Playing Wall Street at its own game

Nice article from Chris Dixon on the areas where the Internet can disrupt the financial services industries (He is responding to Sarah Lacy's original article where she wonders how come the 'Net hasn't disrupted the Financial Services industry yet). He has a number of areas of retail banking, but I want to focus on where the real material differences are - the merchant banking functions:

Credit cards. Charging 20% interest rates (banks) and skimming pennies off every transaction (Visa and Mastercard) is a very profitable business. Starting a new payment company that doesn’t depend on the existing banks and credit card companies could be disruptive. Paypal seems to have come the closest to doing this.

I agree, this is an area ripe for lower cost competitors. Paypal is not loved by a lot of people, but there must be someone who can build a better online alternative.

Proprietary trading. A big trend over the last decade is for more of big banks’ profits to come from “proprietary trading” – which basically means operating big hedge funds inside banks (this trend is one of the main causes of the financial crisis and why the new “Volcker rule” is potentially a very good thing).

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Given that the stock market was flat over the last decade and hedge funds made boatloads of money, the loser in this game are mostly unsophisticated investors (e.g. my parents in Ohio).

As Chris notes, they use powerful algorithms to out-trade less well equipped people (read The Predictors about how this all started). It occurs to me that with the power of computers today, and social media, it may be possible to give small traders technology that matched them. Failing that, education. As Chris notes;

Any website that encourages unsophisticated investors to buy specific stocks is helping Wall Street. Regular people should buy some treasury bonds or maybe an S&P 500 ETF and be done with it. That would be a huge blow to Wall Street.

And how better to spread good practice than via social media. A similar process could be applied to Trading

Trading. The more you trade stocks, the more Wall Street makes money. The obvious beneficiaries are the exchanges – NYSE, NASDAQ etc...... ....But the real beneficiaries aren’t the people who charge you explicit fees; it’s the people who make money on your trading in other ways. For example, the hot thing on Wall Street is right now is high frequency “micro structure” trading strategies, which is basically a way to skim money off the “bid-ask spread” from trades made by less sophisticated investors.

As for the above case, it must surely be possible to give ordinary users technology of similar power today.

Investment banking. .... ....Regarding mergers, there have been endless studies showing that big mergers only enrich CEOs and bankers, yet they continue unabated. This is part of the massive agency problem on Wall Street and can probably only change with a complete regulatory overhaul.

The best thing ordinary shareholders can do is use social media to become active shareholders - I wonder what would happen if more people started to become far more active pressure groups on the activities of their own retirement funds, as Chris points out:

Mutual fund management. Endless studies have shown that paying fees to mutual funds is a waste of money. Maybe websites that let your peers help you invest will disrupt these guys. I think a much better way to disrupt them is to either not invest in the stock market or just buy an ETF that gives you a low-fee way to buy the S&P 500 index.

But I think We The People could do two other things right now:

- Use social media to pressure bankers, politicians etc to behave ethically and get the banking reforms done. Right now there is another asset bubble happening as public money is poured into the banking system (just look at how the stock markets ave jumped) but teh banks are behaving exactly the same ways they did to cause The Crunch - so there will be another one unless things change, and things will only change if the vox populi clamoure s for it.

- Start pulling money out of areas that don't favour them, and where they can't (Penasion funds) satart to pressure them. I also feel there has to be a role for co-operative style independent advice using modern technologies. I like things like Stocktwits as its using real time discussion that any user can access.

The other issue that needs solving is to tear down the artificial barriers that raise entry costs in so many of these areas, allowing them to charge hig prices as there is so little competition. Social action has worked in other areas.

Sadly, the average Facebook or Twitter user is far more likely to show support for a discontinued chocolate bar, or join a Twitter freedom of speech in Iran campaign or similar, than take part in mass action for sorting out the disgraceful behaviour of the people managing their hard earned savings, Until that changes, nothing will change.

Partly its education, but partly its will.