2025-12-06 05:16:46
Programming note: Bits about Money is supported by our readers. I generally forecast about one issue a month, and haven't kept that pace that this year. As a result, I'm working on about 3-4 for December.
Much financial innovation is in the ultimate service of the real economy. Then, we have our friends in crypto, who occasionally do intellectually interesting things which do not have a locus in the real economy. One of those things is perpetual futures (hereafter, perps), which I find fascinating and worthy of study, the same way that a virologist just loves geeking out about furin cleavage sites.
You may have read a lot about stablecoins recently. I may write about them (again; see past BAM issue) in the future, as there has in recent years been some uptake of them for payments. But it is useful to understand that a plurality of stablecoins collateralize perps. Some observers are occasionally strategic in whether they acknowledge this, but for payments use cases, it does not require a lot of stock to facilitate massive flows. And so of the $300 billion or so in stablecoins presently outstanding, about a quarter sit on exchanges. The majority of that is collateralizing perp positions.
Perps are the dominant way crypto trades, in terms of volume. (It bounces around but is typically 6-8 times larger than spot.) This is similar to most traditional markets: where derivatives are available, derivative volume swamps spot volume. The degree to which depends on the market, Schelling points, user culture, and similar. For example, in India, most retail investing in equity is actually through derivatives; this is not true of the U.S. In the U.S., most retail equity exposure is through the spot market, directly holding stocks or indirectly through ETFs or mutual funds. Most trading volume of the stock indexes, however, is via derivatives.
The large crypto exchanges are primarily casinos, who use the crypto markets as a source of numbers, in the same way a traditional casino might use a roulette wheel or set of dice. The function of a casino is for a patron to enter it with money and, statistically speaking, exit it with less. Physical casinos are often huge capital investments with large ongoing costs, including the return on that speculative capital. If they could choose to be less capital intensive, they would do so, but they are partially constrained by market forces and partially by regulation.
A crypto exchange is also capital intensive, not because the website or API took much investment (relatively low, by the standards of financial software) and not because they have a physical plant, but because trust is expensive. Bettors, and the more sophisticated market makers, who are the primary source of action for bettors, need to trust that the casino will actually be able to pay out winnings. That means the casino needs to keep assets (generally, mostly crypto, but including a smattering of cash for those casinos which are anomalously well-regarded by the financial industry) on hand exceeding customer account balances.
Those assets are… sitting there, doing nothing productive. And there is an implicit cost of capital associated with them, whether nominal (and borne by a gambler) or material (and borne by a sophisticated market making firm, crypto exchange, or the crypto exchange’s affiliate which trades against customers [0]).
Perpetual futures exist to provide the risk gamblers seek while decreasing the total capital requirement (shared by the exchange and market makers) to profitably run the enterprise.
In the commodities futures markets, you can contract to either buy or sell some standardized, valuable thing at a defined time in the future. The overwhelming majority of contracts do not result in taking delivery; they’re cancelled by an offsetting contract before that specified date.
Given that speculation and hedging are such core use cases for futures, the financial industry introduced a refinement: cash-settled futures. Now there is a reference price for the valuable thing, with a great deal of intellectual effort put into making that reference price robust and fair (not always successfully). Instead of someone notionally taking physical delivery of pork bellies or barrels of oil, people who are net short the future pay people who are net long the future on delivery day. (The mechanisms of this clearing are fascinating but outside today’s scope.)
Back in the early nineties economist Robert Shiller proposed a refinement to cash settled futures: if you don’t actually want pork bellies or oil barrels for consumption in April, and we accept that almost no futures participants actually do, why bother closing out the contracts in April? Why fragment the liquidity for contracts between April, May, June, etc? Just keep the market going perpetually.
This achieved its first widespread popular use in crypto (Bitmex is generally credited as being the popularizer), and hereafter we’ll describe the standard crypto implementation. There are, of course, variations available.
Instead of all of a particular futures vintage settling on the same day, perps settle multiple times a day for a particular market on a particular exchange. The mechanism for this is the funding rate. At a high level: winners get paid by losers every e.g. 4 hours and then the game continues, unless you’ve been blown out due to becoming overleveraged or for other reasons (discussed in a moment).
Consider a toy example: a retail user buys 0.1 Bitcoin via a perp. The price on their screen, which they understand to be for Bitcoin, might be $86,000 each, and so they might pay $8,600 cash. Should the price rise to $90,000 before the next settlement, they will get +/- $400 of winnings credited to their account, and their account will continue to reflect exposure to 0.1 units of Bitcoin via the perp. They might choose to sell their future at this point (or any other). They’ll have paid one commission (and a spread) to buy, one (of each) to sell, and perhaps they’ll leave the casino with their winnings, or perhaps they’ll play another game.
Where did the money come from? Someone else was symmetrically short exposure to Bitcoin via a perp. It is, with some very important caveats incoming, a closed system: since no good or service is being produced except the speculation, winning money means someone else lost.
One fun wrinkle for funding rates: some exchanges cap the amount the rate can be for a single settlement period. This is similar in intent to traditional markets’ usage of circuit breakers: designed to automatically blunt out-of-control feedback loops. It is dissimilar in that it cannot actually break circuits: changes to funding rate can delay realization of losses but can’t prevent them, since they don’t prevent the realization of symmetrical gains.
Perp funding rates also embed an interest rate component. This might get quoted as 3 bps a day, or 1 bps every eight hours, or similar. However, because of the impact of leverage, gamblers are paying more than you might expect: at 10X leverage that’s 30 bps a day. Consumer finance legislation standardizes borrowing costs as APR rather than basis points per day so that an unscrupulous lender can’t bury a 200% APR in the fine print.
Prices for perps do not, as a fact of nature, exactly match the underlying. That is a feature for some users.
In general, when the market is exuberant, the perp will trade above spot (the underlying market). To close the gap, a sophisticated market participant should do the basis trade: make offsetting trades in perps and spot (short the perp and buy spot, here, in equal size). Because the funding rate is set against a reference price for the underlying, longs will be paying shorts more (as a percentage of the perp’s current market price). For some of them, that’s fine: the price of gambling went up, oh well. For others, that’s a market incentive to close out the long position, which involves selling it, which will decrease the price at the margin (in the direction of spot).
The market maker can wait for price convergence; if it happens, they can close the trade at a profit, while having been paid to maintain the trade. If the perp continues to trade rich, they can just continue getting the increased funding cost. To the extent this is higher than their own cost of capital, this can be extremely lucrative.
Flip the polarities of these to understand the other direction.
The basis trade, classically executed, is delta neutral: one isn’t exposed to the underlying itself. You don’t need any belief in Bitcoin’s future adoption story, fundamentals, market sentiment, halvings, none of that. You’re getting paid to provide the gambling environment, including a really important feature: the perp price needs to stay reasonably close to the spot price, close enough to continue attracting people who want to gamble. You are also renting access to your capital for leverage.
You are also underwriting the exchange: if they blow up, your collateral becoming a claim against the bankruptcy estate is the happy scenario. (As one motivating example: Galois Capital, a crypto hedge fund doing basis trades, had ~40% of its assets on FTX when it went down. They then wound down the fund, selling the bankruptcy claim for 16 cents on the dollar.)
Recall that the market can’t function without a system of trust saying that someone is good for it if a bettor wins. Here, the market maker is good for it, via the collateral it kept on the exchange.
Many market makers function across many different crypto exchanges. This is one reason they’re so interested in capital efficiency: fully collateralizing all potential positions they could take across the universe of venues they trade on would be prohibitively capital intensive, and if they do not pre-deploy capital, they miss profitable trading opportunities. [1]
Gamblers like risk; it amps up the fun. Since one has many casinos to choose from in crypto, the ones which only “regular” exposure to Bitcoin (via spot or perps) would be offering a less-fun product for many users than the ones which offer leverage. How much leverage? More leverage is always the answer to that question, until predictable consequences start happening.
In a standard U.S. brokerage account, Regulation T has, for almost 100 years now, set maximum leverage limits (by setting minimums for margins). These are 2X at position opening time and 4X “maintenance” (before one closes out the position). Your brokerage would be obligated to forcibly close your position if volatility causes you to exceed those limits.
As a simplified example, if you have $50k of cash, you’d be allowed to buy $100k of stock. You now have $50k of equity and a $50k loan: 2x leverage. Should the value of that stock decline to about $67k, you still owe the $50k loan, and so only have $17k remaining equity. You’re now on the precipice of being 4X leveraged, and should expect a margin call very soon, if your broker hasn’t “blown you out of the trade” already.
What part of that is relevant to crypto? For the moment, just focus on that number: 4X.
Perps are offered at 1X (non-levered exposure). But they’re routinely offered at 20X, 50X, and 100X. SBF, during his press tour / regulatory blitz about being a responsible financial magnate fleecing the customers in an orderly fashion, voluntarily self-limited FTX to 20X.
One reason perps are structurally better for exchanges and market makers is that they simplify the business of blowing out leveraged traders. The exact mechanics depend on the exchange, the amount, etc, but generally speaking you can either force the customer to enter a closing trade or you can assign their position to someone willing to bear the risk in return for a discount.
Blowing out losing traders is lucrative for exchanges except when it catastrophically isn’t. It is a priced service in many places. The price is quoted to be low (“a nominal fee of 0.5%” is one way Binance describes it) but, since it is calculated from the amount at risk, it can be a large portion of the money lost. If the account’s negative balance is less than the liquidation fee, wonderful, thanks for playing and the exchange / “the insurance fund” keeps the rest, as a tip.
In the case where the amount an account is negative by is more than the fee, that “insurance fund” can choose to pay the winners on behalf of the liquidated user, at management’s discretion. Management will usually decide to do this, because a casino with a reputation for not paying winners will not long remain a casino.
But tail risk is a real thing. The capital efficiency has a price: there physically does not exist enough money in the system to pay all winners given sufficiently dramatic price moves. Forced liquidations happen. Sophisticated participants withdraw liquidity (for reasons we’ll soon discuss) or the exchange becomes overwhelmed technically / operationally. The forced liquidations eat through the diminished / unreplenished liquidity in the book, and the magnitude of the move increases.
Then crypto gets reminded about automatic deleveraging (ADL), a detail to perp contracts that few participants understand.
(Pray we do not alter them further.)
Risk in perps has to be symmetric: if (accounting for leverage) there are 100,000 units of Somecoin exposure long, then there are 100,000 units of Somecoin exposure short. This does not imply that the shorts or longs are sufficiently capitalized to actually pay for all the exposure in all instances.
In cases where management deems paying winners from the insurance fund would be too costly and/or impossible, they automatically deleverage some winners. In theory, there is a published process for doing this, because it would be confidence-costing to ADL non-affiliated accounts but pay out affiliated accounts, one’s friends or particularly important counterparties, etc. In theory.
In theory, one likely ADLs accounts which were quite levered before ones which were less levered, and one ADLs accounts which had high profits before ones with lower profits. In theory. [2]
So perhaps you understood, prior to a 20% move, that you were 4X leveraged. You just earned 80%, right? Ah, except you were only 2X leveraged, so you earned 40%. Why were you retroactively only 2X? That’s what automatic deleveraging means. Why couldn’t you get the other 40% you feel entitled to? Because the collective group of losers doesn’t have enough to pay you your winnings and the insurance fund was insufficient or deemed insufficient by management.
ADL is particularly painful for sophisticated market participants doing e.g. a basis trade, because they thought e.g. they were 100 units short via perps and 100 units long somewhere else via spot. If it turns out they were actually 50 units short via perps, but 100 units long, their net exposure is +50 units, and they have very possibly just gotten absolutely shellacked.
In theory, this can happen to the upside or the downside. In practice in crypto, this seems to usually happen after sharp decreases in prices, not sharp increases. For example, October 2025 saw widespread ADLing as (more than) $19 billion of liquidations happened, across a variety of assets. Alameda’s CEO Caroline Ellison testified that they lost over $100 million during the collapse of Terra’s stablecoin in 2022, but since FTX’s insurance fund was made up; when leveraged traders lost money, their positions were frequently taken up by Alameda. That was quite lucrative much of the time, but catastrophically expensive during e.g. the Terra blowup. Alameda was a good loser and paid the winners, though: with other customers’ assets that they “borrowed.”
In the traditional markets, if one’s brokerage deems one’s assets are unlikely to be able to cover the margin loan from the brokerage one has used, one’s brokerage will issue a margin call. Historically that gave one a relatively short period (typically, a few days) to post additional collateral, either by moving in cash, by transferring assets from another brokerage, or by experiencing appreciation in the value of one’s assets. Brokerages have the option, and in some cases the requirement, to manage risk after or during a margin call by forcing trades on behalf of the customer to close positions.
It sometimes surprises crypto natives that, in the case where one’s brokerage account goes negative and all assets are sold, with a negative remaining balance, the traditional markets largely still expect you to pay that balance. This contrasts with crypto, where the market expectation for many years was that the customer was Daffy Duck with a gmail address and a pseudonymous set of numbered accounts recorded on a blockchain, and dunning them was a waste of time. Crypto exchanges have mostly, in the intervening years, either stepped up their game regarding KYC or pretended to do so, but the market expectation is still that a defaulting user will basically never successfully recover. (Note that the legal obligation to pay is not coextensive with users actually paying. The retail speculators with $25,000 of capital that the pattern day trade rules are worried about will often not have $5,000 to cover a deficiency. On the other end of the scale, when a hedge fund blows up, the fund entity is wiped out, but its limited partners—pension funds, endowments, family offices—are not on the hook to the prime broker, and nobody expects the general partner to start selling their house to make up the difference.)
So who bears the loss when the customer doesn’t, can’t, or won’t? The waterfall depends on market, product type, and geography, but as a sketch: brokerages bear the loss first, out of their own capital. They’re generally required to keep a reserve for this purpose.
A brokerage will, in the ordinary course of business, have obligations to other parties which would be endangered if they were catastrophically mismanaged and could not successfully manage risk during a downturn. (It’s been known to happen, and even can be associated with assets rather than liabilities.) In this case, most of those counterparties are partially insulated by structures designed to insure the peer group. These include e.g. clearing pools, guaranty funds capitalized by the member firms of a clearinghouse, the clearinghouse’s own capital, and perhaps mutualized insurance pools. That is the rough ordering of the waterfall, which varies depending geography/product/market.
One can imagine a true catastrophe which burns through each of those layers of protection, and in that case, the clearinghouse might be forced to assess members or allocate losses across survivors. That would be a very, very bad day, but contracts exist to be followed on very bad days.
One commonality with crypto, though: this system is also not fully capitalized against all possible events at all times. Unlike crypto, which for contingent reasons pays some lip service to being averse to credit even as it embraces leveraged trading, the traditional industry relies extensively on underwriting risk of various participants.
Many crypto advocates believe that they have something which the traditional finance industry desperately needs. Perps are crypto’s most popular and lucrative product, but they probably won’t be adopted materially in traditional markets.
Existing derivatives products already work reasonably well at solving the cost of capital issue. Liquidations are not the business model of traditional brokerages. And learning, on a day when markets are 20% down, that you might be hedged or you might be bankrupt, is not a prospect which fills traditional finance professionals with the warm fuzzies.
And now you understand the crypto markets a bit better.
[0] Brokers trading with their own customers can happen in the ordinary course of business, but has been progressively discouraged in traditional finance, as it enables frontrunning.
Frontrunning, while it is understood in the popular parlance to mean “trading before someone else can trade” and often brought up in discussions of high frequency trading using very fast computers, does not historically mean that. It historically describes a single abusive practice: a broker could basically use the slowness of traditional financial IT systems to give conditional post-facto treatment to customer orders, taking the other side of them (if profitable) or not (if not). Frontrunning basically disappeared because customers now get order confirms almost instantly by computer not at end of day via a phone call. The confirm has the price the trade executed at on it.
In classic frontrunning, you sent the customer’s order to the market (at some price X), waited a bit, and then observed a later price Y. If Y was worse for the customer than X, well, them’s the breaks on Wall Street. If Y was better, you congratulated the customer on their investing acumen, and informed them that they had successfully transacted at Z, a price of your choosing between X and Y. You then fraudulently inserted a recorded transaction between the customer and yourself earlier in the day, at price Z, and assigned the transaction which happened at X to your own account, not to the customer’s account.
Frontrunning was a lucrative scam while it lasted, because (effectively) the customer takes 100% of the risk of the trade but the broker gets any percentage they want of the first day’s profits. This is potentially so lucrative that smart money (and some investors in his funds!) thought Madoff was doing it, thus generating the better-than-market stable returns for over a decade through malfeasance. Of frontrunning Madoff was entirely innocent.
Some more principled crypto participants have attempted to discourage exchanges from trading with their own customers. They have mostly been unsuccessful: Merit Peak Limited is Binance’s captive entity which does this. It also is occasionally described by U.S. federal agencies as running a sideline in money laundering, Alameda Research was FTX’s affiliated trading fund. Their management was criminally convicted of money laundering. etc, etc.
One of the reasons this behavior is so adaptive is because the billions of dollars sloshing around can be described to banks as “proprietary trading” and “running an OTC desk”, and an inattentive bank (like, say, Silvergate, as recounted here) might miss the customer fund flows they would have been formally unwilling to facilitate. This is a useful feature for sophisticated crypto participants, and so some of them do not draw attention to the elephant in the room, even though it is averse to their interests.
[1] Not all crypto trades are pre-funded. Crypto OTC transactions sometimes settle on T+1, with the OTC desk essentially extending credit in the fashion that a prime broker would in traditional markets. But most transactions on exchanges have to be paid immediately in cash already at the venue. This is very different from traditional equity market structure, where venues don’t typically receive funds flow at all, and settling/clearing happens after the fact, generally by a day or two.
[2] I note, for the benefit of readers of footnote 0, that there is often a substantial gap between the time when market dislocation happens and when a trader is informed they were ADLed. The implications of this are left as an exercise to the reader.
2025-10-11 01:24:13
The ultimate goal of financial plumbing is to enable commerce in the real economy. Consider the humble window: it is a fairly expensive, surprisingly high-tech manufactured good, installed by the dozen in homes by artisans. A window represents a supply chain, and one part of that supply chain is a sales process, convincing a homeowner of the desirability of updating their windows. The sales representative running that process would urgently prefer to leave their single visit to the home with not just tentative measurements but with a durable commitment to buying the window and financing firmly in place for it.
Why finance the purchase? Windows cost $1,000 to $3,000 each and updating all or a large fraction of them quickly becomes a mid-five figures project; relatively few homeowners will pay upfront with cash. Moreover, the sales process would strongly prefer the purchase be financeable, because that will sell more windows than a counterfactual world where windows were only available for cash.
One could imagine a world in which window manufacturers or installers provided financing off of their own balance sheets. This would be a rough world for them: they have upfront capital outlay (the window) and would recoup only after extended periods, bearing credit risk all the while. No, they would prefer to sell windows for money. It’s frequently delivered in milestone payments, perhaps half prior to manufacturing the windows and half upon successful installation.
You could imagine the buyer could bring their own financing, perhaps by going to their usual bank and asking for a home improvement loan. That product very much exists, but it might be surprisingly less attractive to all parties: it will be costly, low margin for the bank, and have poor operational dynamics for the window company. And so you could imagine the window company asking the financial industry to come up with an alternative.
That alternative exists, and can underwrite and paperwork a four-party commercial loan in fifteen minutes, before the salesman has even left their home visit that sold the window. We’ll return to it in a moment.
Again, very many banks do actually make home improvement loans available. But they’re not wonderful loans for the banks.
We’ll begin with the somewhat awkward dollar amount: a home improvement loan is enough money to hurt if it goes bad, but not enough money to justify a high-volume well-oiled machine to underwrite, not like e.g. mortgages. And indeed that is what many banks will immediately try to sell you if you ask for a loan for the purpose of home improvement: can we instead counterpropose a home equity line of credit (HELOC)? You can then borrow against your existing home equity, withdrawing cash, and we have no objection to you swapping cash for a window, a decision we need hear no more about. We have a supply chain for mortgages, including HELOCs, and this supply chain will decrease our capital requirements while smoothing every part of underwriting.
Why does the bank want to take the window out of the window purchase? Because a home improvement loan otherwise requires multiple operationally intensive document reviews and conversations where bankers talk to construction company office managers. Those conversations are frequently unhappy ones.
Consider the case where a construction project flies off the rails, which has been known to happen. The window company says it has installed the windows, and potentially they have a certificate proving that they were indeed installed, allegedly signed by the homeowner or their spouse on the date of installation. The homeowner, however, is unhappy with the windows: they are drafty; the color isn’t the same as the brochure; and goodness was this what they agreed to pay e.g. $25,000 for?! They don’t want to pay it anymore.
The bank must be the adult in this scenario, to release that second milestone payment. They very possibly could be drawn into litigation over their decision, because a few tens of thousands of dollars is just enough to justify calling a lawyer. Then the bank will have to have their own lawyers defend their own contracts in an expensive proposition over what is, to it, a small-dollar loan.
It’s not nearly this hard to generate $25,000 of balances with a credit card issuing business. You mail out the cards and people buy airplane tickets. And then the airline pays you 200 basis points off the top even before you get to originate the high-interest loan! Great business to be in and you never have to talk about a stewardess spilling someone’s drink or it raining in Hawaii that week.
Meanwhile, the window installer has their own complaints about this loan, even before it is originated. Between the day the salesman shakes hands with the customer and the bank commits to the installation, they have very little they can do to influence success. The homeowner might develop buyer’s remorse and, while they might have signed a contract, it’s just rough to compel payment for windows which don’t exist yet. Your staff will not enjoy the process, your reviews will suffer, and it’s not guaranteed that your contract will hold up: in some states, your customer might even have legal right to sever during a cooling-off period. You would prefer to accelerate delivery to avoid them cooling on the idea of windows.
But the bank is slow and has a bespoke underwriting process which requires information from you but which you cannot control, because the window installer is not the bank’s customer. They can’t call the bank up and yell at the underwriters to move faster, and they can’t debate the bank over a credit decision, where a perfectly good sale gets nixed six weeks later because the bank just isn’t feeling it. Very few of those sales will result in the buyer arranging successful alternative financing, partly for very human reasons and partly for a mechanical one: the fact of the hard pull on the credit report for the original loan origination plus non-issuance of a loan from one’s home financial institution signals to the rest of the world “Oh goodness there are probably better ex-ante risks in the economy than this one!”
No, what the window installer wants is a lending product which can be issued at scale, very predictably, in as short a timeframe as possible, by financial institutions responsive to it who ask very few followup questions, always fund milestone payments promptly, and actually want this business.
That product exists.
Consumer credit issuance is, unless it comes directly from a manufacturer, a privilege reserved by law for regulated financial institutions. But, as we’ve established, regulated financial institutions don’t lust for this business on their own balance sheets at scale. (Recharacterizing the home improvement loan as a draw on a HELOC allows the bank to quickly get it off their balance sheet, because the HELOCs will generally be securitized. You could theoretically securitize a large pool of installment loans if you had a business process to generate them, but unless a bank specializes, they are unlikely to have core depositors simply ask for enough of these every year to justify building out the framework required to do this.)
Why is it reserved by law for financial institutions? As Bits about Money mentions often, financial institutions are a policy arm, and one thing the state requires is that Compliance make sure the financial institution is not abusing customers. The state believes that a e.g. window installer might use high-pressure sales tactics or say untrue things to a homeowner about how e.g. an interest-free financing period works, and then perhaps forget about those things when the customer complains. It believes, rationally, that financial institutions will keep extensive records of what they communicate about loans, that those records will be truthful by default, and that the financial institution will not endanger its permission to do business over a single product. Also, and this is a blunt but true observation, the state trusts white collar employees and executives at banks more than it trusts blue collar window installers.
So we need a bank involved, but that bank does not necessarily need to lend (from its own balance sheet). The bank could immediately sell a large portion of the loan, retaining perhaps 1% for form’s sake, to a private provider of capital.
But, again, it is unlikely that a bank will want to call around to hedge funds and see if there are any takers. Someone needs to have capital providers have a standing offer to snap at this product quickly.
That standing offer is variously called a forward funds flow agreement or warehouse financing. I’ve previously discussed the mechanics for Buy Now Pay Later (BNPL), and they’re the same here. Someone, typically a facilitator and not the bank itself, has brought the capital partners to the table, negotiated terms, and has prepared them to receive what they want: millions of dollars of loans, at attractive prices, with known-in-advance credit characteristics… originated by a massively scalable process, conducted partly by commission-earning sales reps bearing iPads into houses needing windows and partly by web applications and operational teams.
This machinery wasn’t originally perfected for windows. It was originally aimed mostly at solar installations, which were heavily tax-advantaged at the time. Capturing the tax credit required a sale and upfront capital outlay, and the pitch was essentially “Sign these loan docs for free money for all of us and, also, you’ll get some solar panels.” But the credits eventually expired, the addressable market for solar got more tapped, and the software and companies yearned for more originations. So, sign these documents, get windows at attractive prices.
The loan application begins with the customer verbally informing the salesman of their phone number or email address. They get given a link which swiftly brings them to a competently-designed web application. That application asks a few simple questions that are required for underwriting. The two most important ones that are not on a credit card application are “Is this your house?” and “Do you live in this house?” This is because the capital partners are much, much more confident that people will not welch on debts tied to their primary residence than that every real estate investor will be above water if 2008 happens again.
Questions about your finances are extremely pro-forma. You’ll be asked to self-state your income, but no attempt will be made to verify it. A credit report will be pulled, which satisfies the twin purposes of a) derisking the applicant pool and b) verifying, via checking for the presence of a mortgage, that you do actually own the house.
I ended up in a fraud queue at this point in the process. Story of my life. The facilitating company does not expose to the sales rep why you are in the fraud queue, but the clock is ticking, and the rep will (hypothetically) strongly prefer continuing to drink tea and chitchat rather than leaving and letting one resolve that issue asynchronously. It was resolved by a combination of automated submission of a passport photo (again, shockingly competent software by the historical standards of loan origination) and an analyst manually clicking a button in a web application.
If I were to speculate what that analyst was doing, it would be reviewing the facts: credit report says high credit score, credit report shows a mortgage, credit report does not match this address, but government-provided ID does match the asserted identity. And thus the wager: is he in his own house, or has he decided to pull a hilarious prank on a window installer and buy someone else windows with a hedge fund’s money? The analyst swiftly concluded I was probably in my own house. (Why did I end up in the fraud queue? I have a lot of weirdness, such as not being listed on the deed due to holding title through a land trust, for privacy reasons. Unfortunately, perhaps that sometimes makes it difficult for cron jobs to conclude I own the house.)
Once you’re approved for the loan, you are automatically sent loan documents for signature. This will not be compelled at the meeting, but the installer sure would appreciate you signing before they leave. Compliance has extensively briefed them on where the line is. Compliance has, in fact, extensively briefed them on many lines, and because Compliance cares more about the law than it does about paying programmers to code a login form, I was able to read their entire Compliance training series and presentations to installers.
Don’t lie. Don’t translate any loan docs from English or provide any gloss of the terms. Don’t say any of the forbidden phrases like “guaranteed approval”, “same-as-cash financing”, “interest-free financing”, etc. And definitely definitely do not touch their phone or computer during the application process.
The financial industry learned some things during the global financial crisis about aggressive salesmanship by its agents. Almost every bullet point in that 40 page PowerPoint has a stack of criminal convictions, billions of dollars of losses, or both to justify it.
The salesman will first quote a scary number designed to anchor you, then present the discount available if you commit within a month. They will then say there is a sweetener if and only if you sign before they leave. Compliance is very clear that if you say that in the context of acting as an agent for a financial institution it had better not be a lie, but percentages are percentages and window companies like making deals for windows, and I would not bet against the proposition that they would offer other inducements on other days for other reasons, perhaps summing to similar numbers.
They then present financing terms. I was pleasantly surprised that this was not presented in the typical obfuscating car dealer financing four square method. The real price stays onscreen on the iPad at all times and you are presented with columns for choices: pay cash (they mean immediately deliverable value, not actually specie), 12-month deferred interest financing, 15-year fixed rate financing, and pay in milestones (e.g. 50% deposit, 50% due on installation) on a credit card.
Compliance will inform representatives that you are absolutely not supposed to use the words “same as cash” and “interest-free” to describe 12 month deferred interest financing. This salaryman is unfortunately forgetful sometimes and so I cannot quite recall what the friendly local salesman actually said while pointing to the iPad. The offer is “If you fully pay for your windows within the next 12 months, you just pay the sticker price. If it takes you longer than that, you will pay us interest, starting from the date of installation, at a rate which is materially higher than the rate we quote in the next column.”
You might think, given that sketch, that the system is trying to trick naive homeowners and surprise them on day 366 with a nasty bill. I’m slightly more sympathetic. This offer is designed to be attractive to people who can bring their own financing without making the window installation dependent on that financing. If, for example, a customer does not currently have a HELOC, but is pretty sure they can get a HELOC, the window installer is saying “Great, convince any bank to give you a HELOC, then do a draw any time in the next year and repay us, and we’ll foot the interest until then. But to be clear this window is going in irrespective of your future discussions with banks. Our capital partners do not want you to attempt to skate if your financing falls through, if you get divorced, if your tax refund is smaller than expected, etc, and you will be penalized if you attempt to turn this into a backdoor installment loan.”
But the next column is where the real action is. I was quoted 6.99% APR for equal amortizing payments over 15 years. They, naturally, express this as a monthly number, but the contract floridly and in bold print (as required by regulations) discloses e.g. total interest cost over the life of the loan, the fact there is no pre-payment penalty, etc. This is as honest as consumer lending can possibly be.
You e-sign the loan documents and then the salesman thanks you for your time and arranges for another professional to come back and redundantly measure the windows. He measured for the quote, and the quote is good, but they’ll measure again because a quarter inch matters a lot more for the physical universe than it does for the spreadsheet. Then the order goes to the factory and, a few weeks later, they install the windows. You sign an acknowledgement, and then the automated software springs back into action, starting the clock on your interest and collecting payments.
Here I am going to speculate in reliance upon publicly available data sources rather than use information which I know as a result of private commercial negotiations. Window salesmen are not the only professionals who have been to Compliance training.
In the 15-minute window between the loan being applied for and signed, software has conducted a four-way commercial negotiation between the window installer, the facilitating entity, the bank, and the capital provider. The loan contract is between the customer and the bank (again, it has to be, regs) but the capital provider is a specialist institution.
There are a few banks which specialize in doing business like this. One of them is Cross River Bank, which keeps a keen eye on trends in consumer lending.
A bank which originates a loan might charge the facilitating entity an upfront fee-for-services, collect a servicing fee from the capital providers sliced out of the APR quoted to the customer, and of course retains actual economic interest in the loan… well, OK, a few hundred dollars of the loan, so that it can tell its regulators “No, really, we are lending money! It would be calumny to describe this situation as renting out a banking license!” Indicatively, that fee for services might look something like 1% of total loan volume, and the servicing fee might be 1% of the outstanding balance annually. (Mortgage servicing fees are about 0.25% but houses cost more than windows do and so you get an economy of scale. The servicing is essentially the same amount of work: you need a 1-800 number, lawyers on standby, the capability to receive checks, etc.)
So who is the capital provider and what are they getting? It will generally be a specialist fund, like say Sunlight Financial, whose name alludes to the solar business they got started in. You might naively assume “OK, 6.99% to the consumer, 1% servicing fee to the bank, so they get 5.99% APR on the loan, right?” I doubt that is the full calculation.
One reason is that loan sounds awfully cheap: the 10 year Treasury rate is currently a hair over 4%, so why would you give a consumer 15 years fixed rate financing for 6%? Even with excellent credit quality, 2% spread doesn’t sound like enough money to make a business out of this.
But: what if, like BNPLs, you could charge someone else a bit of money? Who benefits the most from this transaction? The window installer. So charge them for it. They’re clearly willing to pay something like 2.4% of the entire transaction size already, because they will happily let you buy windows with a credit card. So that’s the floor. A BNPL provider can charge Sephora something like 6% to sell lip gloss. That might be the ceiling. So can you get them to kick in… 5%? Probably.
That moves the APR as perceived by the lender to about 7.9%. (Ask Python or Excel if you don’t believe me.) It’s a bit better than this, too, because of what will happen to the fund if interest rates fall. The value of outstanding bonds increases if rates fall, but this consumer loan might get rolled into e.g. a newly cheap HELOC if rates fall. (The free no-penalty prepayment option is a fundamental challenge in mortgage finance.) So by default this is a lose-lose situation for the lender: if rates rise the value of the loan falls, if rates fall the loan very possibly gets repaid early. But with the origination fee from the installer, if rates fall and the loan is repaid early, the return on capital over the lifetime of the loan rises sharply.
If the loan is repaid after 7 years, which is approximately the average tenure in a house in the U.S., the real rate is about 8.15%. If it’s extinguished after a year, perhaps due to rates-related refinancing, about 12%.
These numbers start to sound attractive to credit funds, particularly when you have a repeatable process for generating them at 9 figure scales with independent credit quality.
As an additional wrinkle: is Sunlight the ultimate source of capital at risk? Well, if I were Sunlight, I might think of tapping the booming private credit market: borrow at a lower rate than I earn in expectation on my portfolio, collect the spread. If I were Apollo (such a natural brand to associate with sunlight, and among the world’s largest credit funds), I might buy an insurer or figure out how to get retail investors private credit exposure to fund billions of dollars to anyone who creates a loan origination engine with demonstrable credit quality.
For much more on that side of things, you should read Money Stuff or listen to Odd Lots, which cover “private credit is the new bank lending” all the time. I’m just presenting the speculative case for how private credit turns permanent capital vehicles into windows.
Compliance will tell you not to describe this as unsecured lending to the customer. I am so forgetful as to offhand comments made during sales presentations, though.
Formally, the lender does have a security interest. However, they do not want to go to the trouble of “dirtying the title” by getting a lien on the house. That can’t be done in 15 minutes. No, they only have a security interest in the window they financed.
A security interest in a car is valuable because people are quite attached to their cars and, if push comes to shove, you can repossess a car. A security interest in a house is valuable because people are quite attached to their homes and, if push comes to shove, you can foreclose on a mortgage and repossess the home. A security interest in a window is valuable because… a security interest in a window is actually not valuable.
However, by construction, the commanding majority of borrowers here have excellent credit. One factor decreasing their credit risk is that many consumers are, and this is an underwriting term of art, “judgement proof.” If you sue them for performance and a court gives you a judgement, that is worth the paper it is printed on, because they have no easily attachable assets and they might have employment in a System D fashion where garnishing their income is difficult.
A homeowner, on the other hand, always has one asset you can attach: the house, by filing a lien on it after receiving the judgement. A lien against a house is an immediately monetizable asset in the United States, because it blocks the sale of the house until it is satisfied, and there is a specialized financial ecosystem which is happy to buy that lien and then attempt collection by some combination of a) asking nicely and then in the alternative b) waiting patiently.
And so the lender’s contract is, to the extent it is concerned with credit risk, concerned with swiftly demonstrating to a court: valid contract, loan paid for windows, customer isn’t paying, issue us judgement, thank you very much, we’d like to file that judgement as a lien against coincidentally the same house. It’s only fair.
Nice new windows are better than broken ones, and the process of buying them is now painless at an attractive financing cost. They are still expensive, but homes are expensive.
Every time anyone mentions innovation in consumer lending, the same comment is made: isn’t this just the financial crisis all over again? Aren’t we stacking up billions of dollars of low-quality loans with intermediating layers of complex products like CDO-squared? Isn’t this going to blow up?
That’s an understandable point of view. But: there is an actual underwriting process here. We replaced “You write a lie on paper, no one reads it” with a computer program that never gets bored at comparing databases. The borrower is actually reasonably good credit quality, rather than a ninja (“no income, no job”; one of the subprime lending era excesses was writing NINJA loans in quantity).
If the installer successfully leans on the origination machine to lower underwriting standards and let anyone who can fog a window buy one with a smile, then the losses are largely not in the regulated banking sector and backstoppable by taxpayers. They’re mostly to sophisticated investors in credit funds, who are being paid handsomely to take that risk. The system is also self-correcting: early defaults would cause the credit funds to tighten their risk appetites and constrain originations fairly quickly, rather than encouraging refinancing to juice origination numbers, until we were all holding (to quote Margin Call) the biggest bag of odorous excrement ever assembled in the history of capitalism.
Besides, if credit quality keeps you up at night, you should be much more concerned about bog-standard commercial real estate loans.
2025-08-14 07:17:05
Much of the operation of the financial industry is legible to people outside of it. Your credit card works basically like you understand it to (excepting the occasional mythmaking about second order consequences). Debates about what terms banks are allowed to offer on credit cards are fairly straightforward and can be easily followed by non-specialists.
But some issues are under the hood, and a societal debate about them doesn’t exactly wear its consequences on its sleeves. Consider the controversy over Section 1033 of the Dodd-Frank Act (and even that framing is an effective medication for insomnia).
In July, JPMorgan Chase announced its intention to charge fintechs for access to so-called Open Banking data. This comes amidst a consortium of banks trying to sue this hithertofore obscure regulation out of existence.
Almost all discussions of it center on “data”, but it’s actually a fight about payments, and whether banks have a right to monopolize and charge for all economic activity their users engage in, irrespective of whether the bank operates the payment method.
Cards on the table: I previously worked at, and am an advisor to, Stripe, a financial infrastructure company which facilitates customers’ use of both bank-sponsored (cards, etc) and competing (account-to-account, stablecoins, etc) payment methods. Stripe does not necessarily endorse what I say in my personal spaces. (I’m also a user and tiny shareholder of Chase. One presumes they also don’t endorse what I say in my personal spaces.)
The Dodd-Frank Act was passed in the wake of the 2008 financial crisis. It included a combination of needed reforms and, effectively, partial negotiated settlements for the way in which banks had reaped enormous profits originating mortgages of less-than-stellar quality then left taxpayers holding the bag once those mortgages could not be repaid.
We’ve previously discussed one of the knuckle raps: banks had their debit card interchange capped, with an exemption for small banks. (Interchange is the fee card-accepting businesses pay to transact with bank customers.) The Durbin Amendment became a major pillar of fintech companies, as it established a revenue model for them. It also became something of a lifeline for smaller financial institutions, particularly those that partnered with fintechs.
Did banks like the interchange cap? No. It made a very lucrative line of business rather less lucrative. Taxpayers had provided about $245 billion in capital to backstop banks, and they (through the ordinary operation of a representative democracy) got a post-hoc concession for it.
The interchange cap was not the only concession in the Dodd-Frank Act. Section 1033 was another one: it is designed to increase competitiveness in financial services by establishing a presumption that banks must allow users to access their own data, including through competing providers.
In the intervening years, that competition has arrived. The banks do not like it, and would prefer it if it went away.
Financial institutions offer their customers a complex bundle of services.
You might reasonably expect that Open Banking is a fight over the budgeting app space. The banks have, via the magic of account records, a large portion of the underlying data about a household’s finances. You could imagine software using Open Banking to allow it to slurp in transactions and then categorize them. That would compete against the lackluster offerings the large banks have in their apps.
But Open Banking is not actually a fight over budgeting apps. Banks don’t make money on them and the best known standalone budgeting app, Mint, was acquired for a relatively small amount of money.
Payments, on the other hand, are an enormous business. They are monetized both by banks and by a diverse ecosystem of fintech providers.
The data banks find it annoying to make Open are, principally, account numbers. This is because, due to the long shadow of checks, possession of an account number (plus the routing number, identifying the bank) is sufficient to attempt to debit a bank account. Direct account-to-account transfers, including “pulls”, are a common payment method in many countries, but they are not a large share of consumer to business payments in the United States.
Why not? One reason is that the user experience of asking someone for their account number is pretty awful. There is no way to check in real time whether an account actually exists. Credit card numbers, in addition to having infrastructure which allows you to query them in real time, are specifically formatted so that typos in them are easily catchable.
Since you can’t know whether the account exists you certainly can’t know its current balance or whether a transaction posted against it today will succeed in a few days or be reversed for insufficient funds (or another reason). This means that businesses which use account transfers as a payment method would frequently suffer credit losses if they released goods or services at the time of “payment.” For many businesses, that isn’t a worthwhile tradeoff.
So they keep using cards. Cards give much stronger (but not foolproof) real-time guarantees of funds availability and likelihood of a transaction going through successfully. The ergonomics of card acceptance, at the register, through your phone, or in a web browser, are also much more palatable to most customers.
Several fintech companies, including Stripe, realized that they could use Open Banking to make account-to-account payments something customers would actually enjoy. The user is prompted at checkout whether they’d like to pay directly from their bank account. They log into their bank account and grants the fintech read access. This is a much stronger signal of authorization than simply knowing an account number. (We print those on every check, after all, and a check is designed to be handed to a cashier or waiter you’ll never meet again.) The fintech then grabs the account number and perhaps e.g. looks up the current balance.
Then, they can pull money from the account, through an ACH debit.
The ACH debit itself is not Open Banking. It is the ordinary operation of existing payment rails in the financial system. The ACH debit was just made much more convenient by Open Banking.
Most use of Open Banking is through so-called aggregators. Plaid and Yodlee are well-known examples.
Prior to the existence of Open Banking, the aggregators (and businesses which needed the data they can make available) were largely forced to build supportability networks, bank by bank, by writing so-called screenscraping software. Screenscraping software emulates someone typing the password into a bank’s website then browses through a live bank account to extract the information needed from it. Hopefully that screenscraping software isn’t bugged, because bugs in scrapers that interface with consequential systems are terrifying.
Aggregators would then ask users to share their bank account passwords, so they could operate the bank accounts via software automation, to get the data the aggregators’ business customers were interested in. Like, say, account numbers.
This is a worse model for users and security of the banking system than Open Banking, because sharing bank account passwords leads to misuse of accounts. The flow for Open Banking, in the best implementations, redirects users to the bank site to authorize the data sharing, without forcing the user to irrevocably cough up the keys to the kingdom.
ACH debits are not new. Businesses have been able to use them for decades. You very likely use them yourself to e.g. pay recurring bills every month, like utilities, mortgage, or credit cards. ACH debits have just been very annoying to use for payments online or at cash registers, and so almost all consumer to business payments go over card rails instead.
ACH debits are almost free.
NACHA, which administers ACH, charges a per-transaction fee of 1.85 hundredths of a cent. This compares favorably to regulated debit card interchange (21 cents plus five basis points of the transaction size) and extremely favorably to Durbin-exempt debit cards or credit cards (generally about 2.X% of the transaction size plus 20-30 cents). The interchange fee is paid mostly to the card issuing banks.
Banks would strongly prefer the world not make novel payment methods that are convenient and cost accepting businesses less than cards. Banks are interested in Section 1033 because they want to continue earning interchange revenue on coffee purchases and software subscription invoices.
But payments for goods and services are not the only interesting Open Banking use case. Useful infrastructure, once it exists, tends to get incorporated into everything.
When you open a brokerage account or engage with crypto companies, you are quite likely to pass through an Open Banking flow to link your existing bank account. You’ll use your linked bank account to fund your investments and, hopefully, eventually receive your returns.
Older users might remember that this used to require asking the brokerage to make trial transactions, typically pushing two ACH payments under $1 in total and asking you to confirm the amounts. This would demonstrate that you hadn’t typoed your bank account number, that the account could actually accept transfers, and that you (presumptively) had authorized access to that account, given that you could read recent transactions at will.
Trial transactions are painful for all parties. They insert a multi-day wait into the account opening process, and many customers abandon the process during that lull. Brokerages and fintechs were overjoyed that Open Banking largely allowed them to move away from trial transactions to authorize every new account.
There are also clever uses of Open Banking to piggyback on banks as oracles. For example, how do you, a financial institution or insurance company, know that I, a particular natural person, have authority to direct Kalzumeus Software, LLC to open a new financial account? One way you could establish that is to ask me to submit a copy of the LLC’s Articles of Organization and a Certificate of Good Standing from the great state of Nevada. Then you pass those to a backoffice paralegal, who can ascertain that the Articles name me the Managing Member, and empower the Managing Member to open new financial accounts. This costs $50 to involve Nevada, and very many small businesses in America will not succeed at the task “please locate an authoritative copy of your Articles of Organization.”
A much faster way is to use an Open Banking aggregator to read a bank account statement issued to Kalzumeus Software, LLC. This allows a second financial institution to make the reasonable inference that if I habitually direct a small business’ banking, as demonstrated by being able to grant access to its accounts, then I probably direct a small business’ banking. This will save their operations team from reviewing 100 pages of boilerplate and cut down on account opening time. (This is one of the rare and underacknowledged benefits of Know Your Customer regulations. Since banks are understood to have KYC responsibilities, the bank “vouching” for you as a customer in this fashion is treated as strong evidence by others in the economy.)
So why is Open Banking in the news now? We’ve had Open Banking for almost 15 years. The competing payment products work and work well. They are lower cost to accepting businesses and easy for customers to start using. Customers are switching to them in increasing numbers. Not all of them, but enough to worry the banks into wanting to strangle the upstarts.
This has happened via a regulatory push, litigation, and ultimatums over fees.
The Consumer Financial Protection Bureau finalized its rule for Section 1033 in late 2024. As you can tell by the lag between 2010 (when the Dodd-Frank Act was passed) and 2024, it was something of an involved process.
Relevantly, the CFPB which passed this rule was the Biden administration CFPB. I try to be non-partisan in professional spaces but will need to neutrally observe how partisan players have seen the CFPB.
The CFPB was not well loved by many people in the finance industry or the fintech community. Critics alleged that the CFPB was less a federal agency and more a one-woman show, with the stars being Senator Elizabeth Warren and a ventriloquism dummy. This was unfair. The CFPB staff was actually quite intelligent in anticipating Senator Warren’s preferred positions and rulemaking to achieve them without the dreary necessity of her writing legislation or convincing Congress to vote for it.
As I mentioned last December in discussing the debanking discourse, influential supporters of the second Trump campaign, including fintech and crypto investors, wanted the CFPB’s scalp. They essentially got what they wanted. The CFPB was hollowed out early in the new administration.
In a swift and ironic turn of events, a policy promoted by the crypto industry due to their frustration with the decisions of large banks (regarding their industry’s supportability) was quickly used by large banks for commercial advantage, catching the crypto industry in the crossfire.
Prior to the election, the Bank Policy Institute, a banking industry trade group, and the Kentucky Bankers Association sued to prevent the CFPB’s rulemaking from taking effect. I think an informed person would understand that their legal arguments are pretextural. Their policy arguments, against the normative intent of Open Banking, I’ll return to below.
The CFPB initially defended the suit vigorously, but the newly hollowed out CFPB in June announced its intention to surrender.
This has caused a bit of chaos in Washington, as Section 1033 is administered by the CFPB but is part of the financial regulatory apparatus that crypto companies actually like.
Exchanges largely monetize by charging a vig on crypto purchases, and the so-called “onramp” (transfering money from the traditional financial system to the crypto ecosystem) enables the rest of their revenue (such as e.g. receiving a cut of interest earned by stablecoin issuers or staking the coins owned by customers).
Exchanges want to accomplish the onramp at the lowest possible cost, which is through ACH debits. Their desired outcome is the new user uses an aggregator to authorize a debit from their bank account. Then, the debit is very close to free, both for the first transaction and also for subsequent transactions using the same banking details. (The exchange bears a bit of credit risk, since the debit is not known to settle successfully until about two business days later and it can be reversed long after that if it was fraudulent. These issues cost Coinbase about $20 million last quarter. It dries its tears on money.)
The legal and regulatory wrangling continues. It’s difficult for me to read tea leaves from Washington in the best of times, and in the interests of avoiding partisan commentary, I’ll refrain from confidently guessing whether statements of the administration predict its future actions over multi-week timescales.
The credit card brands, which were originally created by banking consortiums, consider Open Banking data aggregators to be an existential risk to their business. They have long wanted to co-opt or kill them.
That isn’t just me saying it. Visa attempted to buy Plaid back in 2020. The argument to Visa’s board was (pg 5) that Plaid could potentially be a, quote, “existential risk” to their debit card business, which threatened a $300 to $500 million a year revenue hit. It was cheaper to take them off the table, even at $5.3 billion. Call it an insurance policy, their CEO said.
The FTC quashed the acquisition, saying it would have the anti-competitive harm of protecting the debit card business. The FTC alleged that Visa had a near monopoly in online debit transactions. (This payments geek thinks there is actually a vibrant competitive landscape there, including internationally.)
Some commentators might assume that that was one of the Commissioner Lina Khan era anti-monopoly interventions. (This enforcement environment was part of the causus belli which flipped some notable Silicon Valley personages. It’s a complicated story and not particularly well-told by the press, in part because people with a nuanced view of the situation no longer respond to press inquiries, due to journalists’ repeated defection in an iterated game.)
While I’m not a close follower of anti-trust enforcement, I do happen to know how to use a calendar, and so feel obliged to mention that the action to stop the Plaid acquisition was late during the first Trump administration.
Politics legendarily creates strange bedfellows. Crypto companies are now asking the CFPB to revive a regulation protecting a business the first Trump administration kneecapped, after which the second Trump administration hollowed out that same agency, despite campaigning against kneecapping tech and crypto—leaving the CFPB, long a sworn enemy of big banks, in Chase’s corner dismantling the crypto industry and suppressing competing payment methods, because the administration apparently thinks that’s what its backers want.
Yep, one’s head spins.
Chase is the largest bank in the U.S., maintaining checking accounts for approximately 44 million Americans, and therefore makes up a hefty chunk of total transaction volume within the financial system.
To avoid adversarially screenscraping banking apps, which is unreliable and a bit of a security hole, the better way to do Open Banking is to negotiate API access with as many banks as possible. (Companies make APIs available to let developers access data from them in a safe and controlled fashion. API access allows customers to give secure, scoped, and revocable access to their financial information. Handing over a password is not ideal for those properties.)
This will customarily require signing a contract with the bank, obligating you to e.g. not steal the money, not attempt to hack bank servers, and not abuse customers’ expectations. These are all reasonable requests, swiftly agreed to. Most of the aggregators had agreements in place with Chase, which eagerly promotes their API access to developers.
In July, Chase started sending data aggregators notices about upcoming changes to their agreements.
The typical notice between financial institutions and developers downstream about changes to contracts is something along the lines of “We updated the wording in our privacy policy.”
These notices weren’t that. Chase was altering the deal; pray that they do not alter it further.
Chase demanded payment for access to Open Banking APIs, and would cut that access if companies interfacing with them did not acquiesce. The fees demanded were enormous.
A fintech industry trade group was quoted by the Financial Times as saying:
“Across all the companies that received the notices, the cost of just accessing Chase data is somewhere from 60 per cent and in some cases well over 100 per cent of their annual revenue for the year … Just from one bank.”
Plaid was asked for $300 million, which would be 75% of their 2024 revenue. That is likely more than the wages and benefits for all of the 1,200 people who work at Plaid.
Even as someone whose perennial advice to companies was Charge More, these don’t strike me as serious proposals to put a reasonable price tag on valuable services.
The prospect of Chase monetizing Open Banking has dragged some other banks into the fray; PNC is also looking at taking a bite at the apple. The table gets crowded quickly if even a fraction of the next 4,500 banks try to join.
You can imagine some rapid back-and-forth happening between bank and fintech negotiators happening in the background. There is some reluctance in the industry to speak of that openly, partly because negotiations are delicate and partly because some fear retaliation elsewhere in their business relationships.
But, helpfully, the banks have published their arguments, directly and via their industry associations. They are not particularly persuasive.
The best one is that banks bear risk here, and want to price it. Should a bank authorize a third party to use Open Banking, that third party might use it to exfiltrate value from a bank account. Should a bank customer authorize a transaction but regret it, perhaps because it was to a scam operation, they might ask their bank to make them whole.
Banks bear this fraud risk, the same as they do when they pay out a fraudulent check, until they can recover the money by reversing the transaction. They will not always be able to successfully reverse the transaction.
This is structurally similar to banks’ obligations under Regulation E for debit cards and Regulation Z for credit card purchases. If a consumer gets abused over card rails, the bank is good for it by regulation, less a $50 deductible that the industry universally waives in the interests of their good name. Banks are quite happy with this responsibility for cards, because card issuing prints money, but Regulation E covers almost any form of electronic payment and almost any imaginable form factor of abuse. (For non-limiting examples, see the AI-sung ditty, Doesn’t Matter, That’s Reg E.)
But account-to-account payments are less like cards and more like checks. Indeed, the Automated Clearinghouse part of “ACH debit” refers to being a clearinghouse for check payments.
Banks will occasionally take fraud losses over checking accounts. They mostly can’t charge for checks directly; customers expect to write them freely and businesses expect to deposit them for, at most, a nominal fee. Certainly you’d be laughed out of the boardroom if you suggested a check fee scaling with the size of the check. That’s check cashing nonsense, and not something that regulated financial institutions or their customers expect.
Dimon, in his 2024 letter to shareholders, laments that typical retail checking accounts are a low- or negative-margin business. As an avid reader of Chase shareholder letters, I know why Chase operates that business anyhow: it’s the foundation of their relationship with households, which they largely monetize through credit card issuance, mortgage origination, and the like. It’s also operated by design to charge lower-income lower-asset consumers less and reliably increase monetization over their long relationships with the institution
The deposit franchise, which contributes a lot to the Fortress Balance Sheet™, is most valuable when it attracts retirees, small businesses, and others who keep larger balances earning 0.01% in a savings account or nothing in checking. As a cost of acquiring that business, it offers accounts to e.g. a teenager who wanted to cash the paycheck for their summer job, even though the margins on that account might be negative for the next ten years.
And so suggesting that retail checking account availability is threatened by banks’ responsibility to monitor transactions and pay out if they make mistakes in authorization is, frankly, an insult to the intelligence of anyone familiar with banking.
Checking accounts are also a public service expected by society of banks. This is in return for their lucrative monopolies on industries like e.g. consumer debt issuance and explicit and implicit taxpayer backstops of their operation. Chase is intimately familiar with those, most recently from when it cashed a $13 billion sweetener check to acquire a failed bank.
We have made enormous strides, both from the financial industry and civil society, in banking almost everyone. That should not immediately imply “and thus banks get to charge a fee on every transaction in society.”
Chase is extremely capable of shipping payment products that customers actually want to use. Witness the Chase Sapphire Reserve, which probably half of fintech VCs and management teams use to pay for dinners, to my casual observation.
When Chase can’t successfully convince a customer to use a Chase payments rail that has a Chase CSR standing by to help out at 2 AM, Chase shouldn’t charge the accepting business money. Chase should understand that Open Banking and account-to-account payments are close in character to a check: one facilitates them in the ordinary course of business, for close to free, as part of the larger package offer.
Banks additionally make the argument that Open Banking leads to screen scraping. Certainly, as a financial technologist, I would prefer high-quality APIs with reasonable security guarantees. And some banks, like Chase, used the fifteen years of advance notice they had to develop these.
Other banks had other priorities, and are now using their own inaction to argue that screen scraping is a threat. (One can’t help but notice the bait and switch: first say aggregators must use official APIs rather than screenscrape, then claim that anyone who’s viewed developer documentation has agreed to a bill for 75% of their revenue.)
The banks additionally argue that fintechs are freeriding on substantial technology investments made by banks to serve their customers. This is extremely selective memory. Stripe did over $1.4 trillion in payment volume in 2024. Using no private information whatsoever, that implies that Stripe alone paid the banking industry somewhere in the general neighborhood of $20 billion in interchange fees.
Twenty. Billion. Dollars. From one firm alone.
It’s a little rich, pardon the pun, to cash a check for $20 billion and then whine about fintechs freeriding on your IT spend.
Credit cards are an enormously lucrative business for banks. The capability for businesses of all sizes to transact with customers worldwide over those rails is an enormous service to the world.
But cards are not and cannot be the last word in payments. We, as a society, should continue making things people want. Sometimes, the natural way to buy those things will be less compatible with cards or the assumptions baked into cards’ business model.
There has been quite a bit of enthusiasm for stablecoins in some quarters recently. Part of the sales pitch for stablecoins has been that you get to bypass the traditional financial system rails. This sales pitch does not accurately predict the operation of stablecoin businesses with material volume. Those are often operating something of a crypto mullet, with a stablecoin in the front and a bank transfer in the back. Those bank transfers are often substantially facilitated by Open Banking. This is a necessary part of the growth story for stablecoin businesses, as they are increasingly attempting to interact with the real economy, rather than crypto speculation. The real economy wants dollars and doesn’t much care what brand of database your backoffice uses.
People, particularly at the socioeconomic margins, increasingly use things which aren’t exactly a plastic rectangle. Sometimes that is a Cash App or a Venmo, or wallet directly integrated into a phone, or whatever a YC company invents next week. Our international peers like Japan (and our adversaries) have thriving payments ecosystems.
Developing these innovations will almost always need to touch the banking system because, at the end of the day, businesses want dollars. If we award banks the ability to impose a fee on any transaction that competes with their card business, that will strangle some of these innovations. This would be unfortunate, because customers and businesses benefit from choice.
It also helps us keep the banks on their toes. The industry tends to default to sleepwalking with regards to core services. Bank apps actually being quite good in the last few years is not simply a reflection of their general technical competence. They invested deliberately, after decades of underprioritization, because they saw the younger generation increasingly defecting to apps, and then they realized that would eventually threaten the deposit franchise.
The banks aren’t inherently opposed to shipping good products! They do it frequently! But if you ask the question slightly differently, they will happily bankrupt anyone who threatens revenue streams which are fat-and-happy. In that world, you get to use 1999 banking websites on Internet Explorer 5.0 forever. (And if that sounds unlikely, speak to a Korean friend sometime.)
There was also something of a kerfuffle with regards to banking supportability decisions recently. I have a nuanced point of view on it, but if I can offer a comment: when you let banks look into the economic logic of their customers’ lives to determine their pricing structure, you’re giving them the capability to pick winners and losers.
It has been reported that Chase wants a two-tier pricing system for Open Banking: one fee for data access and another, much higher, fee if someone uses that data access to facilitate a payment. These are the same products from Chase’s perspective. The same servers hold the same data. The same CSR stands ready to answer the call if a customer’s data leaks. But one of them is inimical to Chase’s preferences, and so they charge it more to discourage it.
We should not allow banks to get into the habit of sending demand letters to ruin the economics of businesses they simply do not like. Those demand letters will be inevitably abused, including in ways which are not determined by any conceivable direct business interest.
Banks are good at much of what they do, and it is quite profitable. If they want to maintain their share of wallet in their payments businesses, they employ intelligent people who are capable of shipping good products. Let them compete for the business. They’ll frequently win it, fair and square, including from me. But if customers choose to use someone else or if they mistakenly release payment to a fraudster, eh, have your teams break out Excel and try better tomorrow.
2025-03-06 01:36:15
In the sciences they call it the file drawer problem: studies that fail to achieve significance or reach the "wrong" conclusion end up hidden away, creating a distorted picture of reality.
And so here's me rescuing something from the file drawer of banking procedure: a tale of two Americas, one bank branch, and $50,000 in cash.
A style magazine published an account of a large cash withdrawal that didn't match my understanding of banking reality. I burned several thousand dollars and a year investigating. I now doubt that account less, because I understand the context better.
There exist thousands of banks in the United States, each one independently operated with their own procedures, work forces, and circumstances. They are, broadly, similarly constrained by regulation, industry practice, culture, and perception of the threat environment. There is no such thing as a perfectly typical bank, banker, or banking client. But if we were to ignore the messiness of the real world, for the purpose of making a larger point, here is what is supposed to happen when a customer comes in and asks to withdraw $50,000.
A bank doesn’t expect its CEO or Head of Compliance to individually make decisions on every withdrawal. It has designed procedures to achieve the outcomes it (and its regulators, and other stakeholders) desire, and trained staff in how to implement those procedures. Those procedures happen to very explicitly contemplate this transaction.
The teller or personal banker, junior though they may be, is supposed to ascertain the identity of the customer, and ask themselves whether this is a typical transaction for this customer. Do they, perhaps, run a cash-heavy business which, every few weeks, takes out $50,000 to e.g. stock the ATM fleet they operate? If yes, either the staff knows that to be true personally, or this fact is noted on their account. (That note was written after the bank got extremely familiar with their cash management needs, for reasons.)
Very few customers routinely withdraw $50,000 in cash. We move to the next step on the flow chart. Here, the bank staff will begin to deploy some mix of truths, half-truths, and white lies.
One statement, which may be anywhere along that spectrum, is that the bank branch does not have $50,000 cash on hand. Across all bank branches in America, this is frequently actually, mathematically true. A true-ish variant of it is that the branch does actually have a bit more than $50,000 cash on hand. The branch needs it to service customers with routine cash needs, and the instant customer cannot be allowed to wipe out the bank’s on-hand cash reserves, because that will cause them to disappoint dozens or hundreds of customers between now and the rebalancing shipment of cash they will swiftly order. And then there is a false variant, where at some branches this is factually as operationally straightforward as exchanging a $20 bill for two rolls of quarters, but where the lie is institutionally excusable to save this customer from themselves.
Many people who have never withdrawn $50,000 in cash do not have great reasons for suddenly wanting to withdraw $50,000 in cash. It is quite likely they are being scammed or otherwise victimized. The bank, in consideration of its legal and ethical duties to its customer, would prefer to not facilitate this, even unknowingly. Over the universe of all people with this request, the bank knows, in its soul of corporate personhood, that it has actual knowledge of what is likely happening here.
And so, the staff will likely say that the bank has a rule, procedure, or request that the customer call them a day or two in advance of making large cash withdrawals. This will “allow us to get the cash together.” Now, in point of fact, there is a number that the branch manager could call to ask for an extraordinary shipment of physical currency, but this is mostly intended as a speedbump. Scams and other forms of exploitation rely on isolating the victim and pressuring them into making poor choices. Mandating a cooling-off period causes some scams to effervesce like dew in the morning sun.
Perhaps, as happens in many non-routine requests in banking, the customer will call in third-party professionals. Perhaps the customer, annoyed that the $50,000 they need to consummate a real estate transaction isn’t trivially on offer, might phone their real estate lawyer. This is music to the bank’s ears. Not every voice on a telephone is actually a lawyer, and not every member of the bar upholds its strict standards of professionalism and moral uprightness, but lawyers are so much easier to work with than civilians. And, should the matter be reviewed later, the bank will be able to document its reasonable reliance on representations made by a lawyer.
Fraudsters have frequently targeted real estate transactions in recent years. Banks are acutely aware of this; it’s covered extensively in their professional journals and in circulars from regulators. But banks, who have extensive experience with real estate deals, know that a few hiccups on closing are stressful for customers, but very rarely actually blow up transactions, certainly not like scams blow up bank customers.
The bank is unlikely to reach confidence, in this circumstance, in just a minute or two in the teller line. Many well-off people, with great relationships with their banks, with extensively paperworked transactions, will go through more than a half-hour of hoop jumping to get approval for anomalous transactions.
But suppose, for some reason, the calls do not happen and the extended due diligence is not performed. What is supposed to happen next? Well, typically at large money center banks (and here I cite both general industry knowledge and also sources familiar with banking procedure), the staff dealing directly with the customer will summon a second individual. Sometimes this is the branch manager, sometimes it is a peer. Sometimes the next action takes place verbally. Sometimes it happens in specifically built software which keeps an audit log of both staff signing off.
The bank invokes the Two Man Rule. (Yes, this has been renamed in many—but not all—formal documents recording procedural controls. Regulators have, generally, reviewed and approved those documents.)
If both individuals are satisfied that the anomalous transaction is not sufficiently hinky to refuse, it goes forward. This will generally require asking the customer about what they intend to do with $50,000 cash. Banks very rarely ask this question at $50 or $5,000.
Bankers, by law and custom, holistically review these situations. Elements considered include the account records, the experience of branch staff with this particular customer, and a host of context cues which the financial industry would prefer to dissimulate about.
If you are, for example, a lanky thirtysomething who waltzes into a branch in San Francisco and asks for a six figure wire to fund an investment, helpfully mentioning that you have the KYC/KYB information in a clear plastic folder, neither of the Two Men are likely to actually ask to read that folder. If you walk with a cane, if you speak with an accent, if you present as not really understanding the rituals you are engaged in, the bank and its staff will pay radically more attention to you, frequently not in ways you will enjoy.
Let us assume that a $50,000 withdrawal happens, through some pathway. It will have one more mechanical consequence. Very soon after the withdrawal, the bank will be obligated to file a Currency Transaction Report (CTR) with the Financial Crimes Enforcement Network (FinCEN), unless the customer has had a previously-approved status as someone who routinely needs to do this sort of thing, which almost no customers have. The CTR is a write-once read-probably-never document which mostly serves to get the customer’s banking information into a trivially searchable database for law enforcement.
And then what happens to the $50,000? Whatever the customer wants, really. If they want to put it in a shoebox and give it to a courier, it is, at that point, no longer the bank’s problem.
In February 2024, the style publication The Cut published on its site, and concurrently in the print edition of New York Magazine, an article titled “The day I put $50,000 in a shoe box and handed it to a stranger I never thought I was the kind of person to fall for a scam.” It was written, in the first person, by a financial advice columnist who previously wrote for the New York Times business section.
The Cut and New York Magazine are owned by Vox Media, a private equity firm with material investments in advertising platforms (“We Create Premium Advertising Solutions”, “We Enable Media Companies To Build Modern Media Businesses”). Vox also publishes an eponymous website, notable for popularizing the term-of-art “explainer” and for publishing, about covid, analysis that aged more poorly than perhaps anything in the history of the written word. (It subsequently unpublished it.)
Many of Vox’s publications are good at what they do. The shoebox piece successfully achieved virality and follow-on coverage by several media orgs. A media critic could point to reasons why, such as the specificity and viscerality, the it-could-happen-to-anyone framing, and the complicated mix of schadenfreude, voyeurism, and self-protective reassurance which make so-called “true crime” explorations so explosively popular.
Vox Media sell ads with rate cards justified by the storied legacy of New York Magazine, which has won Pulitzers before, against articles of the caliber produced by The Cut. The print edition of the piece is immediately preceded by a fashion spread for “TOM FORD Halter-neck Jumpsuit and Black Stamped Croc Bar Belt, at tomford.com” A similar item, U0269-FAX1105, on the site bears the price tag $5,790, which is capitalism’s surest signal as to who it thinks is reading a publication.
For a quick vibe check on editorial standards of any publication, by their fruits shall you know them: just read the headlines. I checked them the morning of a presentation on this investigation, and they were “The high stakes of the group family vacation”, “George Clooney didn’t appreciate Biden criticizing his wife”, “The film exec distracted by her crushes at Cannes”, and “Madam Clairevoyant: Horoscopes for the week of June 9-15. Mars, planet of action, moves into steadfast Taurus. Time to knuckle down.”
Time to knuckle down… on hard-hitting journalism about banking procedures.
When I reached the bank, I told the guard I needed to make a large cash withdrawal and she sent me upstairs. Michael [a member of the scamming team] was on speakerphone in my pocket. I asked the teller for $50,000. The woman behind the thick glass window raised her eyebrows, disappeared into a back room, came back with a large metal box of $100 bills, and counted them out with a machine. Then she pushed the stacks of bills through the slot along with a sheet of paper warning me against scams. I thanked her and left.
As the piece went quite viral on Twitter, a number of people reached out to me. One specific question asked was “Are high-value withdrawal rooms a thing?”, which I answered, somewhat confusedly, “I could believe that there is, somewhere among 76,000 bank branches in the United States, a room designed to make $50,000 withdrawals. But no, the standard branch layout has no such room designed or designated.”
If a customer needs privacy, the branch has several rooms with doors, behind which banking business is routinely conducted. Those rooms are not fortresses. The branch is not a fortress. It's primarily a sales office for financial services that happens to handle some cash.
Then, I read the article, with a particular attention to the paragraph quoted above. I felt that several elements of this paragraph were inconsistent with the standard practice of banking.
I have an immense regard for journalism, generally, but the institution has been duped before. Stephen Glass comes to mind. One of the earliest bits of hard evidence against him was that he confabulated evocative details about the built reality of buildings he claimed to have visited. The shoebox piece contained much evocative detail, including some details I felt were, unbeknownst to almost all readers, likely to be checkable… and unlikely to have been checked.
Thus began an investigative journalism project, which ended up taking almost a year.
Having once worked for a Communications department, which very definitely does not endorse anything I say in this piece, I am aware of a social ritual of reporters and PR teams. You can send PR an email and ask them for a reply. By convention this is called a comment or a statement to pretend it is something vastly different in character than an excerpt from an email.
If one defects from this social ritual, many responsible professionals will conclude that one has something to hide. This is part of the reason why e.g. the largest banks in the world will swiftly answer questions asked by reporters working for, for example, a low-circulation weekly in Topeka, Kansas. This produces immense social utility, including by acting as an escalation pathway into the bank regarding, e.g., “Does the bank have a comment on why it is foreclosing on Ms. Mildred, who has shown this reporter a carefully maintained collection of checks that appear, to this reporter, to have been deposited?”
On February 22nd, 2024, I sent an email to Vox Media and asked for a comment. You don’t need to be bitten by a radioactive spider to do this. By custom, PR departments publish contact details widely, in part to avoid hostile journalists construing a lack of contact information as a refusal to comment.
There is, however, a performance of class that is helpful in getting PR departments to take you seriously. Mentioning that you are an avid Factorio player might not counsel an immediate reply to one’s questions. The following introduction is designed to compel one.
My name is Patrick McKenzie. I write a column titled Bits about Money, which frequently covers financial fraud and operational mechanics of banking infrastructure. I have previously appeared on Bloomberg and in the New York Times.
I read with interest the article about $50k in a shoebox, which was also published in the print edition of New York Magazine. I may reference it in future writing.
All claims in those paragraphs are true. Some people resent that one can assert authority simply because of implicit blessing of high-status institutions. I leave anyone to their aesthetic preferences, but will mention that this is a very important lesson for how halls of power in New York and Washington, D.C. work.
When the New York Times attempts to commission a piece from you, they will say apologetically that they can’t pay that well for it, but almost nobody writes for the Times for the money. You are paid in a different coin. Flash it, John Wick style, at a PR department, and it immediately takes you seriously, or it is quickly brought to task by New York’s hidden-in-plain-sight subculture of character assassins.
My email to the press contact asked a few questions and avoided explicitly broaching the question I was most curious about: Did the editorial process understand this piece to be an exercise in… creative writing? This felt unlikely, but magazines publish a spectrum of artifacts. Some pieces are roman à clefs, some are pastiches, some are based in a true story, and some are the more traditional understanding of journalism. On the text of it, the piece reads like it is reporting a true event, but it is in a style magazine and does run next to a piece titled Tweencore (“What the 13-and-under set is shopping for.”) and, you know, one may be forgiven some doubts.
A spokesperson for New York Magazine replied with a statement for publication which removed all doubt about how it perceived this story.
The story was thoroughly fact-checked prior to publication, and as part of this process, we reviewed the writer's bank withdrawal, recordings of phone calls and text messages with their scammer, and their statement to the police.
Since I had publicly expressed doubt that there was any fact checking process, I corrected the record.
Published statements or comments routinely occur in the context of a larger conversation. This is rarely mentioned, and I am promoting this subtext to text. There may have been any combination of on the record, on background, or off the record statements between myself and Vox Media. The world may never know.
But generally speaking, careful titration of how much information passes between PR and reporters, including restrictions (which are closer to handshake agreements than contracts) on what can be used where and when, enables a brisk favor-swapping economy. That economy has failed to function recently in the tech industry, as I discussed previously with Kelsey Piper. (Kelsey works in a different part of the Vocis machinae.)
When it does function, society gets the usual benefits of journalism, PR departments grumble a bit but play the game, the Bat Phone to mortgage servicing gets answered on the first ring, and advertisers sell their wares to willing customers to pay for it all.
So Vox Media’s statement through a spokesperson effectively definitively resolved my doubts about editorial processes… but this did not resolve my doubts about banking procedure.
Fraud investigators, law enforcement, and journalists alike frequently start with intuition then backfill with objective facts. My intuitions were screaming.
The article does not actually name the bank or the bank branch, despite a scene unambiguously set within it, despite the centrality of its failure to the narrative, despite repeated identification of firms that were utterly uninvolved. The transaction does not proceed as what a bank expects to happen if someone asks for the entirety of their savings account in cash. Physical details provided for flavor purposes are very rare in the universe you live in.
The claimed fact checking process struck me as… other than robust, in worlds where parts of the article were not factually accurate.
For example, there are many ways to “review a bank withdrawal.” That review can involve five or more parties, and I’ve been on almost all ends of it at various times. Some “reviews” are low-friction but low-robustness, such as e.g. asking someone to see a screenshot of their mobile phone or a printout of a bank statement.
As I once told a colleague in an unrelated context: a printed bank statement is of limited probative value because it could be forged by a bright high school student.
The financial industry has a variety of ways to resolve this, depending on how much time and toil it wants to expend on the investigation. For example, you can call the financial institution which issued the statement in question, announce that you are in a room with their customer, and then ask their customer to ask them to read the financial institution’s copy of the statement into the open line. Many people I have told about this ritual assume that, due to security concerns, no bank will engage in it. Nope! This is extremely routine and will happen tens of thousands of times next Tuesday. It is obviously more trustworthy than a copy of the statement whose chain of custody includes a non-bank actor.
Anyhow, some years after cracking wise about bright high school students, I chanced upon an infelicity which happened to New York Magazine. It published that a Stuyvesant high school student had made $72 million trading stocks and was shortly to open a hedge fund.
This is obvious nonsense and would be detected within seconds of conversation by anyone professionally involved in hedge funds, but we have a ritual in our society which blesses some writers as being owed the benefit of the doubt when they publish obvious nonsense. If it ran in the pages of New York Magazine, and New York Magazine engaged its standard fact checking process by sending someone to Stuyvesant to review a bank statement, and that piece of paper said Chase at the top and an eight figure number at the bottom, then the clearly the story is defensible, right.
No! Of course not! New York Magazine got punked by a teenager.
And so, reading New York Magazine’s newest written statement about thoroughly fact checking a bank withdrawal, I thought “After ten years memories fade. Vox is currently wearing New York Magazine as a skin-suit, so who knows if anyone involved in that fracas is still around. Perhaps current staff reviewed the newest issue’s most important transaction in an other-than-robust fashion.”
Texts from the scammer? Voice recordings? A statement to the police? All of these struck me as highly correlated rather than being independent evidence: all reliable if one trusts the writer, and all unreliable if one does not trust the writer.
Never having employed or encountered this writer myself, before she wrote things I believed to be improbable about banking procedure, I reflected on what I do trust.
I trust the physical reality of the world. I trust that it is very difficult to corrupt the archives of societal institutions.
Vanishingly few bank branches put teller windows on the second floor. Many people have not ever had reason to deeply consider this true fact about the world. Relatively few people have ever made real estate decisions about siting bank branches or sketched layouts for them.
By coincidence, my father has. And, as someone who listened attentively at the dinner table and on car rides as he geeked out with his eldest son about the relative merits of various corners in Chicago, when I read that there was a bank branch in New York City with thick glass on the second floor, I thought “If that unicorn exists, I can probably narrow it down to a single physical location.”
New York City, ye capital of the world, ye center of global finance, ye city which never sleeps: poets say you contain stories beyond numbering, but bike messengers can count your bank branches. A few hundred. Done. A diligent person could walk into every last one. (Of course the public can just walk into bank branches. That is what they are for.)
I started by attempting to narrow the set, to save some shoe leather. One gets a free 90%+ reduction by narrowing it to one bank in particular. Bank regulators keenly track deposit share concentration (and, therefore, bank branch concentration) in major markets, and NYC, the majorest market, is gardened with an exactitude that makes the feng shui look effortless.
Who knows the bank? Well, Vox (by implication of their statement) must know the bank, and the writer certainly knows the bank, and perhaps one of these would give an on the record comment naming the bank.
The writer engages in freelance journalism, has a professional website which lists her email address, and swiftly answered a question from another writer, on the record.
Bank of America.
Now we are getting somewhere.
Bank of America will trivially give you a list of all Bank of America locations in Brooklyn, for many reasons, including “We would certainly hope you find our financial centers for your financial services needs. We didn’t build this branch footprint and lease out desirable locations for a half century and sweat the details about curb cuts for the sheer joy of it all.”
One can, if one is unusually punctilious, cross reference their list against public records.
One useful sort of public record is the Office of the Comptroller of the Currency’s weekly bulletin, which includes all bank branch closings for nationally chartered institutions in the United States. Why would one care about those bulletins? An investigation, conducted in February 2024, about branches open on October 31st, 2023, might otherwise miss some which closed in the interim. And so I told my research assistant to read a few months of bulletins. (He surprised me by saying there is a search engine these days. Well, this wire transfer compliance influencer learned a new trick in 2024.)
And so we had twenty two Bank of America branches in Brooklyn to look at.
I’m in Chicago, and flying to Brooklyn to spend three days walking into branches seems like an obviously irrational use of my time. So, in the finest tradition of publications assigning scutwork to junior employees, I sent Sammy to Brooklyn instead.
We excluded any buildings which physically didn’t have a second floor. We used sophisticated techniques taught in journalism school, like the fact you can press ten buttons on an iPhone and then someone at a bank in Brooklyn will immediately answer questions like “Does your branch have a second floor?”
We kept a detailed spreadsheet, in the expectation we might eventually have to show New York media outlets that we had done our homework. A timestamped call here, a Street View there, our search area narrowed precipitously.
The final round of investigation involved Sammy physically entering bank branches, walking to the second floor, and looking for physical details consistent with the story as published.
This is a long way to say: I am very confident indeed that the only place in the world the described bank transaction could possibly have taken place at is 1 Flatbush Avenue, at the teller window, on the second floor. Right here.
We took this photo in March 2024, only weeks after publication of the original article.
And then we entered a long, long holding pattern, trying to find one trusted institution to say that, as of earlier than February 2024, they understood the transaction to either a) definitely have taken place at 1 Flatbush Avenue or b) definitely not have taken place at 1 Flatbush Avenue.
If the incident took place in the physical world, then the geospatial reality of the world imposes some constraints on the narrative. The writer unambiguously locates their narrative in Brooklyn. But Brooklyn is large.
Could we narrow it down? Could we do that using only independent, trustworthy information?
I trust, for example, that the city of New York keeps mostly accurate records about who owns property. These are quite useful for e.g. facilitating the orderly operation of the country's largest real estate market. The records are publicly available through the Automated City Register Information System (ACRIS).
I learned two things from ACRIS in early 2024.
One was an address on a mortgage. That address is, factually, a thoroughly doable walk from 1 Flatbush Avenue.
The other: this outsider, trusting at face value representations made by a news publication about the socioeconomic status of the subject of a story, did not successfully predict other facts present on that mortgage.
Socioeconomic class, unfortunately, has a great deal of bearing on how a bank would choose to interact with an individual. This is particularly true as one approaches either end of the socioeconomic spectrum, away from the mass market that most people assume banks must be serving at all times. We have often discussed discontinuities in service at the lower end of the spectrum in Bits about Money. There exist… other discontinuities.
I realize that commenting on the socioeconomic status of a crime victim is uncouth, particularly in ways they might not choose to describe themselves. Class is unfortunately essential to understanding what actually happened at 1 Flatbush Avenue on October 31st, 2023. Permit me a brief recital of the source of my confusion.
This outsider perceived a through-line of the Cut piece as being that the writer made other-than-rational decisions about $50,000 because their financial life was on the line. Here are some select non-consecutive paragraphs reproduced verbatim, with bolding added to highlight statements this outsider apparently read incorrectly.
Calvin [a member of the scamming team] wanted to know how much money I currently had in my bank accounts. I told him that I had two — checking and savings — with a combined balance of a little over $80,000. As a freelancer in a volatile industry, I keep a sizable emergency fund, and I also set aside cash to pay my taxes at the end of the year, since they aren’t withheld from my paychecks.
I almost laughed. I told him I was quite sure that my husband, who works for an affordable- housing nonprofit and makes meticulous spreadsheets for our child-care expenses, was not a secret drug smuggler. “I believe you, but even so, your communications are probably under surveillance,” Calvin said. “You cannot talk to him about this.” I quickly deleted the text messages I had sent my husband a few minutes earlier. “These are sophisticated criminals with a lot of money at stake,” he continued. “You should assume you are in danger and being watched. You cannot take any chances.”
Fifty thousand dollars is a lot of money. It took me years to save, stashing away a few thousand every time I got paid for a big project. Part of it was money I had received from my grandfather, an inheritance he took great pains to set up for his grandchildren before his death. Sometimes I imagine how I would have spent it if I had to get rid of it in a day. I could have paid for over a year’s worth of child care up front. I could have put it toward the master’s degree I’ve always wanted. I could have housed multiple families for months. Perhaps, inadvertently, I am; I occasionally wonder what the scammers did with it.
Because I had set it aside for emergencies and taxes, it was money I tried to pretend I didn’t have — it wasn’t for spending. Initially, I was afraid that I wouldn’t be able to afford my taxes this year, but then my accountant told me I could write off losses due to theft. So from a financial standpoint, I’ll survive, as long as I don’t have another emergency — a real one — anytime soon.
These statements, and others throughout the article, conjured a particular image for me. It was that the writer was upper middle class, dealt with a bit of financial anxiety common to many individuals in precarious or not-particularly-remunerative employment circumstances, and was abused by professional con artists in a calculated fashion to prey upon this financial insecurity.
When recounted these same statements, my friend Byrne Hobart, who has actually lived among this social milieu before, laughed knowingly and said “Ah, family money.”
I will now add three true statements to the above sketch, in the hopes that you understand this transaction the way that a Bank of America teller understood it.
The writer’s positive home equity, trivially available to the bank which wrote their mortgage, is well in excess of ten years of the median household income for New York City. The writer is the president of the family charitable foundation, which per its annual filings with the IRS has in the recent past held approximately $2 million in marketable securities. And the family estate in Connecticut (which the writer’s parents live at) was featured in the local paper, highlighting two hundred years of history.
Discovering these facts radically changed my impression of why, per the writer’s written communication with me, she was not asked for the purpose of a $50,000 withdrawal by any bank staff. It no longer looks like a surprising lapse in procedure, when someone attempted to empty their entire savings account and wasn’t even half-heartedly counseled about caution. It looks like trivial cash management of a well-off, presumptively sophisticated client, whose household, resources, and probable financial future were thoroughly known to the bank.
Would the bank prefer the teller to ask one more question in this circumstance? Perhaps. But it won’t lose sleep over the matter.
Bank of America was asked about this transaction by the New York Times: “‘We have extensive efforts to warn clients about avoiding scams,’ said a Bank of America spokesman, William P. Halldin, via email. The bank declined to comment further.” (The Times, citing policy, refused to confirm the bank branch it understood the transaction to have taken place at.)
And thus we return to our earlier question: can we find an institution which will divulge where this transaction was claimed to have taken place at? Vox Media, the writer, and the New York Times have all been asked, and we do not have an answer yet.
Bank of America is one of the largest depository institutions in the world, and reliably files Currency Transaction Reports when someone moves $10,000 or more into, or out of, the bank in cash. I thought it would be extremely unlikely that FinCEN would cough one of these up to anyone who asked.
But a recent development in Freedom of Information Act jurisprudence gave me some hope: the FOIA now, per the Ninth Circuit, allows for “statistical aggregate data” to be FOIAed. And I thought there was some hope that FinCEN would, rather than showing me a very private Currency Transaction Report, answer a simple question about statistical aggregates.
So I filed a FOIA request, 2025-FINF-00126, asking for a statistical calculation to be done:
How many currency transaction reports were filed. In Brooklyn. For a withdrawal of between $48,000 and $52,000. On October 31st, 2023. Broken down by branch address.
FinCEN efficiently processed this FOIA request, returning a definitive answer in less than two weeks: hell no. It asserted the same argument rejected by the 9th Circuit, that responding would require creating a new record (the results of the SQL query) and therefore it had no obligation to do so. It also asserted a statutory exemption which very broadly applied to many records kept by FinCEN. On reading the statutes, I thought FinCEN likely had the right of them, even if it was unlikely to prevail on the statistical aggregate issue.
Drats. It was worth a shot.
The statement from Vox Media claimed that the writer had filed a police report.
From the perspective of a fact-checker, police reports serve a useful tripwire function. Lying on one is a crime. It is not a particularly serious crime (a class A misdemeanor, which also covers “spilling a drink on someone” and “shoplifting a bottle of Tide”).
One is welcome to one’s guess as to how often New York prosecutors enforce this law, particularly against people in our social class. But it is a useful Schelling point for society: a news publication can gesture in the direction of a police report, and say “Well, everyone knows what a police report means”, and we all pretend that it means a police report necessarily contains no lies.
No police officer need disabuse journalists of their illusions here. Should a publication ever get put to the question, it will immediately pivot into “We didn’t say we agreed with or believed anything on the police report. We simply neutrally reported the demonstrable fact of the police report. Obviously we intended nothing else by bringing up a police report.”
But police reports remain useful even in a world where they sometimes contain lies, because they establish paper trails which are extremely difficult to retrospectively fudge.
I was most interested in two facts on the police report.
One was metadata: when was this report received? (It obviously reads a bit differently if the report was created in response to the fact-checker asking for it, right.) The other: did, prior to the publication of the story, the writer consistently cite 1 Flatbush Avenue, the only location in the physical universe the transaction could have taken place at, as the location the transaction took place at?
I tried to get that police report, by several methods. By June 2024, getting impatient, I was at the point of forcing enthusiastically encouraging the NYPD to follow the law and provide it to me.
Police reports, like many public records, are retrievable under the Freedom of Information Law, New York state’s legislation which mirrors the federal FOIA. The statutory deadlines are five business days to acknowledge a request, and then twenty business days (or such time reasonably required) to release the records or cite an exemption under the law for not disclosing them.
I filed FOIL-2024-056-16750 on June 26th, 2024. On the last possible day, the NYPD updated its timeline to successfully locate a police report: it would need until November. OK, fair enough. I was a bit busy myself, being involved in a house purchase and move, and my one paper copy of a style magazine was hanging out in a box in the basement while we repainted. Perhaps the New York Police Department, annual budget $5.8 billion, was likewise quite busy.
November came. November went.
Eventually, concerned that Santa would not deliver the Christmas present I most wanted, I began to press the NYPD for answers. I did this using a voice and mien which I call Dangerous Professional. Three messages, one phone call, no dice.
And so, in February 2025, after a full six months of waiting on the NYPD, I got out my call log and penned a FOIL appeal. After a brief recitation of the procedural history, that letter did a bit of calculated knife twisting:
This request was filed on June 26th, 2024, more than six months ago. It was originally assigned a Due Date of November 4th, more than two months ago, by the NYPD. Despite three attempts to request an update via the Contact the Agency form online and one telephone message, I have yet to receive any non-automated contact from the NYPD about this request.
The statutory timeframe for production of documents in response to a FOIL request is twenty business days from the acknowledgement of the request. The NYPD's failure to produce this document in more than 100 business days is, accordingly, a constructive denial of the request.
I hereby appeal the NYPD's denial, and require that it produce the documents described in the FOIL request or provide me with its reasoning under the statute why it cannot do so.
An attorney for the NYPD wrote back, forecasting a response within the statutory timeframe (10 business days for an appeal). The substantive response said that the appeal was moot because… the Records Access Officer had, subsequent to my appeal, made a determination that the NYPD did indeed keep police reports and could indeed release them in response to FOIL requests.
Oh happy day.
The police report contains a statement recorded by the police made on October 31st, 2023. I have lightly rewritten police shorthand and corrected some inconsequential spelling mistakes:
Complainant/victim further states listed perpetrator stated complainant/victim needed to pay in order to avoid being arrested. Complainant/victim states she withdrew $50,000 in U.S. currency from Bank of America, located at 1 Flatbush Avenue, at 3:10 PM.
And there we have it: reliable chain of custody to a claim made about the physical world at a known time, within hours of the alleged incident. This transaction was alleged to have happened at 1 Flatbush Avenue. Months later, in writing of her memories of the day, the writer offered a seemingly inconsequential detail about going up stairs to visit a teller window.
That seemingly inconsequential detail is, if one has a very particular set of interests, and is willing to put an irrational amount of work in, independently verifiable. Of all the bank branches in all the towns in all the world, the only one where a Bank of America teller awaits Brooklyn socialites behind thick glass on the second floor is, indeed, 1 Flatbush Avenue.
This would be a very different piece if that police report, or any other documentation at a trusted institution, named e.g. 266 Broadway instead.
As for the rest of the shoebox piece? I have no informed point of view on anything in a style magazine, except for the banking.
2025-01-25 03:42:29
This column doesn’t offer investment advice, as I am not a registered investment advisor. This is not merely a mandatory disclaimer; this is a warning. We will discuss some specific securities below that I am not merely incapable of recommending.
Finance performs a strange alchemy, teleporting value through time and space. Ordinarily, Bits about Money focuses more on the plumbing of it than the deals. But a deal enthusiast who goes by The Conservative Income Investor recently flagged a capital raise to me. It has everything: echoes of the culture that is the American PMC 2020-2024, complex financial structuring, a novel web application to move money, a crypto company in the background, and municipal politics. So it seems squarely within this column’s beat.
The municipality happens to be Chicago, my hometown and (after a 20 year stint in Japan) current residence. And so I feel some sense of civic duty, as a Chicagoan, taxpayer, and reasonably financially sophisticated person, to say the following publicly: What the hell, Chicago.
But before we get to present-day shenanigans, we need to go back several decades, because municipal politics is inextricable from the shenanigans.
Chicago and the state of Illinois more broadly have a deeply unserious polity. It has mortgaged its future through consistently overpaying public sector employees (principally, in Chicago, police/fire/teachers) and undertaxing. Neither decreasing total compensation of public sector employees nor reneging on previously-negotiated deferred compensation (pensions and healthcare for retirees) nor raising taxes to appropriate levels is considered politically palatable. One reason is that the Illinois state constitution (Article 13 Section 5) makes public employee pensions sacrosanct. The constitution is, of course, not a fact of nature; it is a political compromise by, again, a deeply unserious polity.
Long-time watchers of state and local politics know Illinois pensions are the worst funded in the nation, state officials celebrate when Wall Street upgrades its credit rating from close-to-junk, and the possibility of a federal bailout was a constant political issue for decades until it happened by stealth during covid.
And so Illinois and Chicago specifically are constantly on the make for new revenue streams. One which was mooted since my childhood in the 1980s was an expansion of gambling. So-called sin taxes (on gambling, liquor, tobacco, and similar) are politically attractive because they do not cause as much opposition as raising consumption or property taxes.
And so Chicago has had a decades-long campaign to build a casino within city limits. Why couldn’t Chicago actually get this done in several decades? One reason is the usual incompetence. The other reason is that the political economy of casinos is controversial. Many policies create winners and losers, but casinos inescapably create losers much more directly than most policies up for vote. Local political elites often band together against them, worried about siphoning money from local consumers. They also worry that they tend to create spillover effects, such as crime and moral collapse among a portion of patrons.
And so, as I once mentioned in a podcast with Thinking Poker, pro-casino political coalitions try to pick off anti-casino political elites by assuaging their concerns and/or bribing them. (In Japan, the de facto concession was “We’ll limit the amount Japanese people can lose here and maximize for soaking Chinese tourists. Now, let’s write that down in a way which doesn’t say exactly that, because it sounds bad if you put it that way.”)
In Chicago, much of the opposition came from African American political elites. They had the usual set of concerns for casinos, plus one other which is slightly more idiosyncratic. A belief with wide currency in that community is that the community would be much more wealthy than it currently is, but for vice entrepreneurs siphoning that community’s resources out of the community. This belief has lead to e.g. pogroms against Korean liquor store owners. I direct interested readers to histories of the Rodney King riots or the Asian American experience in 20th century America. (This was covered extensively in an elective I took more than 20 years ago, and so I have since forgotten the academic citations for this true but parenthetical point.)
Bally’s won the bid for the newly licensed Chicago casino in 2022, in part due to offering the right mix of concessions and inducements in its Host Community Agreement. One of those was promising Chicago that the new casino would be at least 25% owned by women and Minorities. The M is capital in the Chicago municipal code, and I will preserve this stylistic choice, because the word does not mean what most educated Americans assume it means. We shall return to that meaning later.
In fulfillment of its obligations under the HCA, Bally’s Chicago, Inc., an entity in the corporate web which will build and operate the casino, has conducted a stock offering since December. It runs through January 2025.
The stock offering has a prospectus associated with it. BCI does not appear to be relying on an exemption from registration, in the fashion that e.g. most startups would, restricting them to raising money from accredited investors.
While reading the prospectus, I read a much-remarked-upon statement, and assumed it was a misprint.
This offering is only being made to individuals and entities that satisfy the Class A Qualification Criteria (as defined herein). Our Host Community Agreement with the City of Chicago requires that 25% of Bally’s Chicago OpCo’s equity must be owned by persons that have satisfied the Class A Qualification Criteria. The Class A Qualification Criteria include, among other criteria, that the person:
Why did I assume this was a mistake? Well, for one thing, on the face of it Bally’s has told the SEC that this offering is only available to Minorities who are also women, which does not match the intent expressed elsewhere or during their roadshow. I have immense sympathy for drafting errors. Bally’s, feel free to let the lawyers know they forgot a significant “or” on the first bullet point. [Post-publication edit: An actual lawyer, not an Internet lawyer, informs me that the first bullet point has an implied "or" in this construction. Mea maxima culpa, associate who drafted this.]
The other reason I thought this was likely a mistake is that the American social, legal, and constitutional order is profoundly opposed to discrimination by race, and considers that action malum in se. Even when individual actors want to do it, they usually feel embarrassed enough about it to dissemble.
For example, the last few years tech companies absolutely, notoriously engaged in legally prohibited discrimination in hiring, sometimes as an intentionally directed and explicitly written down policy. This is often assumed to be a conspiracy theory by disaffected white males. Perhaps that is an understandable belief, since people who read the project plans either a) supported them or b) value their future careers and are therefore mostly not leaking them, and thus we only have public evidence of those project plans which end up screenshotted in litigation. Similarly, when I say that the state of California proudly engaged in redlining in the provision of lifesaving medical care in 2021, many people of good-will assume that I simply must be mistaken. I get it, but I was there.
Returning from the ancient history of 2021 to this very week: Chicago has directed a private entity to segregate, and that entity is segregating, principally via web application. If you attempt to engage Bally’s for an investment here, you will see the following blocking question during qualification stages for the investment opportunity. (The web application will also ask for your name, address, social security number, and accredited investor status.)
There is a right answer to this question. If you give the wrong answer, Bally’s will decline you the opportunity to invest. You get entirely stopped by the web application.
I express no opinion on whether this is legal, by Bally’s or Chicago. After all, I am not a lawyer, and this has certainly been seen by many lawyers at this point, in e.g. preparing the submission to the SEC. Presumably all of them went through 1L courses which introduced concepts like the Fourteenth Amendment, case law which says government actions discriminating by race are subject to strict scrutiny, and case law which says that the government cannot proxy through a private entity to do things it is prohibited to do itself. And clearly no one admitted to the bar in Illinois thinks that Chicago can waive the U.S. Constitution if it considers that politically advantageous to get a gridlocked casino through municipal politics.
So I will charitably assume the existence of a memo where competent professionals have laid out a case for the legality of this course of action. They must have concluded that no future Department of Justice Civil Rights Division, not even in an administration elected after the Host Community Agreement had been inked, would descend upon this official act like the hammer of an avenging god.
As Matt Levine beat me to observing: awkward timing.
Long-time observers of Chicago politics might opine that the city very rarely does anything without creating a carveout for politically connected individuals. The local phrase for this sort of social connection is having “clout” or, sometimes, “is clouted.” You can find examples of the sort of carveouts Chicago reserves for the clouted in the professional histories of the board members of Bally’s Chicago, Inc, for example, which are included in the prospectus.
So what’s the carveout here? The definition of a racial or ethnic minority is a legendarily contentious one in U.S. politics, largely because inclusion or exclusion from it makes one eligible (or ineligible) for concrete benefits. Sites of contention often include e.g. are Asian Americans a minority, or are e.g. Cuban Americans Hispanic, etc.
Chicago leaves itself an out for its definition of Minority, which lets it designate any individual or group as a Minority, on an ad hoc, unreported, unaccountable basis. That sounds like I must be strawmanning Chicago. See the below screenshot and explanation in the prospectus
Quoting the prospectus:
Qualification under [the final] clause is determined on a case-by-case basis and there is no exhaustive or definitive list of groups or individuals that the City of Chicago has determined to qualify as Minority under this clause. However, in the event the City of Chicago identifies any additional groups or individuals as falling under this clause in the future, members of such groups would satisfy the Class A Qualification Criteria.
Now, fairminded people reading “groups… found by the City of Chicago to be socially disadvantaged by having suffered racial or ethnic prejudice or cultural bias within American society” would note “Well, OK, on the face of it, that definitely includes e.g. Jewish Americans or Irish Americans. We have some lamentable history as a nation and city, sure. But no intellectually serious person in the United States considers Irish Americans ‘a racial or ethnic minority’ in the common usage of the term.” And thus, the capitalization of Minority.
You’ll have to ask the city for their list of ad hoc exceptions made under this bullet point. Long-time watchers of Chicago municipal politics, however, might say that asking is of limited utility.
I will note that, as a matter of engineering fact, the web application will blithely accept self-certification under this bullet point for anyone. You are welcome to your guess as to whether Bally’s or any city employee will review the 1,000 investors individually and, if they review them, what the process is for determining whether e.g. a particular Patrick counts as a Minority or not.
I’d wager there is no process at all here. It seems like a better bet than most offered in the casino.
Bally’s Chicago is a product of Bally’s, a publicly traded company. You can read their 10-Ks. According to their most recent quarterly report, they operate 15 casinos across the U.S., and have substantial online gambling operations. Like many casinos, they are somewhat diversified, insofar as a casino resort also functions as a hotel and restaurant/bar/etc venue.
Bally’s Chicago has a complex capital stack, which one would probably need to understand to evaluate the opportunity to invest in it. I am not saying “complex” as a criticism: this is fairly ho hum by the standards of large commercial real estate developments, a subject I am not an expert on but grew up hearing about at the dinner table. I am heavily implying that I would not expect a Chicagoan picked at random, or for that matter an alderman, to be able to look at the following diagram and correctly describe what it means. Prospectus, ibid, pg 145.
The entity which Chicago is stumping for is Bally’s Chicago, Inc. (BCI), the central square on that diagram. Marks investors are receiving ownership in that entity, not in the casino, which will be operated by Bally’s Chicago Operating Company, LLC (BCOC). That entity gets 25% economic interest in the future profits (insert very material asterisk here) of the casino; the other 75% flows to Bally’s Chicago Holding Company, LLC (BCHC). BCHC is a wholly-owned subsidiary of Bally’s, Inc, the publicly traded company.
When one offers someone the opportunity to invest in something, one has to decide upon a valuation for the something. The price of a slice of the pie is set in notional reference to the price of the whole pie.
Bally’s says that its good faith guesstimate on the whole pie is the economic interest in future profits of the Chicago casino is… a billion dollars exactly. The prospectus, as is wont for these situations, disclaims floridly that that price might not be accurate. One example of many: “We made a number of assumptions to determine the price of our Class A Interests. If any of our assumptions are incorrect, including our assumptions regarding the total enterprise value of the Company, then the Class A Interests will be worth less than the price stated in this prospectus. In such case, the return on investment or rate of return on an investment in our Class A Interests could be significantly below an investor’s expectation.”
Bally’s will, as is standard and customary for this sort of thing, pretend that investors have read and understood the ~200 page prospectus, and civil society will pretend to believe them.
It isn’t extremely improper to pick a billion dollars out of one’s hindquarters as an investment valuation. That particular number exerts a sort of memetic quality in e.g. Silicon Valley, and there are legendary amounts of negotiation between sophisticated parties to accept just a bit more structure to get a e.g. $920 million valuation to a $1 billion valuation, because so-called unicorn status is good for PR, for attracting prospective employees, and (a real factor) for founder ego.
But if you invest at a valuation not justified by the fundamentals of the investment, you will tend to underperform. This is an inescapable fact of investing. (And that is why the sophisticated investors, accepting a “worse” valuation, want “better” structure to compensate for it.)
And this partially explains why Chicago is holding a roadshow in African American churches attempting to convince participants to invest in a mezzanine-y equity slice of a casino at a $1 billion valuation, perhaps at 100X leverage. (I tip my cap to publicly available reporting of the roadshow.) And not, for example, attempting to convince Goldman Sachs to put together some sophisticated investors and take down the $250 million allocation.
Chicago’s pitch to investors, delivered (per above reporting by Triibe) by “City Treasurer Melissa Conyears-Ervin and members of the Chicago Aldermanic Black Caucus”, emphasizes the potential of creating “generational wealth” (direct quote) with this casino investment. This point of view aligns with the above described political economy of attempting to buy off influential communities and/or community elites with an equity carveout, which successfully got this particular casino through decades of political gridlock.
And so the investment case implies that Bally’s is intentionally giving takers something for nothing. That is, they must be sandbagging the valuation they assigned to this bundle of rights: it’s not really worth $1 billion, it is worth e.g. $5 billion. Only you favored Chicagoans well-loved by your alderman are able to buy at the non-market price, leading to essentially free money. Not merely small amounts of it, either. Generational. Wealth.
The pitch very likely explicitly said the requisite words about this being a risky investment, wink wink, and very definitely described an opportunity for extreme levels of leverage and a lengthy expected road to ROI, which we’ll return to in a moment.
Do I think sophisticated investors would agree with Bally’s that this bundle of rights is worth $1 billion? Reader, I do not.
One reason is the perception of an absence: why is this pitch being given to individual savers in a church at a minimum investment of $250, and not in a swank office to an entity capable of committing $25 million? But perhaps I’m just suspicious.
No, let’s go to more direct evidence: if 25% of this bundle of rights is worth $250 million, then 75% must be worth $750 million, right? And if an entity owning 75% of the bundle, Bally’s, also owns 14 other casinos, online gambling properties, and similar, then that entity must be worth a lot more than $750 million, right?
The market does not agree with this assessment. The entire market capitalization of Bally’s (NYSE: BALY) is, as of this writing, ~$1.5 billion. What’s the difference between the $50 million average imputed value of the other casinos and the $750 million imputed value of the Chicago casino? The $750 million is made up, that’s what.
And, again, the real unspoken logic of this pitch is that the bundle of rights is getting sold on the cheap, and that it is actually worth much more than $1 billion. It very clearly is not, or sophisticated investors would be swooping in and buying BALY’s common stock. Crack it open like an oyster and dig into that sweet sweet Chicago gambling revenue if you need to!
This is somewhat elementary and handwavy napkin analysis of a complicated business which, like most casinos and hotels, is heavily levered with a complex capital stack. But the investment case gets smothered by a napkin.
The Host Community Agreement, as above, obligates Bally’s to find a way to sell preferred Chicagoans $250 million of stock. This was likely complicated by rich Chicagoans not being suckers and less-well-off Chicagoans not having $250 million lying around.
And so Bally’s has introduced a novel structure.
In brief, that structure sells stock to investors on credit, with the credit being extended by Bally’s, and paid down by future dividend distributions of the stock. If you’re very interested in the mechanics, you can find them at length in the prospectus, but the complex legal code is an excuse for this screenshot:
What is the “Attributable Subordinated Loan?” I’m glad you asked. Bally’s staked (ba dum bum) BCI with a few hundred million dollars to fund development. Where did it find the money to do that? A mix of equity and debt financing, as is common for virtually all complex commercial real estate transactions. Bally’s, per their most recent 10-K, has long-term debt from sophisticated investors which costs them 5.x% per year. (It would be more expensive if they wanted to lock that down today.)
In return for Bally’s advancing BCI money through BCHC, BCI owed BCHC money, on an intercompany IOU. This capital offering cancels that intercompany IOU and replaces it with the Subordinated Loans. The prospectus does not quote the rate that the left pocket of Bally’s charged the right pocket of Bally’s. It does quote the rate for the Subordinated Loans: 11% annually compounding quarterly.
The road show makes much of the fact that this leverage is non-recourse. Quoting the Triibe reporting again:
The loan is non-recourse, explained Sidney Dillard of Loop Capital Markets, who is the underwriter of the offering, during the information session. “That loan is not recourse, meaning that you are not responsible for it,” she said.
I am not someone who has ever offered SEC-registered securities for sale, but I am aware that when one does that, one has to adopt a certain level of care with respect to how one simultaneously a) sells a product that one has to offer and b) describes the operations of that product without wandering into lying.
And so this writer would not describe “non-recourse” as a loan one is not responsible for. I have a non-recourse mortgage. I am very, very much responsible for paying the mortgage. If I do not pay the mortgage, I expect to swiftly not own the property securing the mortgage. The “non-recourse” bit means that the lender cannot come after your other assets or income, for example by suing you for a judgement, then forcing you to disgorge your savings account or e.g. interests you own in your small business' LLC.
The Subordinated Loans are, per the prospectus (probably a bit more reliable than the understanding of e.g. Chicago employees on the finer details), not between the owners of the Class A-{1,2,3} equity and any Bally’s entities. They are strictly loans between Bally’s entities themselves. Those loans are senior to Class A-{1,2,3} equity in the payments waterfall of future profits (we need that asterisk again!) from the casino to equity holders. The expectation is that Bally’s will individually book repayments against records which are kept on a per-shareholder basis without actually obligating the shareholder, while keeping the actual cash thrown off by the casino, prior to eventually releasing a shareholder from the indebtedness that Bally’s will say that, technically speaking, they have not actually incurred.
At that point, the shareholder will own the slice of equity that an unsophisticated listener of that roadshow might think they own free-and-clear.
Now, Bally’s forecasts that many shareholders will be very underwater on these investments. (Wow, that’s a robust sentence.) Prospectus, ibid, pg 23:
Given the capital intensity of developing, constructing, opening and operating a casino resort project of this scale, we currently expect that Bally’s Chicago OpCo will not have any OpCo cash available for distribution until approximately three to five years after our permanent resort and casino begins operations.
Assuming the most charitable estimate from that range, a Class A-1 shareholder will have $250 of equity securing a notional $25,000 investment and future obligations of approximately $34,000 (three years of compound interest at 11% on initial principal of $24,750). This suggests that the holder’s equity value is planned to be negative and that no sophisticated investor would purchase that investment for the $25,000 which the unsophisticated shareholder might believe it to be worth in 3 years. They might be willing to pay something more similar to, hmm, negative nine thousand dollars.
Seen in that light this offer of investment sounds predatory. But don’t worry, Chicagoans, Bally’s has your back. You do not have to worry about not being able to sell your stock due to its lack of intrinsic value, because you are not able to sell your stock. Prospectus, ibid, pg 179 under heading Shares Eligible For Future Sale, and elsewhere in the document.
Class A-4 holders, the ones with no notional debt, who purchased their shares for $25,000 cash-on-the-barrel, are not eligible to sell their stock at any time except as allowed by Bally’s to people approved by Bally’s. (I’ll flag that this is not an unusual term in private equities. Bally’s pre-commitment to discriminating racially against future prospective buyers? That’s unusual.)
Buyers of Class A-{1,2,3} stock are unable to sell until the associated Subordinated Loan is paid off in full.
One wonders whether senior Chicago officials will be doing a roadshow in 2030 explaining what happened.
While the natural expectation is that one is participating in the profits of the casino, the prospectus helpfully clarifies that one is not. The "cash available for distribution" does not necessarily correspond 1:1 with profits. It... well. See the discussion on page 22 and 23 of the prospectus, including the excerpt below.
While we and Bally’s Chicago OpCo intend to make distributions equal to 100% of the cash available for distribution and OpCo cash available for distribution, respectively, on a quarterly basis, the actual amount of any distributions may fluctuate depending on our and Bally’s Chicago OpCo’s ability to generate cash from operations and our and Bally’s Chicago OpCo’s cash flow needs, which, among other things, may be impacted by debt service payments on our or Bally’s Chicago OpCo’s senior indebtedness, capital expenditures, potential expansion opportunities and the availability of financing alternatives, the need to service any future indebtedness or other liquidity needs and general industry and business conditions, including the pace of the construction and development of our permanent resort and casino in Chicago. Our Board will have full discretion on how to deploy cash available for distribution, including the payment of dividends. Any debt we or Bally’s Chicago OpCo may incur in the future is likely to restrict our and Bally’s Chicago OpCo ability to pay dividends or distributions, and such restriction may prohibit us and Bally’s Chicago OpCo from making distributions, or reduce the amount of cash available for distribution and OpCo cash available for distribution.
Now, as someone who grew up with a father constantly complaining about sharp operating in Chicago commercial real estate, I can quickly outline about two dozen different ways for one to cause the operating company here to a) transfer money to other corporate entities and b) therefore have less cash available for distribution.
As a representative but not limiting example, you can probably choose your own marks for technology services from a parent to a great-grandchild subsidiary. Sure, there is some notional expectation that the marks be at arms-length price, but what is the arms-length price for e.g. casino loyalty accounting software and a particular chain's database of existing users? What low-resourced investor could possibly mount a court challenge against the entity with all the data necessary to value that asset. In Las Vegas, a casino has to calculate and diligently communicate the house edge before raking punters. Here... not so much.
That would require sharp operating... of a sort which is extremely routine in Chicago commercial real estate. This is a constant risk of being the junior partner in a structure, particularly without an aligned senior partner who would be as adversely impacted by sharp operating as you would be. Of course, here the senior partner owns e.g. the database they are renting to the entity that they also control, and so funds available for distribution from that entity might not match the expectations of junior partners.
Pick your sponsors carefully, folks.
Suppose, and this is very unlikely because it is illegal (Reg T) but run with it, that one has a typical brokerage account in the United States and, with $250, purchases $25,000 of marketable securities. Those securities periodically throw off dividend payments. One periodically pays one’s brokerage interest, because one has borrowed money from the brokerage to buy those securities on margin.
In the typical case, one would be taxed upon those interest payments, which are income. One does not simply net one’s margin interest against that income before paying taxes. One instead must itemize deductions, and then one will be able to (on Schedule A) deduct investment expenses, as described in Publication 550. Feel free to run this by your accountant; the details get complicated and wonky.
If one does not itemize, as many lower-income taxpayers do not, one must of course simply pay the tax on the entirety of one’s interest income. If one protests that one does not actually have any interest income, because it has been taken by one’s brokerage to pay margin interest, the IRS will not be maximally sympathetic.
Bally’s has very creative professionals involved in the structuring of this offering, and realizing the above issue would compromise fitness for purpose, they have… adopted a theory. I will quote that theory, from the prospectus, verbatim. I have taken the liberty of bolding an important bit in the middle of this.
Section 305 of the Internal Revenue Code provides that if a corporation distributes property to some shareholders and other shareholders have an increase in their proportionate interests in the assets or earnings and profits of the corporation, such other shareholders may be deemed to receive a distribution that could be a taxable dividend. In this case, because we and Bally’s expect to treat the Subordinated Loans as “stock” for U.S. federal income tax purposes, “property” distributions will likely be considered to be made to “some shareholders” of Bally’s Chicago, Inc. as payments are made on the Subordinated Loans, and equivalent cash (“property”) distributions will be made with respect to the Class A-4 Interests. In addition, as payments are made on the Subordinated Loans, particularly those that repay the original principal amount of such Subordinated Loans, the proportionate interests of holders of our Class A-1 Interests, Class A-2 Interests and Class A-3 Interests in the assets or earnings and profits of Bally’s Chicago, Inc. may be viewed as increasing. Accordingly, it is possible that such increase could be treated as a deemed distribution under Section 305 of the Code or otherwise as taxable income to such holders under other theories. However, under the Treasury Regulations relating to Section 305 of the Code and other IRS administrative guidance, certain financing arrangements in the form of preferred stock investments that fund a corporation and then are systematically eliminated through property distributions until they are fully retired, and are designed to facilitate the ownership of a business with an effect of increasing another stockholder’s proportionate interests in the assets or earnings and profits of a corporation over such period, do not result in a deemed distribution to such other stockholder. The applicability of these authorities to the holders of our Class A-1 Interests, Class A-2 Interests and Class A-3 Interests in this situation is uncertain. Although the matter is not free from doubt, we intend to take the position, and this discussion assumes, that U.S. Holders of applicable series of Class A Interests would not be treated as receiving a deemed distribution from us or otherwise realizing income as a result of repayment of the Subordinated Loans corresponding to such shares. However, there can be no assurance that the IRS will not take a contrary position, for example, treating the proportionate interest in our earnings and profits owned by U.S. Holders of the applicable series of Class A Interests as having increased upon repayment of the Subordinated Loans corresponding to such shares, and treating such U.S. Holders as having received a distribution. In that case, such deemed distribution will be taxable as a dividend, return of capital or capital gain as described above under “— Distributions,” and U.S. Holders may be subject to U.S. federal income tax without the receipt of any cash. U.S. Holders should consult their own tax advisors about the application of Code Section 305 and any other potential deemed receipt of income risk with respect to our Class A Interests .
Now, I’m neither a lawyer, tax accountant, nor am I someone who listened carefully to the roadshow when it doubtlessly stepped through this for the benefit of the audience. But here’s what it means:
Bally’s is taking the position, though they acknowledge that the IRS might disagree, that owners of the Class A-{2,3,4} interests aren’t actually getting any income until the Subordinated Loans have been paid in full. This means that they don’t have to pay income taxes in years where they are not actually receiving cash distributions.
No, they wait until the Subordinated Loan is paid in full, and then immediately owe income taxes in one whack, at the difference between their basis in the stock (say, $250) and the then-FMV of the stock (say, $25,000). Resulting in Bally’s diligently filing a document with the IRS saying that e.g. a lower-income Chicagoan has just received a bit less than $25,000 in income from them, and should probably pay taxes on it. You can, of course, receive income without receiving immediately available cash; it happens all the time in tech, and is the cause of much structuring to avoid the consequences of it, which can be painful for e.g. early career employees.
Those taxes will be paid substantially out-of-pocket, because there is almost no conceivable universe where a stock of an actual healthy operating enterprise worth e.g. $25,000 pays an ordinary dividend of e.g. $5,000. The market would adjust the value of the stock upwards to account for the extraordinarily rich stream of dividends, which would adjust the tax bill upwards.
Financially sophisticated investors might prepare for a tax bomb like this by e.g. borrowing against the value of the stock. That’s basically impossible for this issuance, due to the stock not being publicly listed, the restrictions on transfer, small dollar amounts, etc. The other option is, of course, selling the stock, to whomever Bally’s deigns to approve.
Tax-motivated transactions are, of course, motivated transactions, and the lucky buyer will probably be able to extract a bit of a deal, doubly so because they are likely much more sophisticated than the initial buyer of the stock, and they have less risk to account for (because of e.g. several years of operating history of the casino before the tax bomb explodes).
I am not an investment advisor, and not your investment advisor. I am, however, a recreational poker player who lives in Chicago. I intend to periodically donate money to the Chicago economy by making poor decisions on the river at Bally’s Chicago.
I do not, however, presently intend to participate in Bally’s stock offering, nor do I presently intend to buy their common stock.
I will note, out of an overabundance of scrupulousness, that I own a tiny amount of MGM stock, which is a direct competitor to Bally’s. I caught the poker bug at a conference in Las Vegas (hosted at the Tropicana, since acquired by Bally’s and then brought down in a controlled implosion).
MGM, across the street, actually had poker tables. I have had many enjoyable post-conference excursions staying at their hotel to (in several but not all years) lose money at those tables. I bought the stock for the same reason I buy stock in every hotel, airline, bank, and similar I use: in the unlikely event a not-particularly-high-stakes poker player has a routine customer service complaint, Investor Relations is available as an escalation strategy, over e.g. hotel staff who might be long-since inured to listening to complaints from people who lost money in a casino.
Oh yeah, I mentioned that there is a crypto angle to this. The registrar and transfer agent for offering 100:1 leverage to retail investors on a casino stock is, see prospectus pg 41, BitGo Trust. If I had made up that detail, as a crypto skeptic, you might have accused me of being a bit on the nose.
2025-01-16 04:37:22
Happy New Year! I have a housekeeping message (which you will see immediately below, if you’re reading this via email), a review on 2024, and then some updates about Bits about Money as a publication. Spoiler: BAM is not going anywhere; I’d be obliged if readers supported it with money.
Are you reading this in a web browser? Supporters of Bits about Money who got this in an inbox saw a brief reminder about billing details. If you are a paying supporter of BAM and need a refresher on billing details, see the account portal, which will likely require a magic link to be sent to your email address. If you have further questions or concerns, email me.
We’re up to 53 essays at Bits about Money. Nine of those were new in 2024. This is a bit below my target, assuming typical form factor, which is 2,000 to 8,000 words. However, a few of the 2024 essays were longer-form deep dives, so I was approximately happy with BAM’s delivery in 2024. I am also broadly happy with how the publication has evolved.
The best piece of last year is almost certainly Debanking (and Debunking?). I am told it is still bouncing around the corridors of power. The piece addresses Marc Andreessen et al’s claims that crypto has been discriminated against as a result of intentional action by the government. We examine the procedural history, law, incentives of commercial actors, and political ramifications of these claims in substantial depth.
It is a rare piece about financial regulation of the cryptocurrency industry that is publicly praised by both the crypto VC who came up with the phrase “Choke Point 2.0” (“... the best and fairest treatment of the issue [I] could expect from a skeptic…”) and also by a former federal banking regulator (“This is a tour-de-force. This is absolutely excellent. Anyone interested in this issue should read this piece.”) Citation links.
The experience of writing that piece sort of brought BAM together as a project for me. Publications often have a beat and/or self-conception. BAM is aimed pretty squarely at deep dives into the weeds at the intersection of finance and technology. Blogs/Substacks/etc, however, sometimes suffer from being experienced by readers as disconnected essays unified only by authorial voice and recurring themes. And so it was edifying when, in explaining e.g. why crypto entrepreneurs and bodegas alike experience AML-related debanking, I was able to refer to substantial past dives into related topics, in addition to other reporting, statements of federal agencies, and similar. The substantial discussion of how the crypto industry underrates its own credit risk to banks, which included an extensive worked example of how Voyager Digital’s bankruptcy sunk Metropolitan Commercial’s crypto practice, was improved by many previous discussions of how deposit accounts in the U.S. are actually credit products.
The year also featured some pieces I’m almost uniquely qualified to write, such as the (fast!) postmortem on the Crowdstrike bug bringing down banks nationwide (including an analysis of why regulatory diktat and enterprise SaaS sales motions resulted in a security software monoculture). I also wrote an extended explanation of medallion guarantees, ACATS, and why your brokerage is unlikely to verify with you if another brokerage asks them to send away all your assets. Executive summary: you probably don't need to worry about this, but brokerages certainly do.
All in all, a pretty good year!
I’m presently coming up on the two year anniversary of leaving full-time employment. (I remain an advisor at Stripe, my prior employer. Stripe does not necessarily endorse what I write in personal spaces.)
I’ve treated these last two years as something of a sabbatical, after many fairly intense years focused on work to the exclusion of other concerns. This allowed me to relocate my family from Japan to America (mostly for family reasons), catch up a bit on fatherhood and video games, and spend some time thinking of what I want to do next professionally. I do not yet have a high-quality answer to that, but when I do, I’ll let the Internet know.
Professors sometimes use sabbaticals to write books. I likewise used freed up cycles to produce public professional output. BAM is the best known at present.
I also started a podcast, Complex Systems, which is very likely relevant to your interests. Complex Systems is perhaps a 40% overlap with BAM in terms of topics. The remainder involves wide-ranging discussions about various forms of infrastructure with experts in those fields. You can find it in your podcast client of choice or on the above website.
Complex Systems has published 26 episodes since July 2024, and (thanks to my intrepid assistant Sammy and the relative ease of speaking rather than writing book-length pieces) actually sustains a predictable publishing schedule: every week on Thursdays (less holidays).
BAM readers would likely enjoy my conversations with Lars Doucet on property taxation in the U.S., Ricki Heicklen on teaching trading in capital markets, or (my father) Jim McKenzie on commercial real estate development. If you are more of a reader than a listener, you'll be happy to learn that there is a full transcript (and substantial inline notes) with every episode.
An announcement: sometime in 2025, Bits about Money will release a companion audio version. I’m still playing with the exact format, but an experimental episode had me read a classic BAM issue (The optimal amount of fraud is non-zero) aloud and enhance it with essentially live commentary. I’ll let you know once there is a dedicated podcast feed for you to sign up for. This audio product will be free and public, thanks to the generous support of BAM readers. I presently intend audio episodes to follow the publication of BAM issues by a week or so. This product was built in response to requests from members, because apparently some of you e.g. want to listen about financial infrastructure at the gym or during your commutes. I’m happy to oblige.
I’m presently planning on ~12 issues of BAM in 2025, indicatively, but I understand that readers are primarily interested in quality/taste/curation and not word count. Should plans change, I’ll let you know.
Future topics are, as always, both dealer’s choice and heavily informed by suggestions from readers. Sammy and I are (knock on wood) nearing the tail end of an involved investigative journalism project which I’m excited to share, on bank fraud. Investigative journalism is an interesting change of pace from the usual explainers, commentary, and deep dives, but you should expect those to remain the heart of the publication.
Bits about Money is supported by its readers. Thank you, again, to those of you who helped me pay the mortgage while writing 53 unpaywalled deep dives about financial infrastructure. I’m particularly committed to keeping Bits about Money publicly accessible for free, which is unusual for professionally-focused writing of its caliber. Your support allows me to do that. It is also essentially an ongoing bid for me spending time and attention on writing focused on this beat specifically.
I sometimes get asked why there is not a paywall. That is certainly not a revenue-maximizing decision. (Many technologists have deeply irrational cherished beliefs on this score.) BAM doesn’t have a paywall because I optimize for its reach and impact over its financial success. That has always mattered because some readers, like students and regulators, either can’t afford a subscription or (for structural/cultural reasons) find it difficult to justify expensing a trade journal. Most of BAM's hundreds of supporting members are professionals in tech and/or finance; support which is cheap to you is useful to many, including in leveraged fashions (e.g. via informing better public policy or educating prospective employees for your company).
The public availability also helps for an emerging use case: when you talk to LLMs about these topics, that actually works pretty well. This didn’t require a special negotiation with the labs; their crawls include the public Internet, in a way that they don’t include most professional writing about finance. When I was younger I would have apologized for this fact, because it means that a user asking an LLM about crypto-oriented debanking might get an answer informed by me, and not by e.g. the Wall Street Journal. As of today, the weakest link in the chain is the LLM, because my writing on debanking is substantially superior to the WSJ’s.
(The WSJ is very, very good at what they do, which is weighted more towards breaking news and not towards expert commentary on why the world works the way it does. I hope they negotiate a side agreement such that LLMs grow up reading the WSJ, much like I did. As I’m less capable of negotiating agreements with every lab in the world, publishing to the open Internet accomplishes the same aim.)
If you already are a paying Bits about Money supporter, thank you for your support. If you aren’t, please consider purchasing a membership. Most supporters are on the annual plan (currently $165 a year). We also have memberships available on a month-to-month basis and a more expensive option, playfully named after my most useful pricing advice to others.
A Bits about Money membership is likely a tax-deductible expense for businesses. It is also likely covered by your education budget if you work in tech or finance. Most of your other questions are answered on the memberships page.
Thanks in advance for your consideration. As always, I read emails sent to me, and particularly welcome comments on topic selection.
See you soon.
