you don’t like a lot of people have talked about the psychology of markets and trying to predict how other investors will think and act and go counter to their trends and so forth. And but it’s just very hard to do that, if not completely impossible. When you’ve got all of these different motivations and big institutional players, it’s just a whole different world. It’s not very logical in a lot of ways. Is it? Right?
Scott Patterson 59:45
Yeah. Or maybe it’s becoming too logical one or the other? Yeah, it’s kind of a
Scott Patterson 59:49
it’s kind of a conundrum. I mean, I didn’t think that there’s gonna always be room for the really smart investment manager, who you know, like Warren Buffett, I used to cover Berkshire Hathaway for the journal and I got to know, Buffett and became very impressed with his discipline and his ability to pick stocks. But there’s no question that more and more computer trading is is going on. And at the end of my book, dark pools I, the final chapter, I write about a small hedge fund in New York City called rebellion research. And this is run by a group of really young 20 something guys who have designed a an artificial intelligence trading system that buys and sells stocks for the long term, kind of I call it like a digital Warren Buffett. So in a way, I felt like you know, this is we know that the computers are running to the second by second microsecond by microsecond trading of stocks, but there’s always going to be a role for the fund manager who can you really dig into the balance sheet and figure out the long term investment. But these guys have created a computer that can do that. And it’s been very successful actually, over the past four or five years. So who knows in 10 years from now, it you know, is your fund manager going to be a computer and possible
Jason Hartman 1:01:20
very interesting stuff? Well, besides dark pools, which just came out, I guess last month Hmm, that’s dark pools, high speed traders, ai bandits.
