Heard a couple of comments at FinTech conferences recently. CEO of a marketplace lender (paraphrased): “Yes, I’m sure I will have to either buy a bank or become a bank at some point in order to get access to deposits. But if I do that, I get valued as a bank, not a tech company.” (Company in question has not yet IPO’d.) CEO of an alternative investment platform (paraphrased): “We are a technology company, nothing else.”
The online alternative investment industry is going to have to pull its head out of the sand at some point and admit to being more finance than technology.
CEO #1 clearly sees the issue here. P2P platforms have largely transitioned to sourcing funding from institutions rather than people, and dropping the “P” to become marketplace lenders. But that funding is fickle. Come the next downturn, both hedge funds and people will have less money to deploy with marketplace lenders. Deposit-taking banks have access to large amounts of lazy, cheap, reliable money. Marketplace lenders might need access to that sort of funding. But CEO #1 is clearly hoping that that will happen after he’s done his IPO. When he does make that move, he’s right, his stock price probably will suffer. As will the retail investors who invest directly or via mutual funds in the IPO.
CEO #2 is not seeing the issue. His platform connects investors with startups. That’s a risky and regulated area and to the extent that he ignores securities laws or tries to convince himself and his investors (VC funds) that those laws don’t apply, he’s putting those investors at risk.
The online alternative investment community is going to have to face the fact that however cool our tech might be, the “finance” part of FinTech really does matter.
Mark Carney is worried about an “imminent” Uber-ization of banking. He’s right of course apart from the fact that banking is not about to be Uber-ized imminently. The Uber-ization is taking place right now. Looking for a place to deposit your savings? LendingClub or Prosper will let you create a properly diversified portfolio of loans, paying more than Megabank’s 0.2%, providing you can beat the institutional investors to the best deals (you may need Orchard to help you source deals). Use Transferwise for currency exchange. Keep your money in an e-wallet. Need investment advice? Use a robo-advisor like WealthFront. It’s not just consumers; companies seeking funds can borrow from hedge funds on electronic platforms, or sell to small investors directly. Fintech companies and the shadow banking system have everything you need, with the possible exception of “classic” business checking accounts (if you know of anyone providing those services in a non-bank setting, some cannabis companies would be interested).
Banks are getting disrupted not just by disintermediation but also dismemberment. It turns out that the various elements in the package of services we used to think of as “banking” can be provided separately and less expensively online. I don’t know why anyone is bothered about “breaking up the banks” when technology is doing that pretty effectively in real time.
OK, I’m taking this one personally. All this criticism of Antonio Weiss’s resume is just BS. Some folks on the progressive side are saying that he’s not qualified to be Undersecretary for Domestic Finance because he’s spent the last however many years doing GLOBAL finance. In PARIS. Where he’s probably been eating CROISSANTS and possibly even BRIOCHE. Maybe even talking French, for goodness’ sake. Possibly drinking his coffee from tiny little unAmerican cups.
So listen up. Ya’ll are talking like “global” finance and “domestic” finance are two separate and different things. Like the difference between plumbing and mongeese. They are not. They are just “finance.” You can’t do “global finance” without a complete and absolute understanding of how the US domestic markets work. Because the US markets are the most important markets in the world. You can’t be in charge of foisting US Treasuries off onto foreign treasuries and SWFs unless you understand the way the non-US markets work. You certainly can’t put together deals like the Burger King/Tim Horton one unless you are an expert in US finance. Burger King is (soon to be was) a US company, remember?
If the problem with Weiss is that you want someone who is a knight errant for domestic consumer finance regulation, then say so. But this global thing is a complete red herring.
By the way, apple pie was invented in Europe. Global world, see?
“Securities are sold and not bought.”
“We are a nation of consumers, not investors.”
Put these two aphorisms together and it becomes clear that the key to making the online alternative investment market take off is to make securities products into consumables. And how better to do that by offering actual consumables, in the form of delicious chocolate? Let me explain. A few years back, the UK chocolate company, Hotel Chocolat (which makes truly excellent choccy, btw), started to issue “chocolate bonds.” You lend the company a certain amount and they pay interest in the form of chocolate.* Mmm, chocolate… Sorry, got carried away for a moment there. It’s all a brilliant marketing idea, they get to pay interest in kind, and as a young company they presumably have more chocolate on hand than they do cash. And what a great gift! How better to introduce youngsters to the principles of sound investing and weight management?
You can also now buy Chilango’s “burrito bonds” on CrowdCube, the preeminent UK crowdfunding site. Same principle,* different part of the food pyramid.
And of course when something is done on a UK crowdfunding site, we can probably expect it to happen in the US at some point. But both issuers and investors must take into account the heavier (intentional pun) regulatory load that applies in the US. First, we have to remember that these bonds are regulated as securities in the US, which is not generally the case in the UK, so there’s the issue of an exemption from registration under the Securities Act, and the disclosure that goes with some of the applicable exemptions (Section 4(a)(6), for example). Second, accounting. If you are making payments in kind as your interest payments on bonds or dividends on preferred stock, the (fully-loaded) costs of those payments need to be reflected as interest or dividends, and not turn up in costs of goods sold. And finally, tax. The IRS requires investors to pay taxes on interest received in chocolate in cold hard cash. And don’t forget to issue 1099-DIVs or 1099-INTs to all your happy consumers!
* Technically both companies issue gift cards as opposed to sending chocolate bars and burritos in the mail. But the principle is the same and investors will have to pay taxes even on the unused balance of the card. In some cases, issuers might be able to structure their deals as promotional discounts of some kind, but not without weighty professional assistance.
LendingClub just filed its S-1 for its IPO and everyone is talking about disintermediation. I believe that LC is one of the most important companies of this century, and that people like Sheila Bair, who is awesome in other respects, are misguided in criticizing the fact that LC lets people lend money to people who refuse to document their income. [And yeah, I do know the structure isn't strictly me lending on LC's platform to Joe X but me lending to LC, who buys Joe's note from the bank and all that, but the overall economic result is if it were really "peer-to-peer".]
Here’s the proposition for investors in old-style asset-backed securities backed by consumer debt: “We are going to collect the consumer debt of a whole bunch of folks generated by a whole bunch of different intermediaries. We will collect them into pools according to some complicated formula and someone will check (at least the contract says they will check) to make sure that specific debt is in the right pool and that if something goes wrong the debt is substituted according to another complex formula. You will own a very small piece of that very large pool and you will be paid according to this other complex formula. Here’s a 200-page prospectus that lays it all out for you.”
Here’s the proposition for investors on LC: “You can invest in a note that will only get paid back if Joe X pays his debts. Joe’s credit score is 750 and he says he’s a teacher but he has not proved what his income is. Click here if you want to lend money [in effect] to Joe.”
The LC model is a lot more efficient in many ways. The reason we used to need traditional ABS (and traditional banks, for that matter) is that it was so difficult to match people’s specific needs with respect to maturities and risk with what was available in the markets. Banks functioned as massive maturity alchemists and risk distributors. But now, financial technology has made it so easy to match a consumer’s needs that the bank’s role as intermediator is becoming superfluous.
Part of the reason for this is the ability to make tailored investments in very small denominations — to get granular, as it were. I’ve been watching U-Haul’s “Investors Club” with interest. The U-Haul parent company is offering notes in amounts as little as $100, secured by things like a specific identified truck or a pile of wrapping cloths. No bank, no investment bank, just a direct loan to U-Haul’s parent.
Part of the story in both these investment alternatives, of course, is disintermediation. The lending is direct and you skip the traditional intermediaries, because of the ability to connect lender and borrower online. But I think the more important aspect of the story is granularity: the ability to make micro-investments in specifically identified risks, which was only recently made possible by modern processing power.
Michael Lewis’s books are short, well-written and easily understandable. That means they can be read even by Congresscritters so we can expect EVEN MORE hearings on HFT soon. Did they listen to the Zombie Bears? No they did not. Do they pay attention to the postings on Zero Hedge, where people who are quite funny and clever but also scary post doom and gloom every day and where they have been going on about HFT for lo, these four years and more? No. Do they pay any attention to Eric Scott Hunsader from Nanex who knows about these things (and whose Twitter feed I have been enlightened by for some time)? Nope. Did they read any of the other books about HFT? Nah. It’s not news on the Hill until Michael writes about it. And thus, Mr. Lewis moves markets.
It’s a really good book. I mean, he’s written a cliffhanger about a bunch of Asberger-y guys and Canadians and introduced more human interest than would probably be apparent if you met them in person. He’s explained some really complex stuff in a way you can get totally into, and mostly understand.
One question though: at what point did Michael Lewis become the story? This is all super-recent stuff. It’s not something he heard about and then went back and recreated. The book reads like from some point he was actually there in the room and along for the ride with the IEX guys (alternatively, someone with total recall described what everyone said and what t-shirt they were wearing and I’m not ruling that out because hey, on the spectrum, right?). And that wouldn’t matter if he wasn’t him, writing this book. Because now, Heisenberg-style, his book is going to influence where this industry goes.
I raised this before: see the bit about cross-border custody when I started the ZBI. It’s not inconceivable that Russia will respond to financial sanctions by more or less specious attacks on Western financial institutions that operate in Russia. Like acting as custodians of equity securities. It would not be the first time that Russian authorities have taken such actions and if I were holding Russian ADRs . . . well, I wouldn’t be holding Russian ADRs.
Because seriously, no comment is possible when crazy meets crazy. I came to this page because of the Beck/Freeman interview. But I stayed because it has Illuminati, Freemasons, Gold and Bitcoins! And suicided bankers and random Capitalization and apostrophe’s. And the world ending on March 4. And gold and Bitcoins! Gold Bitcoins! But hide them in the ground because the Freemasons will be starting WW3 shortly (although they’d better get it done soon on account of said end-of-the-world thing).
Ah, teh intertubes. Bless.
A continuing theme in this blog is that there is a huge need for financial literacy in the United States. After reading some of the comments on the SEC’s newly-proposed Regulation Crowdfunding I’m beginning to think that the need is just for regular literacy. Possibly also a need for some folks to repeat junior high civics classes.
Here’s the thing. The JOBS Act set some very specific constraints around securities crowdfunding and instructed the SEC to implement that legislative mandate. THE SEC CANNOT CHANGE THE LEGISLATION. If we did let an unelected government agency do that, it wouldn’t be very democratic, would it? So the legislators make the law, and the SEC has to implement it. That means when Congress imposes a $1 million limit on a crowdfunding raise, the SEC has to follow that. The SEC says so in its Proposing Release; people should read it.
So let’s be clear:
1. The $1 million limit on a crowdfunding raise was imposed by Congress, so anyone with problems with that should take it up with their Representative or Senators. In fact, the SEC is doing the best it can to expand that $1 million limit by saying that you can do an unlimited accredited-only raise at the same time as your crowdfunding raise, which I think is going to become standard practice.
2. Investor limits: also Congress’s idea, not the SEC’s.
3. No-one is planning to touch donation and rewards crowdfunding. If you’re not offering securities, the SEC is not planning to impose any regulations on you at all. You and your zombie movie are the FTC’s problem, not the SEC’s.