Is Technology Changing Finance?

A lot of people seem to believe that technology will fundamentally change or disrupt finance and the financial markets.  Many, if not most, of those people seem to be developing technology, selling it or using it to sell products to investors and financial consumers.  Most of these people seem to have degrees or backgrounds in technology not finance.

Having a background in technology does not give you an understanding of finance or the financial markets.  You cannot fix or disrupt what you do not understand and the lack of understanding behind many of these products is simply ridiculous.

I only write about the law and the financial markets. I spent my career as an attorney working in and around the financial markets. I also taught Economics and Finance so I have a pretty well rounded idea about how the capital markets work and how they are evolving.

So I feel perfectly justified to call out the many techies who think they understand the financial markets even though they have never worked in the markets or studied finance. Nonetheless many seem hell-bent to create products that they think are making these markets better and are quick to label the products that they sell as “disruptive”.

I call these people the “algorithms fix everything” crowd.  It is an interesting thought, except that these mathematicians have no math to back up much of what they say about finance.

At the same time, there is an ongoing narrative that suggests that everyone who works in the financial markets is evil. I find it amazing how many people actually think that all bankers and stock brokers get up in the morning thinking “who can I screw today?”  I have personally brought more than 1000 claims on behalf of aggrieved investors against Wall Street firms and written a book about some of the really bad things that Wall Street firms can do, but even I know that Wall Street firms are not evil.

The capital markets handle millions of transactions every day involving trillions of dollars and the almost all of those transactions settle with both the buyer and seller happy. Banks and stockbrokers fund schools, universities, roads and hospitals and virtually every company since WWII, again without serious problems or complaints from anyone. Banks aggregate and intermediate capital and over all they do it quite well.  So what, exactly, needs disrupting?

Still there is a never ending stream of new products and services which claim to be revolutionary and which promise to disrupt the capital markets. On closer examination many of these innovations are more hype than substance. Say what you will, there is nothing disruptive here.  A few examples for your consideration:

1) Algorithmic stock trading – This is a good place to start because it is pure technology applied to the existing markets. “Quant” traders use computers to evaluate trends and trading patterns in the market of various securities. They attempt to anticipate the price at which the next trade or subsequent trades will occur.  Logic says that computers should be able to take in more information that is pertinent to stock trading, analyze it almost instantaneously and execute transactions in micro seconds.

It sounds right, but the reality is that all stock trading is binary; every buyer requires a seller. No one buys a stock unless they believe that the price will appreciate; sellers generally will only sell shares when they think the price will appreciate no further. Both sides to any trade cannot be correct.

Analyzing the information or executing faster is of no use unless each trade you make is profitable.  No one has yet figured out how to accomplish that, nor are they likely to do so.  What we are talking about is predicting the future which is difficult to do even if only a micro-second or two ahead.   And please do not suggest that artificial intelligence will change this.  If there is one right answer based on the current information, e.g. buy APPL, then who is going to sell it?

2) Robo investment advisors- These are similar but much less sophisticated. Robo-advisors do not actually attempt to anticipate future market performance. They make investment recommendations based solely on the past performance of the markets. Anyone who has ever bought a mutual fund is required by law to be told that past performance is not a basis for future results. But that is all you get with a robo-advisor.

FINRA did a study of a half dozen robo investment platforms and found that they provided widely divergent portfolios for the same types of investors. No robo is any better than any other and none is really worth anything.

3) Crypto currency- It was a discussion about Bitcoins that was the initial impetus for this article. Aficionados of crypto currency actually think that they are developing an alternative currency for an alternative financial system. People seem to want to just print their own money and on one level I can understand that.  But that level is more of a fantasy than reality.

The reality is that I can buy food or virtually anything else in most places in the world with US currency. Why do we need Bitcoins? What exactly, is their utility?   When I ask that question I get any number of weak responses. More often than not, I get a tirade about banks and/or governments being evil.

What proponents of crypto currencies never want to face is the fact that the crypto currency market has been full of people laundering money from illegal activities.  The banks that crypto currency fans love to hate are required by law to know their customers and have systems in place to prevent money laundering.  It costs money to follow the law and have those systems. It is money that the crypto currency platforms do not want to spend. If there is a common thread in the crypto currency world, it is that people want to skirt or simply ignore the regulations that keep the markets safe and functioning.

4)  Crowdfunding Platforms- Crowdfunding clearly works and works well as evidenced by the significant amount of money that it has raised for real estate and real estate development projects.  At the same time the crowdfunding industry is populated by a great many people who fall into the “I do not care what the rules say, I am in this to make a buck” crowd.  I have written several articles about how some of the crowdfunding platforms do not take the time to properly verify the facts that they give to potential investors.  Due diligence can be expensive and some of the platforms just refuse to spend what it takes to do it correctly.

Crowdfunding replaces the role that stockbrokers typically fulfill in the process of raising capital with a website and do it yourself approach.  With a stockbroker, the company that was seeking capital got that money the vast majority of the time because the brokers were incentivized to sell the shares. With crowdfunding it is very much hit or miss whether the company will get funded. Many of the better crowdfunding platforms charge close to what a brokerage firm would charge and the investors get none of the protections or insurance that they would get with a stockbroker.

5) FinTech and FinApps – I can go to my bank’s website and send a payment to my electric utility company. I can do the same at the utility company’s website. I admit that it is convenient, but it is hardly disruptive.   Remittance companies like PayPal merely move money from my bank to a vendor’s bank.  And PayPal posted a $3 billion profit in the last fiscal quarter.  So they may charge less of a fee per transaction than a bank, but is not essentially different, and again while PayPal holds my money, I get no insurance against hacking or theft.

Apps that allow me to apply for a mortgage on my phone are really doing no more than eliminating a bank employee who would enter the same information from a written application into the bank’s computer. Again, it is convenient but not necessary.  And the money for the mortgage comes from either a bank or stock brokerage firm so there is nothing disruptive here, either.

Is there nothing truly new and disruptive in finance? Of course there is. They deservedly gave the 2006 Nobel Prize in Economics to Muhammad Yunus for developing a system of micro-finance that continues to create millions of entrepreneurs and lift millions more out of poverty. I doubt that one line of computer code was needed.

Micro-finance has the ability to put globalization on steroids.  Who will be disrupted?  Quite of few people with big school pedigrees and enormous student debt who write code to disrupt finance but who never understood finance in the first