
How to disrupt Wall Street - rpledge
http://cdixon.org/2010/01/23/how-to-disrupt-wall-street/
======
loganfrederick
Much of this post is written off the cuff, but my initial thought is that
disrupting Wall Street is hard.

1\. Lots of regulations ensure high barriers to entry. 2\. Lots of money to
ensure regulations stay in place.

Here is Dixon's list and my reasons why it is so hard to disrupt (usually due
to the two reasons above):

1\. Retail Banks- I'm not very knowledgeable on the specific regulations that
banks face, but various rules that have changed throughout time are the areas
where banks can operate (part of Glass-Steagel, Gramm-Leach-Bliley repealed
it, again not an expert on their specifics), branches vs no branches, capital
requirements, etc. Pretty much any of these and the ones I've left out create
difficulties for any newcomers. You see some successful online alternatives
like ING Direct, and hopefully the future of banking goes in a similar
direction.

2\. Credit Cards: To address one of Dixon's points, how do you have a payment
company that DOESN'T rely on current financial infrastructure to some degree?
He lists PayPal as an example, but PayPal is basically a payment
processor/credit card alternative. They address the credit card problem but
not the banking one, and there's still much room for improvement here (if
Square was tied to banks instead of credit cards, they'd be one step closer).

3\. Proprietary Trading: Some ideas to improve the system would be lowering
accredited investor rules to allow more people to invest as they please and
decreased regulations on hedge and mutual fund requirements to allow more
competitive behavior between the two. Also added transparency on the
availability of financial information and especially the actions of the
proprietary trading desks within non-investment firms, so that shareholders of
banks know the trading behavior occurring.

4\. Trading: Similar to #3 except focused on the broker-dealers and not the
investment banks. Most of the same points stand. Generally this industry has
improved quite a bit over time, with commissions on trades dropping in 20
years from $100+ down to $7-$0. The latest concern Dixon points out is high-
frequency trading. I'm not in favor regulating fair HFT, just the shadier
dealings of front-running where they are using knowledge of other individual
trades for their own game, essentially pumping up stocks before the public can
buy them because they know what the public is buying before they buy it.
Generally, as long as any citizen either directly by investing in an HFT firm
(which is rarely, if never, allowed due to accredited investor rules) directly
or through their hedge/mutual fund, then it's not really that unfair a playing
ground.

5\. Investment Banking: I am more sympathetic to the plight of the i-banks
than most. I spoke once with the owner of a boutique i-bank in Illinois that
does M&A and bond issuing on a mid-level scale and he said the regulations
here are fewer than those related to trading. This is anecdotal. My gripe here
is the same as everyone else. Due to their size, investment banks are have
been protected from their losses by the government, when there were other
options to cushion the blow while still holding the firms liable for their
malinvestments. One of the few, but best ways I've thought of disrupting this
industry is to have boutique specialist firms really start competing on price
and features. The obvious problem here is that i-banking is often an industry
of "it's who you know" as opposed to actual competitiveness. I.E. A company
looking to do a bond issuing or M&A will go to the firm where they're
comfortable friends of the people on the other side of the negotiation table.

6\. Research: Dixon barely points out any problems here. The biggest problem
is that similar to lots of consulting firms; they produce garbage for large
fees. The simple solution is that well-meaning people and financial firms
should only hire research firms that perform well. This industry should
probably consolidate because theirs so much shitty finance research and
modeling done.

7\. Mutual funds: Could start measuring their compensation on performance,
rather than fixed fees they receive now. Make the industry more lean. They
might be "finance" companies, but they're traders, not investment banks. Being
based on performance would mean every year half the industry would go starving
while the rest were feasting, so it's unlikely to see that happen much. But if
it did, it'd allow the industry to consolidate a bit. Traders/investors at
large funds who think they could outperform their companies could start a new
firm to get even greater personal gains. To me, that's the price for wanting
to be in the trading game. It's like a salesman who works only on commission.
You're paid for doing your job well.

What we have in modern finance is a regulatory-protected cartel. I believe
some of the ideas I've brought up and problems Dixon pointed out could lead to
a healthier financial future for the world.

However, many of these regulations are in place for good reasons, and I
understand that. Most people should NOT have to dedicate their lives to
handling their finances when it can be outsourced to specialists. That's how
we manage most industries. Like in other industries, competition is the check
and balance to that freedom. No one firm can dominate forever without
continually improving its service if it doesn't want another upstart to come
eat its lunch.

In that regard, the financial system we have now is significantly better than
it was 100 years ago when people could get conned out of money by characters
such as Charles Ponzi or whole towns could become bankrupt because the local
bank couldn't diversify risk.

Simply put, we have put faith in financiers and have allowed regulations to
protect them when we were trying to protect their customers. Now I believe is
the time to bring down some of the walls so they may face competition. This
will result in a healthier financial landscape.

It is my hope that as we move forward through the economic challenges facing
out country, the financial industry is allowed to innovate, whether in a
regulated fashion or not, in order to return to being a "financial services"
industry.

Financial firms should exist to support industries and people, not abuse them.

~~~
simonsez
I think the point re: credit cards is that PayPal has actually been able to
create an alternative payment system that lives outside the banking system - I
think PayPal itself is a bank (am I wrong?) in that they take your deposits
when you leave your money in your account.

I agree that there is no getting around the banking system completely (unless
you rely in cash somehow), but theoretically you could enable another way to
move money from one bank account to another without charging 20%+ interest
rates and exorbitant late fees, no?

~~~
yummyfajitas
_...but theoretically you could enable another way to move money from one bank
account to another without charging 20%+ interest rates and exorbitant late
fees, no?_

Like a debit card, a wire transfer or a check? Or like setting up online bill
pay to pay off your credit card in full every month?

~~~
simonsez
Right, so all of those work now through the existing financial system, but
they take a long time to clear (I believe ACH is several days).

I imagine a startup (would it have to be a bank? I'm not sure) could build
something where the transfer is semi-instantaneous and disperse the risk among
it's other customers somehow in a more equitable manner (perhaps charging a
fee?). It might, of course, be difficult to compete against the credit card,
which seems free to most consumers (but is subsidized by the merchants and
those borrowers who don't pay in full)

------
yummyfajitas
Many of these ideas seem aimed only at harming "Wall St", not at providing
benefits to consumers.

For example, 1. No one forces customers to deposit money in banks, they do it
because a valuable service is provided (ATM's, direct deposit). How will using
a check cashing place (thereby disrupting wall st) help me?

Or 4. If you don't want your money "skimmed" by high frequency folks
(disclaimer: I'm one of them) and don't want to pay commissions, use ALO
orders [1]. This has the problem that your order might never be filled. If I
want to own 100 shares of Tesla now (and I believe it is worth $1.00, assuming
a bid/ask of $0.01), how does harming wall st help me?

Or 8. The author seems unaware that mutual funds are already being
disrupted...by the ETF's (issued by _Wall St_ ) he suggests we buy. Maybe we
should stick are money under a mattress?

To borrow a phrase from other discussions, "the goal isn't to kill facebook,
it's to help our customers." This applies here - focus on the consumer, not on
the competitor.

[1]
[http://www.nasdaqtrader.com/content/ProductsServices/Trading...](http://www.nasdaqtrader.com/content/ProductsServices/Trading/postonly_factsheet.pdf&pli=1)
[http://www.nyse.com/equities/nysearcaequities/1157018931913....](http://www.nyse.com/equities/nysearcaequities/1157018931913.html)

~~~
_delirium
I think there's a good correlation, though. High profit margins are a big
flashing red light that consumers could be getting something better or cheaper
or both, since in competitive markets, high profit margins don't persist. So
they're a decent way of identifying where disruptive opportunities lie: figure
out why these high profit margins are persisting, and how your startup can
move in on that territory.

~~~
yummyfajitas
_...in competitive markets, high profit margins don't persist_

A couple of the markets Dixon identified are not competitive, namely credit
cards and mutual fund management [1].

But quite a few are highly competitive and don't have high profit margins:
retail banks, market making (HFT) and research, for example.

Prop trading is also highly competitive, but profits are high because the risk
is high as well. Dixon explicitly advises individuals not to compete with the
big players because they will probably lose. It's hard even for big players -
remember AIG, Lehman and Bear? Thousands of hedge funds went under, so many
that the big banks had to lay off most of their prime brokerage divisions.

[1] Mutual funds benefit from an agency problem - your employer selects which
funds you can put your retirement into. I'd love to buy low cost ETF's, but
then I wouldn't get the tax advantage.

~~~
jbooth
Competitive doesn't necessarily mean productive.

The stock market functioned perfectly well (well, you know what I mean) for
100 years before HFT came about. Now that it's here, does the stock market
work better? No, it works worse, if anything. It's just another way for
insiders to win by rigging the game.

My problem with Wall St and seemingly Dixon's is that it's all about rigging
things to your advantage rather than competing on quality. HFT doesn't create
value, it just agglomerates wealth to those with servers in the right colos.
Mutual funds and credit cards, as you say, are optimized towards leveraging an
immovable market position to extract money from the rest of the economy.

If someone on Wall St is creating value commensurate with their salary, I'm
all about that. But it seems like the vast majority are extracting their
salary from the rest of the country as an effective tax on investment rather
than actually creating wealth.

~~~
yummyfajitas
Why do you believe the market works worse than in the past? I'm genuinely
curious why you think this, because based on what I can see, the market is
vastly more efficient today.

In the past, you'd pay a market maker 1/8 or 1/4, and even then only in
thickly traded securities. In thinly traded securities, your order might just
go unfilled. The market makers were humans with a physical seat on the trading
floor rather than a server in a colo and you'd pay your broker $100/trade
(assuming you could get him on the phone).

Now you pay a $0.01-0.02 spread, maybe $0.10 on thinly traded securities. You
pay your broker $0-$10/trade and you can trade from your N1 or iphone. A colo
server is also much cheaper than access to the physical trading floor.

HFT provides value: liquidity and immediacy. If you don't believe that is
worth $0.02, you can place ALO orders and you won't need to pay for it.

~~~
jbooth
Because it penalizes people who want to buy a stock based on company quality
and either hold it or swing trade.

Let's disambiguate 2 developments here : There's the computerization of
market-making, which leads to efficiency gains and transparency gains,
allowing trades to be fulfilled more cheaply and for more bids/asks to be
visible at a given point in time, adding liquidity. None of that really
constitutes "high frequency trading" in my mind, more just the inevitabilites
of IT.

Then there's stuff like front-running, or micro-arbitrage where the first one
to the post wins the money. Are these fulfilling a need that didn't exist
before? Or is it just a large amount of money being invested by brokerages in
order to extract a larger amount of money from people without servers in the
right places? My instinct leans towards the latter. It's not like 1/4-second
price inconsistencies were creating some huge problem before. I don't even
notice 1/4 second, and the stock market shuts down at 4pm anyways. Prices
don't have to be a continuous curve.

If I don't believe HFT provides value, I can go spit up a rope -- it'll still
eat away at my margins if I try to invest based on value. God help me if I
tried to day trade or swing trade.

As far as "works worse than in the past", I did qualify with "if anything",
but to my mind it's become less reflective of the value of companies and more
reflective of the current state of various algorithms, which may or may not
have anything to do with company value. I see that as a recipe for bubbles and
calamities.

~~~
yummyfajitas
You believe HFT is bad because it makes _swing trading_ and _day trading_
unprofitable?!? Fun fact: they aren't unprofitable, since the algorithmic
traders you criticize are swing trading and day trading. It sounds like your
complaint is simply that machines do a better job than you.

Concering micro-arbitrage, if you don't notice 1/4 second price
inconsistencies, you also won't notice if computers resolve them in 1ms rather
than a fast fingered human resolving them in 1/4 sec. The money is being
extracted regardless, the only difference between now and the past is that a
geek with a computer beats the fast fingered frat boy. That's bad if you were
the human trader, but who else is harmed?

Front running is illegal and has been for a long time. I'm also not sure how
you think HFT traders do it - do you think HFT firms have trojans which alert
them when your mouse is hovering over the "place order" button at etrade?

I'm really curious how you believe HFT will "eat away at your margins" if you
make long term value investments. If you believe apple will go up 20%, do you
really care about the $0.01 spread? Even if you care, how can the HFT guys
make money off you if you place an ALO order? Could you explain the mechanics?

~~~
jbooth
I think HFT is bad because it substitutes "create value" for "game the
system".

I won't miss the .01 that much, but if they do it a billion times.. they still
didn't create anything. They just extracted money from the system while
producing zero value.

EDIT: As far as who's being hurt? All of us. Smart people should be creating
value, not playing silly parlor games against each other for money. We're all
missing out by making a video game more profitable than creating things.

~~~
yummyfajitas
I actually agree with you on the component of HFT/speculation in general that
is fighting over the _distribution_ of profits rather than creating profits
(i.e., beating other traders to the punch); this creates no new gains. Of
course, once we reach the point where most of HFT/trading is fighting over
distribution of profits, we've reached the point where it is barely
profitable. Presumably smart people will start exiting in droves at that time
- I certainly plan to do so.

But I suspect that the transition to HFT over human market makers/daytraders
is a net gain even with regards to smart people creating value; isn't it a
good thing to have 3 geeks writing programs to replace 100 daytraders? (Based
on your previous comment, I assume you agree with me that profitable day/swing
trading does create value.) In general, isn't replacing lots of humans by a
few smart people + machines a good thing?

~~~
jbooth
Well, if we're down to the portion of HFT/speculation that's extracting gains
rather than contributing to the economy, we've made it pretty far.

As far as robots running the stock market -- I don't know. Frankly, I'm
inclined to be awfully conservative about the stock market at present. If you
told me we were going backwards 5 years in technology and there'd be way less
money made on the stock market, I'd probably be ok with it, for a few reasons.

1) Frankly, I'd rather be conservative on cutting edge approaches to stock
pricing for a little bit.

2) To my mind, the stock market doesn't exist to enrich participants, it
exists to efficiently distribute capital. Enriching participants is good
motivation, but it shouldn't be legalized gambling and game playing. If an
unreasonable share of that capital is going to the console cowboys rather than
being distributed to companies and investors (not traders), then something's
wrong there. I'm not sure if we're at that point but I don't like the trend.

3) As I said upthread, I don't understand the gains for the economy as a whole
of smoothing out the price curve in the sub-second range. I really don't.
Anybody who's going to spend a lot of money on something takes more than a
second to make up their mind, right? They probably had to get it budgeted and
everything. So the subsecond trading on, say, commodities seems to me to be at
the expense of actual purchasers of commodities. The gains have to come from
somewhere, right?

In general, I'd settle for slower, dumber and less profitable day traders if
the upshot is less risk to the system, greater portions of investment gains
going to grandma and a more deliberately moving stock market. I'd be fine with
that state of affairs, despite my general drive towards futurism on anything
else.

~~~
yummyfajitas
_I don't understand the gains for the economy as a whole of smoothing out the
price curve in the sub-second range._

I'll make it simple for you. There are none.

HFT traders as a whole make no gains from trading in microseconds as opposed
to milliseconds or even seconds. If an investor wants to buy 100 shares right
now with a spread of $0.02/share, market makers will earn $2.00 over the next
few seconds. The only question is _which_ market maker will earn the $2.00,
and the answer is whoever is fastest.

Trading fast doesn't increase profits, all it does is redistribute them. Of
course, one HFT firm could also outbid the rest, lowering the spread to
$0.01/share and allowing the retail investor to pay only $1.00. That's why
competition among HFT firms is good.

But you are correct that all the effort put into lowering latency (rather than
improving trading strategies) is a deadweight loss to society.

------
leelin
My guess is real estate will be disrupted long before Wall Street.

Having worked in both finance and real estate, the parallels between real
estate transactions and I-banking deals are shockingly similar, only I-banking
deals are much more complex and high stakes. If you think investment bankers
will soon be out of work, you should also be betting the real estate broker as
a profession will be eradicated the way eTrade destroyed the old school retail
stock broker.

Sadly, right now I'd take the other side of the trade for the next 5 years
(long Wall Street, short startups trying to disrupt M&A). When amateurs engage
in very complex and high stakes deals, such as buying or selling a house
priced more than their net worth, they tend to want professional hand holding,
among many, many other things.

~~~
aspiringsensei
> eTrade destroyed the old school retail stock broker

Don't look now, but these guys are still very much alive[1].You may not use
them, but plenty of people are still charging $150 for a stock trade under a
theory their advice is of value.

[1] Assuming you're referring to the mid-80s school of brokers, not the
standardized commissions school.

------
mkramlich
Wall Street appears to be doing a lot of insider trading, front running and
shell games. To disrupt them, somebody just has to come along and provide some
truly useful and non-parasitic financial service, while not doing those other
things. Keep the baby but not the bathwater. I'm not sure exactly how to do
that in a reliable and consistent way, while not say keeping all your cash
under a matress. Because if you just deposit cash into a local bank, it can
then indirectly end up in their hands.

~~~
fanboy123
I have no idea how wall st and retail banking got mixed up in everybody's
minds. Stegall only allowed the two to be run under the same roof...

Why keep money in a mattress when the FDIC and its insurance is backed by the
full faith of the USGovt? If you buy a share of stock well, that is different.

When you buy a share of stock, what does that mean? How is the value derived
(of the share)? How does the system that tells you that value work? Most
people can't answer these questions and yet invest money anyways.

The banking/financial system provides plenty of valuable services. That it
also participates in value-destroying activities is always partially the fault
of the consumers who want these activities to exist in the first place.

~~~
mmt
_Stegall only allowed the two to be run under the same roof..._

I think "only" is dismissive of the whole point, which is that they have been
intertwined from a regulatory standpoint, arguably undermining the regulation
of each.

 _Why keep money in a mattress when the FDIC and its insurance is backed by
the full faith of the USGovt?_

The mattress alternative is a patent strawman, but FDIC insurance hardly
protects against all the damage a bank failure causes its depositors. What's
the average amount of time between a bank failing to pay its depositors and
the FDIC paying a claim?

------
larsberg
I think the author doesn't realize how much money prop trading firms make off
you even if you "just invest in the S&P 500". Between changes in index makeup,
differences between underlying and derived instruments, and the need for the
ETF to keep the required balance of actuals, there's quite a bit of movement
to make money off of.

And it's not exactly hidden knowledge when which large pension/mutual funds
make their adjustments.

------
iamelgringo
We're hoping to be added to the mix at some point at <http://Newsley.com> .
We're transitioning from social news to financial news search based on
semantic analysis of news articles. We are still in very heavy development,
but little by little, we're getting there.

By the way, if you're having problems doing financial research, I'd love to
hear about them. Ping me. My email is in my sig.

------
T_S_
Most nimble startups will run away from the regulated aspects of Wall Street.
Really none of the functions list escape regulation.

To disrupt Wall Street you would have to get legislation passed and regulators
on board. The time scale for change is a different order of magnitude than
most startups can handle.

These people generally come from or are connected to the industry and will
fear change. Also, what type of disruption would actually benefit society? Not
saying nothing is needed. It's just that the arguments would have to be strong
to even get an audience in Congress, and they think they just fixed
everything.

