Will Fintech change finance? Will its impact be positive?
In this blog series, I consider how potential of Fintech solutions to change finance for the good hinges on the resolution of some pretty basic unknowns. To start with, some think Fin-Tech means the importation of technology into finance while others envisage Fin-Tech as the transformation of finance into technology. Is Fintech finally more “Fin” or more “Tech”?
TECH-FIN ISN’T A SUSTAINABLE IDEAL
After the Crisis, a consensus began to emanate from social media circles that Fintech would change finance, make it less focused on money, more focused on quality of experience and millennial values: Less “Fin,” more “Tech.”
I think this is highly unlikely on first principles. Fin and Tech are different cultural and work spheres. As a liberal-arts graduate with some background in mathematics and statistics, none in engineering, and about thirty years of practical experience in finance and an MBA, I run a business where I’m often the sole interpreter between two groups of people: Those who build, and those who explain. They speak very different languages.
Although technology and finance have increasingly been paired in modern finance, each is nonetheless constituted to attain different goals by traversing different paths of thinking. IT is a framework of logically determined linkages between data and information that produces results which others (inclusive of people and robot-others) can produce by executing the same data routines. Finance is a framework of linkages between the stocks and flows of money and assets in the economy. Such linkages are more like articles of faith than strict logical determinations. Some only hold up under highly irreal conditions, like the Merton Modigliani principle whereby capital structure is irrelevant to firm value…assuming no taxes, agency costs or default risk, and constant returns to scale.
Crucially the benchmarks of success in these two domains are also different.
High quality IT exhibits integrity, objectivity, logical consistency and elegance. Qua IT, it is relatively agnostic with respect to belief structures or winners and losers. Financial narratives are concerned with winners and losers much more than they are concerned with logical defensibility. Successful financings lead to profits and avoid (or transfer) risk.
If the two domains diverge on goals and tacit rules, they share a common quest for speed. That is a compelling reason why people crossing over from the tech space to finance—even those with the best intentions to make it less greedy and more beautiful—will most likely wind up thinking and acting like bankers when they begin to bear bottom-line responsibility. They will quickly adapt to the fact that in finance, imitation is the fastest, surest way to attain the desired results.
A deeper, darker reason is that when the social context changes, values change. Consider how fast the Woodstock generation (we) turned our backs on peace and love once we’d savored the joys of money and property.
The case of P2P lending speaks volumes about “improving” finance by making it more “tech.”
The launch of Lending Club, America’s biggest and first P2P, coincided with the publication of James Surowiecki’s 2005 popular book on crowd wisdom and the word that P2P would prove more human than banking went viral. His thesis seemed to rationalize the premise of P2P: Large groups of people are smarter than an elite few, no matter how brilliant…better at solving problems, fostering innovation, coming to wise decisions, even predicting the future (from the Amazon website).
P2P also offered very attractive yields. For this reason, mainstream interest in P2P mushroomed after the Crisis, beginning in 2009. The new narrative was a 90-degree pivot from a financial smile-on-your-brother-try-to-love-one-another anthem to a brand new tune. P2P was going to overshadow traditional banking because it was smarter. It used Big Data and ran on brand new algorithms with a superior understanding of people. The irony was almost too good to be true.
So were the yields. The most plausible explanation for P2P’s astronomical results was its freedom from regulatory scrutiny. The reality of the risks of unregulated lending didn’t begin sink in until after the IPO of Lending Club (LC) in late 2014. Angel investor Liron Petrushka characterized its going public as a “no brainer”, but within days negative sentiment began to afflict its stock price. From a peak of almost $26 on 12/26/2014, LC’s stock price had lost 50% by mid-October 2015, the time when Santander announced it was selling its LC portfolio and terminating the relationship.
One of the tacit drivers of negative sentiment over time may have been the time series data published on LC’s website post-IPO, of its loan portfolio and rejected loans. Nevertheless, spring 2016 was also a turning point in P2P imaging, as irregularities in LC’s due diligence coincided with a string of P2P failures in China. LC’s price hit a low of $3.51 in the second week of May, which coincided with LC’s CEO’s ouster over loan disclosure irregularities and conflicts.
The role of online lending in the transformation of finance continues to be debunked. On August 18, 2016, Brian Weinstein, CIO of Blue Elephant, wrote a letter to investors calling for a renewal of fiduciary responsibility and better tools. His fund had purchased loans originated by Prosper, another U.S. peer lender. Simultaneously Max Chafkin and Noah Buhayar of Bloomberg published an expose with the subtitle, “If you knew where to look inside the loan company, things were worse than anybody realized.”
The unraveling of P2P continues….