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Fintech in Chains (johnhcochrane.blogspot.com)
106 points by avoidboringppl 3 days ago | hide | past | favorite | 77 comments

> For banking there is a reason for regulation, and it is precisely deposits. Deposits are open to runs. Runs are bad for all sorts of reasons. Financial crises are runs. Hence we have banking regulations. That's not a defense of current banking regulation. But there is a problem and a reason for some regulation.

> But fintech doesn't take deposits. The one central problem with banking is gone.

All banking regulations are due solely to the fact that banks take deposits? There is no other reason one could imagine for why banks, FinTech, or other financial services providers need to be regulated? All financial crises are runs on deposits?

Pretty undeveloped and unconvincing reasoning. If you think for a few seconds it’s easy to imagine other situations that led to necessary regulations in banking.

> All financial crises are runs on deposits?

Interesting question. I'm thinking he means more than just folks withdrawing their cash at the teller when he says "run". I found this:


"At its core, our financial crisis was a systemic run. The run started in the shadow banking system of overnight repurchase agreements, asset-backed securities, broker-dealer relationships, and investment banks. Arguably, it was about to spread to the large commercial banks when the Treasury Department and the Federal Reserve Board stepped in with a blanket debt guarantee and TARP (Troubled Asset Relief Program) recapitalization. But the basic economic structure of our financial crisis was the same as that of the panics and runs on demand deposits that we have seen many times before.

"The run defines the event as a crisis. People lost a lot of money in the 2000 tech stock bust. But there was no run, there was no crisis, and only a mild recession. Our financial system and economy could easily have handled the decline in home values and mortgage-backed security (MBS) values—which might also have been a lot smaller—had there not been a run.

> At its core, our financial crisis was a systemic run. The run started in the shadow banking system of overnight repurchase agreements, asset-backed securities, broker-dealer relationships, and investment banks.

Note how none of these things are consumer deposits. Fintech and shadow banking are two names for the same thing, and the same risk of runs and need for regulation applies.

Shadow banking isn’t fintech. It’s non-bank lenders like hedge funds.

I should've said fintech is a subset of shadow banking, because not all shadow banks are tech-oriented. But a fintech company is more-or-less by definition a non-bank doing bank-like things, which is the definition of a shadow bank.

FinTech is more than that though. Fintech is also advanced analytics for helping banks price derivatives. And for auto-pricing real estate.

Derivatives pricing and real estate pricing were major causal factors in the last financial crisis. A lot of the banking regulations regarding reporting, data integrity etc. are if anything even more important when the data analysis is being done by a separate entity from the one that's performing the transactions.

The run he's describing there is fundamentally the same as a run on retail banks. Retail banks in the US are pretty much run-proof due to the FDIC, but that's not the case for the shadow banking system.

It's completely wrong. 2008 didn't come from a run on the bank, it came from a collapse in value of assets used as collateral for other assets, triggering widespread bankruptcy, triggering collapses in assets backed by the loans written off in those bankruptcies, triggering more bankruptcy by owners of those assets, triggering collapses in assets backed by loans those institutions had... You get the point. Deposits were totally irrelevant. Investments were overleveraged across the board.

Banking crises can come from any form of leverage. It doesn't matter what the original collateral is, whether it's deposits or private investment. All you need is for losses to exceed collateral at a large scale. In 2008, this came from a chain reaction, which is the main point of broad limits on leverage, and that risk absolutely applies to fintech.

How does Fintech create leverage?

Not sure what you're getting at. They may use leverage, depending on the niche. As far as how, same way anyone else does. They use an asset as collateral to buy more of another asset (or they offer a service to do so).

>> But fintech doesn't take deposits. The one central problem with banking is gone.

> All banking regulations are due solely to the fact that banks take deposits? There is no other reason one could imagine for why banks, FinTech, or other financial services providers need to be regulated? All financial crises are runs on deposits?

FWIW, the way I interpreted this was “crises are caused by over-leveraged systems becoming insolvent”, which sounds less wacky.

But when you say it that way it actually does apply to fintech, doesn't it?

I can think a few: - Deposits (you would want your money back) - Mortgages and loans (money lent was your deposit, you might want to ensure that borrowers observe a certain criteria to ensure repayment, and priced accordingly so the loan pool can cover eventual defaults) - Preventing Money Laundering and Terrorism funding - Forcing Banks to provide you with enough data about investment products so you don’t end up gambling your savings on leveraged derivatives

Having worked in Financial Services for 20 years (both Banks and Fintech), and being aware any broad generalization is unfair, I can tell you a lot of the flack Banks get it’s due to regulations they would shed on a snap, while fin techs choose to skip them altogether.

Lending to unbanked, unprivileged minorities sounds great on The brochure and is hard to argue against. The part they leave out is the money they are lending belongs are the lifelong savings of a 80-year old couple snared on the promise of safe, 2% returns, and then tell them than most micro-loans defaulted and their lost their capital.

Rules are there for a reason. They are cumbersome, archaic and way too many, but If you remove them, consumers will end up hurt.

And the US Banking system is not a great benchmark as it is borked.

> There is no other reason one could imagine for why banks, FinTech, or other financial services providers need to be regulated?

He boils it all down to crises, but that's not the sum total of what can go wrong with this kind of thing. Look at something that another kind of "fintech" has been doing for years: predatory lending via payday loans. Usury is real, and usurers prey upon those with the least financial literacy in stressful times when they are vulnerable. Credit cards and lines of credit similarly can be extended to people who may not realize truly what they're getting themselves into, or who may have no choice given their circumstances.

It is for these situations and these people that we need additional regulation in order to save people from terrible crushing debt.

We need to provide people with fewer options to prevent them from making bad decisions?

How come non of the anti-payroll loan advocates ever propose a way to provide these customers with better loans?

I don't want them to get loans. They can't pay back the loans, so why should they get loans? It's not like people use loans to buy bread, they use them to buy things they don't really need.

This exactly.

Whether OCC specifically is well suited to do this work is more of an open question.

> All banking regulations are due solely > to the fact that banks take deposits?

Yes! Ability to take deposits is pretty much the definition of a bank[0]. So, by definition, all banking regulations are due to banks' ability to take deposits.

There are other financial regulations that apply to wider ranges of financial businesses (e.g. those related to detecting and preventing money laundering), but these are not specific to banks. Given that they apply to businesses that aren't banks, they can't be considered 'banking regulations'.

[0] I'm not from the US, so this UK reference was easier to find than a US equivalent: https://www.bankofengland.co.uk/statistics/data-collection/i... If you want a list of banks in the UK, you will look at the Monetary Financial Institutions (MFI) list, which lists 'all banks and building societies who have permission to accept deposits in the UK.'

In general, I'm in agreement with this thesis, but it ignores consumer protection. What entity should handle consumer protection in respect to fintechs? Should it fall under state and local laws? Then, what if Jonny in California (which has strong protections) takes a loan from Fintech X in South Dakota. Can Jonny apply California regulations to his loan, placing a cap on interest that he has to pay Fintech X? Can Fintech X take Jonny's house that he signed over as collateral, ignoring California's regulations?

Financial regulation is a giant headache here and in many of the countries we've worked in. Looser regulation should be beneficial to most consumers. But what about consumers or businesses that sign themselves into bad deals or get purposefully taken advantage of? Which is really the heart of a lot of politics, how much do we protect people from their own poor choices.

Post 2007's run, the Consumer Financial Protection Board was specifically established federally to regulate exactly the area of consumer protection in respect to financial services.

Protecting the stability of the banking system, which is inherently unstable (borrowing short, lending long) is a requirement for defending the value of a nation's currency and national debt.

Protecting consumers from predatory financial practices is not the same sort of regulatory requirement and shouldn't be regulated by the same people.

The CFPB is similar to the FDA, it protects consumers from predatory producers. That's completely different to the Fed/OCC protecting the banking system.

For the OCC to say that part of their scope is "providing fair access to financial services" is regulatory overreach and scope creep. There's a reason they're called the Comptroller of the Currency.

The author even calls out that hot dog stands are regulated for cleanliness and possible danger to consumers.

Consumers do things not in their own best interest all the time. Think MLMs, rent-to-own appliances and furniture, upside down leases, etc.

For me the point of regulation is when some of these fintech companies start to hold deposits, which some of them represent themselves as doing even though the actual account is with a traditional institution. The consumer doesn’t necessarily know that though.

It’s sort of like regulating hotdog stands that are everywhere at once. There has to be something keeping those hot dog stands clean and the steam trays warm and full, and it apparently isn’t the operator’s good manners and sense of fair play.

See you had the first comment here. This was my thinking too. Whole thesis about free market and protecting markets and not being beneficial for competition etc. I'm all for easing this.

But every coin has its flipside. Consumer protection many of these regulations also include consumer protection. This is what most people I discuss this with forget....

>What entity should handle consumer protection in respect to fintechs?

Does the same entity that handles all other consumer protection not work in this case? Why, what makes it unique?

How in the world is looser regulation of opaque (at best) SV bullshit CO's a good idea? The more relevant question to ask is what exactly is the value prop of fintech?

I don't see it as any different than the mortgage brokers of the 2008's: stripping fees off transactions with ZERO value add to the consumer...

If you want to really fix things start with the national market system. At this point between dark pools, HFT and non-public company markets it is an unqualified effing disaster from both a price discovery and accessibility perspective.


Well, speaking from my experience of working with people on the "bottom of the pyramid" across the world, I can attest that there are various regulations which has led to the traditional banking system to not provide credit or opportunity to these entrepreneurs.

Prior to fintechs getting into the remittance space, fees were as much as 20% on average of transactions.

Prior to microfinance institutions and then true fintechs such as Tala, Branch, GoPay, Ant, etc. there were 10 of millions of merchants who could get no access to credit.

Prior to fintechs, you needed to physically go to a bank to become eligible for a loan and fill out paper forms. This may not seem like a high barrier to you.

Short of it is, heavy regulation leads to: * High compliance costs * Low appetite for risk * Slow to little innovation

There are regulations that don't make sense for small merchants: Anti-money laundering laws for instance which are generally good, but impose a completely undue burden on merchants that want to borrow $500.

Or a risk modeling team at a bank that has dozens of staff may make sense cost-wise for loans of $100k+, but they don't make sense for < $10k loans and their risk models also don't work at those levels.

This also isn't just Silicon Valley. It's a common problem in most countries of the world, speaking from experience.

> stripping fees off transactions with ZERO value add to the consumer...

The explosion of online shops made possible by companies like Stripe enabling secure credit card processing without imposing PCI DSS compliance on small businesses would disagree with you on whether there’s value to the consumer. If nothing else, greater variety of shops available means greater choice, which is generally considered good for the consumer.

Or PayPal, which allows the unbanked population to load funds to a widely-accepted online wallet and actually participate in online marketplaces, which they might otherwise be unable to do.

Or Affirm, which provides on-demand credit to consumers and lets them amortize large one-time costs over a few months, enabling them to afford, e.g., tuition when they otherwise might not be able to. (Tuition is maybe a bad example since most universities already offer tuition financing options; but online education services frequently don’t)

Are you asking what value Square and other transaction processing systems have added to the market? And is that a serious question, because if so I will explain.

As this blog bluntly points out, deposits are subject to runs when used for lending and reserve requirements must be met. If you don’t lend against deposits, runs are of no consequence (hold deposits in a Treasuries money market fund, implicitly guaranteed by the Fed and the Treasury, no different then a brokerage core account). If you want to lend, originate it, securitize it, and sell it on the bond market (last point the blog makes about FinTech doing most mortgage origination volume now). The Fed is working on providing instant payment infra, which minimizes the need for domestic wires and Zelle (bank consortium instant payment platform) long term.

One of the most annoying issues I have with the Fed and the OCC are the denial of charters for narrow banks to prevent competition against legacy banks. I am very pro consumer finance regulation but very anti regulatory capture enabling regulation. You can, in a very straightforward way, protect consumers from predatory financial business practices while supporting financial innovation (which, at this point, is cannibalization of inefficient banking goliaths and necessary evolutionary pressure).

Most definitely, remove the chains from innovators and let them build more efficient platforms for their customers on open protocols and existing derisked primitives.

There's still a need for some degree of attentive supervision for deposit-only institutions to make sure that they're actually investing their customers' money in liquid, secure, assets.

In the absence of regulation, the incentives for management would be to invest customer deposits in high-yield, and therefore high risk and/or illiquid, assets. Customers need to be protected against losing their deposits because management invested everything in junk bonds or real estate.

There's also the risk of embezzlement to consider. Non-bank accounting controls might not be adequate to protect large volumes of consumer deposits from theft.

The fragility of (unregulated) cryptocurrency exchanges paints a very clear picture of what would happen if deposit-only institutions were allowed to operate without any supervision.

Yes! I agree, but this is exactly what these regulators are for, and systems should be required to be built to attest to and meet continuous compliance requirements as it relates to monies management. When deviations are detected via instrumentation and telemetry, triage is triggered to ensure controls haven’t been breached (and if they have been breached, regulators assume control to provide an orderly transition for the benefit of the financial consumers in question) (ie Don’t be Citi risk management)

Disclosure: I work in financial infrastructure. Thoughts, opinions, and rants are my own.

Does this financial innovation ever go into a different direction than higher risk?

How about

- money transfers within seconds, rather than day(s)

- wire fees measured in pennies or dimes, rather than double digit dollars

> - money transfers within seconds, rather than day(s)

This is higher risk - what if the money transfer was part of a scam/fraud or criminal activity? The bank might be liable in these cases. At best, the convenience comes at the cost of (hidden) higher risk for both sender and receiver.

What stops a regular bank from doing this?

Their profits.

Cochrane seriously misconstrues what the WSJ op-ed is about, which I think is understandable since it adopts a pro-regulatory tone while in the underlying Second Circuit appeal that the op-ed is about the OCC is adopting a (sort of) deregulatory position.

I think this article gives a better understanding of what’s actually happening: https://www.kilpatricktownsend.com/Blog/fintech/2020/8/Banki...

In brief, if you want to set up a fintech company now, you may need to comply with 50 states laws. That isn’t just being basically law-abiding, but involves serious compliance work. I started looking up licenses for Square as an example and got bored after the first few as state web sites are all different and inconvenient:




Each of those, and also for all the other states, involved satisfying a state agency that Square was adequately solvent and would comply with a host of laws. You may notice that the first two have license numbers and the numbers are small. That says something about how easy it is to get the licenses. This is a meaningful part of these companies’ moats.

The OCC action that New York is challenging is to provide a federal alternative structure in which companies would get one federal license and receive nationwide permission to engage in a host of banking-like activities. They would still be able to get state licenses instead, if they wanted. This system (of picking between a state and federal regulator) is called dual chartering and has existed in the banking industry for a long time; it establishes a check on both state and federal regulators by allowing the regulated entity to switch to an alternative regulator.

Fintech companies often do take deposits in the short term. People have balances with PayPal, which could potentially go bust or be looted. There's no deposit insurance.

Classical money transfer companies like Western Union don't hold money very long, days at most. But PayPal, Venmo, etc. do.

> People have balances with PayPal, > which could potentially go bust or be looted."

This is true. But PayPal's terms say that customer money is ringfenced: "These pooled amounts are held apart from PayPal’s corporate funds, and PayPal will neither use these funds for its operating expenses or any other corporate purposes"

> There's no deposit insurance.

This is not exactly true. As I understand it, some PayPal USD balances have FDIC insurance because the funds are stored at Wells Fargo in the customer's name: "If you have a PayPal Cash Card debit card as part of a Cash Account, have enrolled in Direct Deposit, or have established Goals in PayPal, such funds will have pass-through FDIC insurance as further detailed in the PayPal Cash and PayPal Cash Plus Account Terms and Conditions."

Seems like this should be just a theft issue. If Fedex goes bankrupt while my package is in transit, I wouldn't expect them to be allowed to auction it to pay off their debt.

Money is a lot more portable than parcels. If Daniel H. Schulman wires all paypal customer deposits to a bank account in a hostile jurisdiction, then flies his private jet to that country, what should the US do?

Should the US say, start a literal war with Russia because Schulman stole $20M? You could say "economic sanctions", but what economic sanctions hasn't Congress already enacted against Russia?

There are a lot of countries that don't have extradition treaties with the United State, and many more than that which don't mind seeing American customers ripped off.

There’s underlying banks with fintechs that are regulated and FDIC insured. All fintechs are doing is layering technology on top of existing banks to add more functionality and a better experience.

Can't read the WSJ article linked, but

> For banking there is a reason for regulation, and it is precisely deposits. Deposits are open to runs.

I don't agree that this is the sole reason for banking regulation. For instance, Glass–Steagall was not a regulation designed to prevent "runs."

Actually, that is exactly the reason it was put in place. Banks had a habit of losing money on the investment side, which was commingled with deposits side, leading to rumors and the resulting bank runs.

Glass-Steagall prevented many of the activities that led to bank runs, and its passage greatly increased the safety of a saver’s deposits.

This should be a pretty reliable source: https://fas.org/sgp/crs/misc/R44349.pdf

Yes, it was about the activities that led to bank runs, in particular:

> Banks had a habit of losing money on the investment side, which was commingled with deposits side

Not the bank runs themselves.

By definition, bank capital is commingled. If you and I both have an account at a bank and the bank loses enough money, then we lose money.

What Glass-Steagall did[0] was separate the investments from the deposits, thereby eliminating one of the ways a commercial bank could lose capital.

My apologies if my use of the word “commingled” caused any ambiguity. For anybody who has ever worked on Wall Street or in investments, rumors run like the Mississippi during a spring flood through the community. Those same rumors can take down an investment house (e.g. Bear Stevens with the repo rumors) or a pre-Glass-Steagall bank. Hence the importance of eliminating the source of those rumors and the accompanying bank runs.

[0] The law did more than that of course. I’m merely showing one key piece of it.

Here's an archived link to the WSJ Article - Fintech Can Come Out of the Shadows - https://archive.vn/3C57W

Cheers! I thought that archive.is trick no longer worked which is why I didn't try.

Fintech can be summed up as "companies doing illegal things to lose money". It's seriously the thing that made me realize there is something very, very wrong with tech today.

For most of history the reason to do illegal things was because it was profitable but I have personally witnessed self described "fintech" companies do illegal (or at the very least questionably legal) things that anyone with a brain would say "wait, that will clearly lose more money than it makes"

Of course the trouble is that no regulatory bodies can actually enforce the majority of the regulations they are supposed to. If the government had the staff to enforce the regulations they are responsible for half of the CEOs doing fintech work would be in prison.

"bubble" doesn't even come close to describing the situation we're in.

Square and stripe are doing illegal things to lose money?

Stripe and Square are more expensive than the prior regime. They’re more convenient but more expensive. It’s not clear there’s a benefit to consumers.

This is a fair line of reasoning. However, Stripe are one YC's darling businesses so there is a lot of pre-formed opinion around here.

A sufficiently high convenience bar makes the entire project nonviable. I personally know at least a handful of businesses who got fucked over by paypal integration breakage or traditional merchant account and had all those problems go away when switching to stripe. I know of many more who looked at the hassle involved and decided not to bother (and then tried again when stripe became available in their country). If you consider the added ongoing effort to stay on top of that shit as zero-cost, yeah I guess they're more expensive. Convenience is not the right word for the peace of mind you buy by never having to deal with paypal policy or integration hassle again.

(not affiliated with stripe, just a happy customer)

Convenience implies a reduction in cost. These businesses are doing well and their customers are happy.

What do you think is happening? How are consumers getting screwed?

> Convenience implies a reduction in cost.

No, why would it? Convenience and cost are two completely separate things.

Cost is not purely monetary (price); transaction costs also factor in convenience, risk, and other factors.

I'm pretty sure GP was talking about monetary cost. This is moving the goalposts.

Disagree. Consider the phrase "time is money". That is, if Stripe costs more money, but saves me time, and I can do other things with my time, and some of those things make me money, then... is Stripe actually more expensive?

This is especially relevant if "I" am a small business rather than an individual. Then the person whose time is saved can do something else with the time that can make money for the business. Or the business can run with fewer people, which saves money.

The reason for banking regulation is so that banks do not take high-risk-high-reward-huge-losses types of risks with other people's money. If fintech does the same behavior with indirect or direct leverage of other people's money, then they should be subjected to regulation as well.

> high-risk-high-reward-huge-losses > types of risks with other people's money

Many HN readers run or work for businesses that take these kinds of risks (with money from VC funds). But those businesses (along with fintech companies) are different from banks: banks can take retail deposits.

If a bank fails then, in the absence of a government-run deposit guarantee scheme, regular people can lose their entire life savings.

If a business other than a bank fails, it's unlikely anyone other than the owner(s) will lose a large percentage of their wealth.

Then maybe the relevant distinction is "big boy investors", "fully informed of the risks", or "sharing in the rewards". Retail depositors think banks are safe places to put their money, are not equipped to parse complicated financial statements, and are not going to reap the benefits if the bank's financial wizardry pays off.

But if you have someone who is able to understand the risks, fully informed of what they are, and invests for a payback that is proportional to the risk... I don't see a problem with letting them do so. Just don't make the little guy take that risk, especially when he doesn't know he's doing so.

I see fintech companies promoting and using heavily cryptocurrencies and ledgers. A strong use case for them is the fact that in certain jurisdictions they witness a high level of trust thanks to strong financial regulations, while in others there's too much room for transaction fraud. So a distributed ledger works actually to provide a level of trust otherwise brought by regulations.

Those poor gamblers, if only they were allowed to show all the recklessness they're capable of. What a disgrace.

Why regulation of fintechs? Wirecard

That's an interesting example; Wirecard is a case of regulatory failure in that it before its collapse, the German financial regulator BaFin had been instead filing criminal complaints against reporters and short seller covering the firm.

Sure that proves that Wirecard was not regulated properly, and needs regulation.

If a city burned down because all firefighters were drunk, noone would be arguing that we don't need firefighters.

Quite right - in that case, wirecard bank was (poorly?) but the parent company is a more ordinary but prominent public company and they were clearly more concerned about potential market abuse in the stock then what the company itself was up to.

Wirecard fell under strict and already existing regulations.

Off topic, but for the longest time I thought "Fintech" referred to tech companies based in Finland or Scandinavia more broadly.

Those have a word, don't they?

As an aside, Finland is not in Scandinavia, as it is usually defined:



Roughly, Scandinavian refers to mainland Europeans who speak a language derived from Norse. Scandinavians are the majority in Denmark, Sweden, and Norway, so those are Scandinavian countries, and a minority in Finland, so that is not. Tove Jansson, Linus Torvalds, and Michael Widenius are all Finnish Scandinavians, apparently.

Nordtech sounds right, though. I imagine that various places have already been dubbed Silicon Fjord, Silicon Sauna, etc.



Only one thing could possibly improve the travesty that is fintech: a per-transaction tax. Even a $.0001 tax per trasaction would buy universal college education and universal medical care, with plenty left over to replace all coal and oil-fired power with renewables and storage and replace the air fleet with hydrogen-powered craft.

> Only one thing could possibly improve the travesty that is fintech: a per-transaction tax. Even a $.0001 tax per trasaction would buy universal college education and universal medical care, with plenty left over to replace all coal and oil-fired power with renewables and storage and replace the air fleet with hydrogen-powered craft.

That would only happen if fintech didn't change their behavior in response to such a tax. I do not find that to be a reasonable assumption.

It would still be worth conducting fintechy business. It would barely affect bonuses. It would still buy all that stuff after behavior adapted to the change.

Your claim is of a piece with claims that raising the minimum wage would destroy jobs, and people on minimum wage would be out of work. Guess what, we tried it anyway, jobs didn't vanish at all, poor people have more money to spend on necessities, and everyone is better off.

US healthcare spending in 2019: $3.6 Trillion

US Financial Sector profits: $422 billion

>It would still be worth conducting fintechy business. It would barely affect bonuses.

It is absurd and blatantly false to claim the entire burden of the U.S. healthcare system could be placed on a single industry with little effect.

Still it's worth a try.

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