Thread by @ccneill

I was looking forward to this episode with @profplum99 on @ErikSTownsend's new Smarter Markets podcast, and they delivered big time!

Some takeaways 👇

https://twitter.com/profplum99/status/1345417570959155202

The story many are familiar with goes like this: because BlackRock and Vanguard are so dominant in the asset "management" space, they can charge low fees but make it up on volume

This is true, and leads to further consolidation as investors focus more and more on fees

https://twitter.com/ericbalchunas/status/1344665760682176512

Jack Bogle himself called this out in a WSJ op-ed as an area for concern with passive funds - size would lead to lower fees, fewer players could compete, leading to a feedback loop of more concentration and dominance as big players grew bigger

wsj.com/articles/bogle…

Because only a few players dominate in this space, lobbying funds concentrate in their hands, and they're able to talk up the "benefits" of passive investing generally (*cough QDIAs cough*) and low fees to regulators

But Mike points out, they actually make MORE money doing something almost no one thinks about:

They lend the shares they hold for their investors to short-sellers!

Mike previously mentioned this in his interview with @ttmygh and @fleckcap, regarding the insane action in HTZ/CHK

https://twitter.com/ccneill/status/1281491718010019841

Another area of distortion: "free" trades via Robinhood et al are actually never handled on an exchange

Instead, a very small number (4?) of "systematic internalizers" execute the trades at prices that are favorable for themselves

They're able to do so by putting small orders on exchanges for a short moment of time, such that there is a gap between bid/ask spreads which they then exploit

They execute your "sell" at the depressed bid or your "buy" at the elevated ask, and pocket a tiny spread on every txn

Robinhood recently got slapped by the SEC for misleading investors about this practice of selling order flows in the past

cnbc.com/2020/12/17/sec…

Once again, because there are only a few large firms capable of performing this function, lobbying dollars concentrate in their hands

They can use their influence to talk up how avoidance of exchange fees via this system is "good" for mom and pop

Once again, we come back to @EpsilonTheory's "markets as political utilities"

Because government has focused on making markets into risk-free savings vehicles, markets' true function as efficient allocators of capital has been destroyed

And no one wants to upset the applecart

https://twitter.com/ccneill/status/1344425152285650944

The transparency envisioned by those promoting blockchains for traditional securities like stocks and bonds is not in the interest of current (powerful) players

Investors/regulators more easily seeing the winding paths those securities travel today does not benefit these players

Erik asks about supplanting the existing system with a new DeFi system that is better for investors & securities issuers

Mike emphasizes the difficulty of doing so - the current "network effect" (huge pools of capital and assets) makes it cheapest to herd into the current system

https://twitter.com/ccneill/status/1290485278528790529

This is the most pernicious part of markets' transition into political utilities - almost no one is incentivized to pursue alternatives, because "stonks only go up" is THE killer app

It'll be incredibly hard to generate interest in alternatives until the current system implodes

The work of @nntaleb and @ole_b_peters (which I can't delve into fully here) highlights why we cannot have a risky system that simultaneously produces only good outcomes - we simply cannot know enough about such a complex, dynamic system to build perfect "risk controls"

We have to take responsibility for providing for retirement or any other political goal if we, as a society, think it is valuable

There is no free "stonks only go up" lunch. It results in all this corruption already described, and unseen risks that undermine our society

Mike cites @ProfessorWerner's work empirically demonstrating the fact that banks create money out of thin air as an example of the kind of research that must be done on stock markets/etc to better understand what's really happening there

sciencedirect.com/science/articl…

Current ESG structures are a map to nowhere: they say to investors, "you can't actually do what you want today, i.e., make sure your investments are good for the planet, but here is a structure that at least *looks* like it does that so you can CYA"

techiavellian.com/the-map-to-now…

Mike has highlighted the need for society to take responsibility for the risk-taking behavior it needs for us to progress, without letting the risk-takers be thrown to the wolves

There is NO SUCH THING as costless risk-taking!

https://twitter.com/profplum99/status/1343058330575544322

Without stating it explicitly, I think Erik and Mike are thinking of something like @nntaleb's skin in the game - bearing the risks of one's own behavior

Instead, our government and society seem hell-bent on ELIMINATING skin in the game

@paulportesi highlights this constantly

The role for society is to ensure that the ones who bear those risks and costs aren't discarded

Failing this, we empower more and more cronyism, concentration, and domination by Too Big to Fail "elites" who pretend to eliminate those risks by stuffing them under the mattress

Another person who speaks about this a lot in the context of the "Great Moderation" is @EricRWeinstein

He and @nntaleb saw the earlier iteration of this game - the mortgage-backed security bonanza - as the fraud it was, and yelled it at the top of their lungs

No one listened

https://twitter.com/ryanholiday/status/1223274873784586242

Final thought: this incoming administration is filled with exactly the kind of people who will soothe you to sleep with their assurances that they've got your back, they'll worry about the risks, don't you fret your little heads, while perpetuating the system that got us here

https://twitter.com/profplum99/status/1345404981784924162

Thank you to @ErikSTownsend and @profplum99 for this excellent, important conversation

This topic is relevant to everyone, not just finance nerds. That's why I, a lowly computer nerd with no professional finance experience, harp on it so much!

Go listen!

https://twitter.com/Smarter_Markets/status/1345291040731881472

An important table re: securities lending, and the percentages of revenue each company returns to its investors

https://twitter.com/kscull2/status/1345554440632348679?s=20