How to disrupt Wall Street

Discussion in 'Wall St. News' started by jagadish, Jul 21, 2010.

  1. I would argue the best way to try to disrupt Wall Street is to look at how it currently makes money and attack it there. Here are some of the big sources of revenue.

    1) Retail banks. Retail banks make money on fees and by paying low interest rates on deposits and then doing stuff with those deposits (buying stocks, mortgages, issuing credit cards, etc) that gets them a much higher return. To disrupt them you need to get people to stop depositing money in them. Zopa and Prosper are trying to do that. Unfortunately the regulatory system seems to strongly favor the incumbents.

    2) 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.

    3) 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). For example, most of Goldman Sachs’ recent massive profits came from proprietary trading. Basically what they do is hire lots of programmers and scientists to make money on fancy trading algorithms. (Regrettably, I spent the first four years of my career writing software to help people like Goldman do this). 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). 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.

    4) Trading. The more you trade stocks, the more Wall Street makes money. The obvious beneficiaries are the exchanges – NYSE, NASDAQ etc. There were attempts to build new exchanges in the 90’s like Island ECN. The next obvious beneficiaries are brokers like Fidelity or E-Trade. 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.

    5) Investment banking. Banks make lots of money on “services” like IPOs and big mergers. A small way to attack this would be to convince tech companies (Facebook?) to IPO without going via Wall Street (this is what Wit Capital tried to do). 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.

    6) Research. Historically, financial research was a loss leader used to sell investment banking services. After all the scandals of the 90’s, new regulations put in stronger walls between the research and banking. As a result, banks cut way back on research. In its place expert networks like Gerson Lehrman Group rose up. LinkedIn and Stocktwits are possible future disrupters here.

    7) 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.
  2. Wall Street is doing a pretty good job on its own cannibalizing itself. I wouldn't read too much into it or concentrate on reacting to it. Make your own logical trades and you can do well even if you've never set foot on Wall St.