The Tiers of Finance

Finance is a mystery to a lot of people.  Even intelligent and smart people.  They don’t understand the ins and outs of the financial system.  It’s almost impossible to keep track of all the ways to create it, to insuring it, storing it, trading it, and then paying taxes on it.   The tax code is so complex it is reasonable to assume that every US corporate CEO doesn’t truly understand their own company’s tax return.

Finance has always been a tiered system.  That historical tiered system has been passed down through the ages.  You might call it “trickle down finance”.

The heartbeat of any financial market is the bid/ask spread.  It’s the internal combustion engine of markets. It’s where price discovery happens.  It’s where the market is made, and it changes moment by moment.  The closer anyone can get to the bid/ask spread, the more information they will have about a marketplace.  More information means more precise decision making.

Many marketplaces have been revolutionized by technology.  Tiers of distribution have been eliminated.  That’s made things more competitive and driven down prices for people.  However, in the bulk of finance this isn’t the case.

I think that is going to change.

The transparency of the internet combined with new technology and novel approaches to deliver that technology will change the face of finance.  Customers that didn’t have a view into the internal combustion engine of the marketplace will have a front seat.

Those of us that have been in finance all our lives know where some markets and processes are truly opaque.  In many cases, they are deliberately being kept that way.  There are economic incentives to hold on to the status quo.  With the advent of technology and increased transparency, those economic forces are changing.  There is demand building on the other side to see what’s behind the curtain.

No amount of regulation will change that demand. The revolving door between industry and government gives the entrenched a leg up, but eventually it won’t matter.  The major players that have run the game for so long are still going to be a part of the game.  But, new entrants are going to come in and cut into their business.  Existing participants are going to be armed with tools to enable them to get a better deal.  Entrenched players are going to be forced to compete, or buyout competitors.

They will have to choose their battles thoughtfully.  As we have seen in places like consumer food products, the big guys often don’t have the credibility to win.

  • Andrew Page

    This is an interesting topic to think about… there has been enormous disintermediation in the capital markets industry over the past 20 years that is well documented on this blog and others.

    I also see huge disintermediation coming in the next 10 years to other consumer-facing finance applications. I hope that mortgage lending, small business finance, insurance, and other industries will be transformed.

    However, I think there is a window of opportunity for even greater change for those industries. While you don’t have brokers taking orders over the phone, or floor traders executing orders, etc. like how the trading industry operated through the 90s, I would argue that the base infrastructure of the derivatives market, for example having CME Clearing act as buyer to every seller and seller to every buyer, and having customers maintain a relationship with an FCM, is largely unchanged here in Chicago.

    I would love to see fundamental business changes in other industries such as using alternative metrics (non-FICO) to determine the cost to borrow for consumers, or disintermediation of title insurance, or maybe mortgage lending process innovations that decrease our reliance on FNMA and FHLMC. Business process changes that will deliver value to consumers who are buying insurance, buying or selling their home, or borrowing money for business or education are really interesting to me and I hope that’s where we’ll see more innovation in the next decade.