Last Thursday, Robinhood Financial LLC announced a new product called “Robinhood Checking & Savings,” which would allow anyone to open a deposit account with no-fee ATM access, a debit card, insurance from the Securities Investor Protection Corp. and a 3 percent interest rate. We talked about it on Friday morning. Robinhood is not a bank, so it can’t issue checking or savings accounts, and anyway the SIPC doesn’t insure checking and savings accounts, so it was all a bit weird. I assumed, perhaps foolishly, that Robinhood, uh, has some lawyers, and that they had thought about this and figured out a way to do it legally. For instance, Robinhood can’t issue a “checking account,” or a “savings account,” since those are things only banks can do, but “checking & savings” is technically neither of those things and so perhaps it falls into a gray area. “A magic ampersand,” I called it.
Well, no. By Friday afternoon the head of the SIPC had told reporters that SIPC would not insure the accounts, and had reported Robinhood to the Securities and Exchange Commission. And by Friday evening Robinhood Checking & Savings was no more. The web page announcing the product is gone, and Robinhood’s website now contains a very-slightly-chastened-for-a-fintech “Letter From Our Founders” walking back the whole thing. “We plan to work closely with regulators as we prepare to launch our cash management program,” says Robinhood, now, “and we’re revamping our marketing materials, including the name.” The magic ampersand did not save them.
It is such a pure fintech story: Things broke faster than they could move! “What if we just offered a checking account and paid 3 percent,” someone presumably said, and rather than responding to that idea in the traditional financial-industry way (by calling their regulator, or at least their lawyers), they instead responded in the bold new fintech way (by doing it, or at least by publishing a blog post saying that they were doing it). And now look where they are. By the time they finish revamping the name with the SEC it’s going to be called the “Robinhood Penance & Risk Bad Idea Account.” “Keep the ampersand, we know how much you like ampersands,” the SEC will say smugly.
Doesn’t this kind of make you feel great about financial regulation? I mean, sure, the SIPC and SEC stamped out some innovative experimentation here, but the experimentation was “pretending to be a bank,” so I am not sure society has lost all that much. And the SIPC and the SEC stamped it out fast , and emphatically; one lesson here is that a hot tech startup that pretends to be a bank will get shot down a lot quicker than a hot tech startup that pretends to be, oh just for instance, a blood-testing company.
One possible explanation for the regulatory efficiency here is that so many of fintech’s financial innovations have been tried before. Robinhood was certainly not the first non-bank to get the bright idea of pretending to be a bank and taking deposits! 1 There are some basic ideas in finance—borrowing short to lend long, slicing a thing into shares and selling those shares, building a market for derivative bets on a thing, etc.—that are powerful and intuitive enough that people keep independently discovering them. Long experience has taught that those basic ideas are mostly good, but have some problems, and a regulatory system has been built to remember and address the problems. If you borrow short to lend long you’ll want deposit insurance; if you sell shares of a thing you’ll need to give buyers some disclosure; if you trade derivatives you should make sure your counterparties understand them; etc.
In many areas of “tech,” companies are racing to do things—in virtual reality, in artificial intelligence, in surveillance and data collection—that have genuinely never been done before and that pose novel social and regulatory challenges. In many areas of fintech , though, companies are racing to do things that were done in the 1920s, before modern financial regulation came into effect, only this time with an app. The regulators know how to handle that.
When Malaysian government investment fund 1MDB borrowed $6.5 billion from international bond markets and paid Goldman Sachs Group Inc. some $600 million in underwriting fees, and then the (alleged) criminal mastermind behind the fund (allegedly) stole about $2.7 billion of the money to finance his lifestyle and (allegedly) pay bribes to the Malaysian government officials and Middle Eastern sovereign-wealth fund employees who (allegedly) helped him, who was the victim there? There are about three main possibilities:
- If Malaysia pays back the bonds, then the victims are the people of Malaysia who have to pay billions of dollars to finance the lifestyles of some crooks.
- If the bonds just get torn up and Malaysia gets to keep whatever money is left in 1MDB, then the victims are international bond investors who loaned money to 1MDB thinking it was going to development projects that would support the debt, when in fact it was going to bribery that would not.
- If the bonds don’t get fully repaid, but in a drawn-out and controversial way that damages Malaysia’s international credit and costs a lot of money, then Malaysians and bondholders are both victims.
It’s a bit more complicated than that—some of the bonds are guaranteed by Abu Dhabi’s International Petroleum Investment Co. and thus have another possible victim—but that seems like the basic idea. I guess I’d bet on option 3? Really even if the bonds do end up getting fully repaid, their market value dropped after the extent of the 1MDB scandal came to light, so at least some bondholders have lost something. And certainly Malaysians shouldn’t be happy about it.
Everything, I like to say, is securities fraud, and of course issuing bonds to pay for theft and bribery is securities fraud. 2 On the other hand, I also like to point out that treating everything as securities fraud is an odd symbolic choice. If your real complaint about 1MDB is that it allowed crooked politicians and their friends to steal from the Malaysian people, then you’d want to focus on the theft and bribery, not the fact that bond investors were misled.
But with 1MDB you don’t have to choose: Last month U.S. prosecutors brought charges against two Goldman Sachs employees for facilitating money laundering and corruption—that is, on a theory that they helped victimize Malaysia by underwriting bonds that they knew would be used for corruption—while Malaysian prosecutors today brought chargesagainst Goldman itself, as well as those two employees, for, effectively, securities fraud against bondholders:
The indictment focus on circulars and memoranda that Goldman prepared for the 1MDB bonds, saying that they contained statements that were false or misleading or both. Malaysia is pursuing the claim on the basis that the relevant bond documents were sent to the regulator in its offshore banking haven in Labuan, and therefore were covered by its securities law, Thomas said in the statement.
There are some advantages to the securities-fraud approach. In particular, bond offering circulars tend to be official documents, approved by lawyers, with the bank’s name right there on the cover. So it is easy to believe that, if the offering documents are full of lies, those lies are somehow the bank’s fault. Whereas if the bond deal gets done and the banker in charge wires all the money to the bribes account, it is perhaps easier to argue that that was the banker’s fault, and that the bank itself didn’t do that. (“Goldman has blamed rogue employees for any wrongdoing in relation to 1MDB.”) Those are fuzzy distinctions—the bank is made up of bankers, and there is no “correct” answer to the question “did the bank do this or just some individuals?”—but they might matter.
(Disclosure: I used to work at Goldman, where despite the occasional temptation I never stole billions of dollars of bond proceeds.)
The two main worries about banks are:
- That they will lose a lot of money by doing dumb things, and
- That they will make a lot of money by doing bad things to their customers.
“We’re not going to do anything crazy to the customer—and we’re not going to do anything crazy for the customer,” is Bank of America Corp.’s new-ish motto, distancing it from an industry history of both. Intuitively it would seem like these are opposite worries. A bank that profitably gouges customers will have plenty of money and won’t need to take a lot of market risk to get it; a bank that loses tons of money is, often, making the customers on the other side of the trade very happy. And in fact these worries are sometimes in tension: Banks that are forced to cut back on market risk sometimes load up on customer fees to make up the profits, and there are sometimes claims that banks shouldn’t be harshly punished for misbehavior that harmed customers, because punishing them might destabilize the financial system.
But a lot of the time the worries actually seem to reinforce each other. Gouging customers in particularly egregious ways ends up being bad, not just for customers, but also for the bank’s financial health, as it eventually loses customers and pays huge fines. (See above.) More generally, it is tempting to imagine that there is just a certain quality of badness possessed by some banks, or some bank employees or units, that makes them bad in every direction at once. If you just love risk-taking and boundary-pushing, then you might enjoy both gouging customers for easy profits and taking unjustified market risks. If you love conservative old-fashioned banking and general upstandingness, you’ll probably do neither.
Proprietary trading is a former profit center for banks that has been severely limited since the global financial crisis. The main popular worry about prop trading—the worry of politicians and regulators and commentators and the general public—is Worry 1: Banks were making risky bets using their own money, and if those bets go wrong then the banks might collapse and bring the financial system down with them.
But banks’ trading customers always had a different worry about prop trading. Their worry was a form of Worry 2. Banks, in their regular flow trading business, handle lots of customer orders and know a lot about who owns what and who is looking to buy or sell. If the proprietary traders had all of that information, it would give them a big advantage in the market; they could trade against customer orders by front-running them, or building up big positions opposite a weak hand in the market, or whatever. Banks therefore had information barriers to prevent their prop desks from getting information about customer flows from their flow desks. Cynicism about those information barriers is, I think it is fair to say, total; you will not find a lot of hedge fund managers who believe that banks completely insulated their prop traders from the flow traders. But if this worry was right, then it would work against Worry 1: If banks’ prop desks regularly used a lot of inside information to cheat, that’s bad, but the good news is that they shouldn’t have been that risky. Right?
Ha, no, here is a story about prop trading in metals at Barclays Plc in 2011. Barclays is being sued by a hedge fund called Red Kite, which “alleges that Barclays allowed staff to share confidential information about its positions with the bank’s proprietary traders”:
The hedge fund claims that Macrae and Saunders used their knowledge of Red Kite’s positions to trade heavily against the fund. In court filings last week, Red Kite cited disclosures from Barclays that the fund said indicates that Macrae had sought to justify his position to risk officers by pointing to Red Kite’s opposing trade.
Bad! But also:
Two metals traders at Barclays were dismissed seven years ago after racking up losses of $396 million, according to documents disclosed in a court case. The losses – some of the biggest ever disclosed by a bank in the commodities markets – were denied by Barclays at the time.
Iain Macrae, who ran metals trading at Barclays until his firing in 2011, was let go “for irresponsible risk taking” that led to a $327 million loss.
Also bad! They allegedly cheated, and they allegedly still lost. Still it is a little strange that Red Kite is suing: If Barclays’s prop desk set itself up to trade against Red Kite, and if it lost $396 million, shouldn’t Red Kite have made money?
Cryptocurrencies are still a young enough asset class that there are no standardized valuation methodologies. Normal stock-valuation techniques don’t work (there are no cash flows), normal currency techniques seem inappropriate (the economy of Bitcoinia is not comparable to that of, say, Switzerland), and while there are some crypto-specific methods, none are universally accepted and they all strike me as a bit ad hoc. My favorite crypto valuation method runs roughly like this:
- We will issue 50 million Blahcoins.
- Even if each Blahcoin is only worth a dollar, that’s still $50 million.
It is an interesting feature of the crypto industry that this sometimes … seems … to … work? Like, 10 years ago, if I had said “I will open a spreadsheet with 50 million cells, and even if each one is only worth a dollar that’s still $50 million,” people would have immediately understood that I was crazy. But then Bitcoin was created and it was worth a penny, and then a dollar, and then thousands of dollars, and then more thousands of dollars, and then fewer thousands of dollars again, and people made vast fortunes by buying and holding Bitcoins, and the creators of subsequent cryptocurrencies could say, without sounding completely insane, that even if their currency was only one one-thousandth as successful as Bitcoin that would still be pretty good.
Again I do not want to vouch for this methodology but I must say I see a lot of it. It seems, as far as I can tell, to have been the valuation methodology behind Civil, the saving-journalism-through-blockchain cryptocurrency, which got partner newsrooms to pay journalists partly in CVL tokens by explaining that, even if the tokens were only worth 75 cents, they’d be worth 75 cents. (They were not worth 75 cents.)
Or here is a Bloomberg Businessweek feature story about the Marshall Islands’ so-far-ill-fated sovereign cryptocurrency, the SOV, which the country teamed up with an Israeli startup called Neema to develop:
The country would issue 24 million SOVs, of which the Marshall Islands would get half. Neema projected that the SOV could trade for $50 each. The country planned to sell half of its coins right away, which if the projection was correct, would raise $300 million. Of the nation’s share, 2.4 million SOVs would go straight to Marshallese citizens in payments over five years. … If the cryptocurrency plan seemed like a get-rich-quick scheme, that was, to some extent, what the Marshall Islands needed.
I don’t know where that $50 number came from, but I do not intend to think too hard about it.
Another big appeal of cryptocurrency, beyond just getting rich quick, is that it might notionally free you from the tyranny of the international banking system. But that too is a mixed bag. The Marshall Islands found the SOV appealing in part because, as a small remote country, it is pretty isolated from international banking:
The only bank with branches throughout the islands relies on First Hawaiian Bank, and its connections to BNP Paribas SA, to provide basic services such as international money transfers or cashing locals’ paychecks from the military base. First Hawaiian has said it plans to shut down that link but has agreed to a delay while the country looks for replacements. So far, it hasn’t found any.
With the new currency, Paul thought, the Marshallese wouldn’t be held hostage to banks to get money off and on the island. The government could go from begging for banks to come and stay to asking why it needed them at all.
Nope! What actually happens, when you start a sovereign cryptocurrency, is that the international banks flee even faster. The U.S. Treasury and the International Monetary Fund have expressed concern about terrorists and money launderers using the SOV, and “Marshall Islands officials had a similar meeting with First Hawaiian Bank, which said launching the SOV could lead the company to pull out of the country.” The problem with cryptocurrency being a well-known way around the international banking system is that, if you get too into cryptocurrency, the international banking system may want nothing to do with you.
Ask me anything
I will be doing an “Ask Me Anything” on Reddit (r/IAmA) today from 2 p.m. to 4 p.m. Eastern time, if you have any questions you’d like to ask me. I don’t have the direct link to the AMA page yet, but I’ll tweet it shortly before it starts so, you know, follow me on Twitter.
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