Capitalism without Capital and after COVID (#37)

Structural Shifts with Stian WESTLAKE, co-author of ‘Capitalism without Capital’ book.

Our guest is Stian Westlake, co-author of ‘Capitalism without Capital: The Rise of the Intangible Economy‘ and we discuss the implications of an economy built increasingly on intangible assets, even more so in the post-pandemic world. In this podcast, we discuss the four S’s that explain how intangible assets behave differently than tangible ones, why we’re not seeing more economic growth or higher productivity right now, even though intangible assets are more scalable, what governments need to do to mitigate the increased income inequality that’s occurring in part due to the rise of intangible investments, and more. Stian serves as the Chief Executive of the Royal Statistical Society. Previously, he served as an advisor to three British ministers for science, innovation, research, and higher education. He also led the policy and research team at Nesta - UK’s National Foundation for Innovation.

Full transcript
Structural Shifts with Stian WESTLAKE

Sometimes there are things that are very easy to measure at the big picture, but they get harder to measure the more granular you get — and intangible investment is definitely one of those things

[00:01:30.26] Ben: Stian, thank you so much for coming on the Structural Shifts podcast. We’re really delighted to have you on. I think there are a few structural shifts as profound as the one you’ve been investigating, most notably through your 2018 book, “Capitalism Without Capital”, which is the shift from a tangible to an intangible economy. This is a phenomenon which has been playing out over the last 40 years in developed economies, and which, as we’ll discuss, has likely been accelerated by the pandemic. It’s also a phenomenon, which, although it might seem slightly esoteric, is at the roots of or contributing to some of the biggest changes we’ve seen in society, such as inequality, as well as in business, such as the rise of big tech platforms. So if it’s okay with you, let’s start by just defining what we mean by an intangible economy. So, do you mind just kind of setting the scene and telling us the extent to which investment has shifted from tangible to intangible assets?

Stian: Yeah, of course. If you think about what the economy used to be like 40, 50, 100 years ago, the majority of the stuff that businesses, that governments invested in were stuff you could see and touch — what economists would call tangible capital. So, it was machines, it was factories, it was vehicles, it was buildings — all these kinds of things. One of the things that we’ve been noticing is there has been a really slow but pronounced change over time, such that now the majority of investments that businesses make — buying an investment, I mean, something that you incur a cost upfront, and it delivers you a benefit over time — most of the stuff is stuff that you can’t see or touch, things that you can’t stub your toe on, as it were. It’s things like investing in r&d to create new ideas, new patents, things like investing in marketing, advertising, customer understanding to build brands, it’s things like employer training. And it’s stuff that has this kind of fuzzy idea of things like organizational development. So if you think of a company like Apple, one of Apple’s competitive advantages is its remarkable supply chain. Now, the supply chain includes some things that you can touch — it includes factories — but Apple doesn’t own them. So those are to some extent tangible. The stuff that really creates value for Apple is these privileged relationships, the expectation of doing business, and their access to these suppliers, which allows them for example, to get products to market at volume, fast. These things are investments, they’re costly to acquire, they deliver benefits over time, but they’re very different from the world where your investments were the machines and the factories or the land that you grazed your cattle on.

For most of history, tangible assets represented a much bigger slug of the economy, than the investment in intangible assets. And about 10 to 20 years ago, depending on the country, those two lines crossed.

[00:03:59.18] Ben: The book is full of brilliant graphics but one of the ones that really stands out is the one that shows the acceleration in investment in intangibles and the point at which it crosses over. So intangibles now represent or comprise a larger proportion of overall business assets than tangible assets.

Stian: Yeah, that’s right. So if you think of these as a percent to GDP, so in relation to the size of the economy, for most of history, tangible assets represented a much bigger slug of the economy, than the investment in intangible assets. And about 10 to 20 years ago, depending on the country, those two lines crossed. The intangible line has been moving up and up and up, slowly but steadily for decades. They crossed. If you look in rich countries now, the intangible investment represents roughly 15% of GDP of national annual output, and tangible assets more like 10–11%. One of the nice things about these slow but steady changes is you can be pretty confident that these things are reliable. We have so much data on this. This is a change that’s been going on for a very long time.

[00:05:06.17] Ben: You say we can be confident in the reliability of the data. But, I mean, you used the term ‘fuzzy’ for some of these intangible assets earlier on. And that sort of suggests that there might be things that are quite difficult to define, and therefore quite difficult to value and capture on a balance sheet or in economic statistics, GDP statistics.

Sometimes there are things that are very easy to measure at the big picture, but they get harder to measure the more granular you get — and intangible investment is definitely one of those things in that national accounts do a kind of okay job of representing this.

Stian: So it’s a really good question. And it’s one of these things that have traditionally not been very well captured in either economic statistics — the kind that governments put together — or in business statistics, the kind of thing that your accountants would put together. And one of the interesting parts of this work, my co-author, Jonathan Haskell, along with many other economists, have really spent a lot of the last 20 years trying to work out ways of measuring this intangible investment at the level of the economy. And they used surveys, they’ve used fascinating historical data sets; it took quite a while to get a handle on this stuff but the results are pretty conclusive that this intangible investment is growing. Where things get tricky — you mentioned company accounts — sometimes there are things that are very easy to measure at the big picture, but they get harder to measure the more granular you get — and intangible investment is definitely one of those things in that national accounts do a kind of okay job of representing this. Nowadays, most countries will record their r&d investment and record some of their human capital investments. But corporate accounting standards don’t recognize this stuff. So, you will find very few intangible assets on a balance sheet. And I guess one of the interesting aspects of this is if you look at the job of people who try and value businesses with a lot of intangible assets — such as sell-side investment analysts, people who work for hedge funds or other investment funds; it’s really interesting, there was a whole bunch of research done on what these guys spend their time doing when they’re on CEO calls, CFO calls, and someone managed to code all these conversations. It turns out that most of these things are actually asking about intangible assets, to try and understand the value of whether it’s supply chains, whether it’s the r&d going into the new product line. And there’s a kind of an interesting opportunity here if you’re involved in investment because this stuff is harder to value — and if stuff is harder to value that’s good for the people whose expertise lies in valuation.

The reason why we should care about the change to intangible capital is that from an economic point of view, intangible capital behaves differently. And the four S’s are the four ways in which it acts differently: scalability, sunkenness, spillovers, and synergy.

[00:07:19.18] Ben: It’s true, I never… I suppose I had thought about it, but not like that exactly, which is it’s kind of an arbitrage opportunity there because I suppose superficially, things like return on capital might be understated, or profits might be understated because so much of this stuff should be on the balance sheet, but it is an expense to the p&l. And then, you know, just having a better understanding of the things that are not recorded in annual accounts or in the annual report potentially gives you an edge.

Stian: Yeah. And I guess, you know, if you think about the way things have always worked in, say, on the sell side, when you look at sectors like pharma. So pharma is a sector that has always been heavily based on intangible assets. The value of GSK is kind of the value of its pipeline of drug ideas. And I guess, if you’re an analyst in that sector, what you’ve always done is basically, you’ve done a bunch of valuations of what you know to be the product pipeline with some kind of option value based on what you think the individual capability of the firm is. And I guess in an economy where intangible capital gets more and more important, more of the task of investment analysis is going to look more like the pharma investment analyst or even a kind of an analyst of the VC house.

Intangible assets have a lot of spillovers, and that means that a company that makes them can’t always be sure that it will get most or even any of the benefits of an investment that it makes. […] It’s much harder to control those spillovers than it is with tangible assets, […]. And so, managing those spillovers becomes a really important part of what successfully managing business looks like in an intangible economy.

[00:08:30.22] Ben: Definitely. You talk about the four S’s of intangible assets. Do you mind just running us through it? Because I think it’s really critical that we understand the properties of intangible assets. And since they behave differently, that then, in turn, means that economies behave differently, and so on. Do you mind just telling us about the four S’s?

Stian: Yeah, totally. If you take away only one thing from the book, this is the thing to take away from it. So the reason why we should care about the change to intangible capital is that from an economic point of view, intangible capital behaves differently. And the four S’s are the kind of four ways in which it acts differently. The four S’s are scalability, sunkenness, spillovers, and synergy. So I’ll just quickly give an example of what I mean by each of those. So scalability: if you compare an intangible asset to a tangible asset, a tangible asset, you can only get a certain amount of use before you need to kind of invest in more of those tangible assets. If you own a fleet of taxis, if you want to carry more of a certain number of customers, you need to buy or lease more taxis. If what you own is an algorithm for dispatching private hire cars like Uber, you can scale that if not infinitely, then arbitrary. You can scale that across a very large number of taxis and a very large number of cities. So valuable intangibles go a really long way. And one of the implications that means that we can go on to talk about is that if you’re a big company with some valuable intangibles, you can get very big, you can create a lot of value.

Stian: The second S we talked about — sunkenness. So sunkenness refers to the economists’ idea of sunk costs — the fact that sometimes once you invest in something, you can’t recover the value of it. And that’s very much more true for intangible assets than tangible assets. So if you own, for example, an office building — a tangible asset — and you go out of business, you can very often sell that office building, you can recover quite a lot of the value from it, even if you’re in a distress sale. If you own a patent, you can sell patents but patents are very often worth almost nothing to anyone apart from a small number of providers. A brand of a company that’s gone bust is not worth a lot. As we can maybe come to talk on later, that’s got some really important implications to how you finance businesses that have a lot of intangible assets because debt investors do not like sunk costs.

Stian: The third S is spillovers. The idea of spillover is, intangible assets have a lot of spillovers, and that means that a company that makes them can’t always be sure that it will get most or even any of the benefits of an investment that it makes. So, there are classic examples all through the history of tech, but Xerox PARC — kind of one of the foundational stories of Silicon Valley — they invented almost every foundational computing technology, every desktop computing technology you can think of. They make no money from it. Most of the value was captured either by Apple, by Microsoft, or by a host of other companies. It’s much harder to control those spillovers than it is with tangible assets, where we’ve got a set of very clear rules around them, they’re kind of physical, they’re kind of easier to keep tabs on. And so, managing those spillovers becomes a really important part of what successfully managing business looks like in an intangible economy.

There is a lot of productivity growth, at the moment, it’s just not evenly distributed. So, if you run one of these companies that can benefit from the synergies and the scale of intangibles — i.e. own a bunch of valuable intangibles, you can scale them across a really big business, and you can combine them in ways that make it very difficult to compete with you. 

Stian: And then the fourth S — synergies — is this idea that intangible assets seem to be especially valuable when you combine them in the right way with other intangible assets. So, a classic example we talk about in the book is the EpiPen — the epinephrine injector for stopping allergic reactions and anaphylactic shock. And what we talk about in the book is how that isn’t really a typical pharmaceutical invention. In fact, it’s based on a drug with a patent that expired over 100 years ago. But one of the things that EpiPen’s owners have very effectively done is they’ve combined a whole bunch of intangible assets from the design of the injector, to their very privileged supply chains, to the various legal moats that they put around things to even the brand name — the recognizable brand name — of the product that you kind of want to be able to recognize when describing in an emergency. And together, all of those things, all of which are kind of intangible assets, combine to create a big competitive moat around the product, but ultimately kind of very profitable, very value-created product for them. And these synergies exist, you know, between talent and intangibles, between different intangibles. And again, it means that if you’re a company that has a bunch of these valuable intangibles, you can create a lot of value for shareholders.

[00:12:59.01] Ben: Fantastic. So I think the four S’s give us a really nice framework to dig into some of these other topics, right? So I wanted to move next to growth. You talk about the scalability of intangible assets, right? So if the economy is made up of more intangible assets, and those intangible assets are more scalable, why don’t we see more economic growth or, you know, or higher productivity growth than we do at present?

Stian: So that’s a really good question. It’s something that really ever since we started working at this, we’ve been wrestling with, and it’s a big subject of our follow-up book, which is coming out later this year. But I guess one of the things here is that there is a lot of productivity growth, at the moment, it’s just not evenly distributed. So, if you run one of these companies that can benefit from the synergies and the scale of intangibles — i.e. own a bunch of valuable intangibles, you can scale them across a really big business, and you can combine them in ways that kind of make it very difficult to compete with you. Those businesses, as far as we can see, are very profitable, their profitability is growing, they make a lot of money for their shareholders and their employees, and they’re kind of seen as iconic businesses. So, you know, your classic dominant internet platforms, Google and Facebook, and whoever would be examples of that. But, you know, we see this in other areas as well. So, you know, Domino’s Pizza — a classic example of a business that looks very old fashioned, but has totally killed it in terms of developing a very powerful internet platform. So you have a world where some businesses, because of the intangibles are doing really well. And one thing that we’ve been looking at is the fact that in an economy like that, because of these spillovers, you create kind of perverse incentive for the rest of businesses. If intangibles have quite a high spillover and if some firms are really good at getting the benefit of those spillovers, the rationale for investing, for your kind of laggard businesses, your runners up in industries is plausibly much less.

there’s been a ton of research over the last kind of 20 years now, looking at that gap between your so-called leader firms and laggard firms. And basically, in every country, in every industry, that gap is growing. And really, interestingly, it’s growing the most in the industries that have the greatest number and that have the greatest proportion of intangible assets.

Stian: You know, if you’re in a traditional — if you imagine a very tangible-based economy like an industry like, I don’t know, running a laundromat, let’s suppose the best laundromat has the best washing machines and the best building; if you run the second best and the third-best laundromat, you can catch up in due course. You can borrow money from the bank, you can buy better machines, it’s kind of pretty obvious what you need to do to catch up because you can visit the other businesses and look at what they’re doing. There you would expect to see over time the gap between the most productive, most profitable businesses, and the least, would shrink because you can just copy. Now, if you’re in an intangible economy, those dynamics change. Imagine you want to compete with Uber. Okay, you can try and develop your own dispatching app but the scale effects are such that you’re going to be up against vast fixed costs, it’s very unlikely you’re going to be able to compete with the huge amount of money that Uber can pour into their development. And because of scale, you won’t be able to kind of amortize that across a large business. Okay, so you say, “Okay, well, I’ll come up with some new product feature that Uber hasn’t come up with.” Let’s suppose you’re an absolute product development genius, and you come up with something. In this economy, because of the synergies and because of the spillovers that we talked about, you might not be very well advised to do that, because Uber could quite simply copy it, or, you know, they might buy you, which would be kind of a good story for you but in terms of the dynamic, your business goes away, and therefore the leader business grows more powerful. So, rather than the world of laundromats, where catching up with the leader is about copying, it’s about acquiring probably mass-produced tangible capital, where you can probably get a bank loan for it, in the intangible economy, it’s much harder to catch up like that.

Stian: And I guess this comes back to your original question about what might be going wrong with productivity. If you can imagine an economy where the best businesses are doing really well, they’re generating a lot of money for their shareholders, they’re being really productive but there’s huge disincentive for a large chunk of the economy to invest and to catch up. In aggregate, that could come to an economy where productivity growth is actually pretty slow. And in terms of the evidence for this, there’s been a ton of research over the last kind of 20 years now, looking at that gap between your so-called leader firms and laggard firms. And basically, in every country, in every industry, that gap is growing. And really, interestingly, it’s growing the most in the industries that have the greatest number and that have the greatest proportion of intangible assets.

One of the issues of spillovers is businesses will invest less than is socially optimal in R&D. If you’re in a world where you want more R&D investment, but businesses won’t do it, that probably means you need governments or research institutes to do it. Again, that’s quite a judgment-based process, so you’re sort of saying you’ve got to trust people in positions of authority to do this kind of thing, which is particularly challenging in today’s political circumstance. So that’s a real dilemma.

[00:17:23.07] Ben: Do you think there’s another thing at play as well, which is, in the world of tangible assets, economies of scale were eventually subject to diminishing returns, right? Whereas in the world of intangible assets, you know, where we have network effects, you could argue that a lot of times, you get just increasing returns to scale. You talked about Uber — I guess the more customers you have, the more drivers you can attract, the more drivers the more customers, and you get these virtuous self-fulfilling feedback loops, meaning that you get increasing returns to scale, whereas in the past that almost wasn’t possible in economic terms.

Stian: Yeah, that’s definitely true. And I think those network effects you talk about are a really important part of this kind of scalability of intangible assets.

[00:18:07.18] Ben: Do you think we should be using more antitrusts? So you talked about Facebook and when I think about Facebook, I think, you know, the initial platform was super successful, had very strong network effects, it delivered a lot of utility to its customers. But since then, you know, it’s copied features from other people like Snapchat, it bought Instagram. And I just wonder, you know, should we be using antitrust to stop the big platforms from getting even bigger through copying and m&a, for example?

Stian: Antitrust and competition policy clearly become very important in an era of intangible assets because of this kind of tendency of the best companies to do really well. The flip side is, I think a lot of the old rules become a lot harder to apply. So, traditionally, we’d look at an economy, and also we’d look at an industry and we’d say, if the kind of concentration ratios are above a certain level, then that’s a problem and we need to break up the leader firm or we need to block acquisitions. That becomes a lot harder in this kind of economy, I think, for two reasons. Firstly, because these synergies because there are so many crossovers between different types of assets, it becomes a lot harder to define an industry. So, for example, you know, are Facebook and Google in the same industry? I mean, on one level, they’re clearly not — one is a search engine, one is a social media site. But, you know, if you’re an advertiser, they might look a lot like they’re in the same industry. So it becomes a lot harder to make those distinctions. I think the other thing is that, you know, the kind of silver lining of scalability and spillovers, is that although businesses can thrive and grow and their dominance can get entrenched, the flip side is, when things go wrong, they collapse very quickly and your rivals can grow up very fast. So the kind of optimistic vision of competition in a world of intangibles doesn’t look like a market where there’s kind of, you know, seven or 17 or 70 competitors all in the same market. It might be a market where you have people who temporarily look a lot like very dominant, almost monopolistic players, but where there’s a lot of competition almost across industries, and where you have enough dynamism, enough opportunities for startups, that people like Facebook and Google occasionally get dethroned.

[00:20:29.04] Ben: I agree with that. I think there’s not enough documentation of negative network effects. Because, you know, on the way up, it’s exponential; potentially, on the way down, it can be exponential too. Are you saying that competitive or antitrust policy is difficult to execute, therefore, we shouldn’t try? Or are you just saying that we need to find new sort of yardsticks for anti-competitive behavior? Because similarly, you know, it’s difficult to look at concentration; it’s also difficult to look at price because so often these platforms lead to lower prices because they’re monitored indirectly.

Stian: I think the short answer is, it’s probably the latter of your two things. It’s more that we need to kind of come up with new ways of analyzing this new way of looking at it. And that’s really tricky because one of the nice things about the world of 20 years ago, if you were a competition regulator, your job — I don’t want to say it’s easy; it was a difficult job — was quite rules-based. There were ratios and there was a whole academic infrastructure of how you would think about the concentration ratio in a particular sector, although a lot of judgment needed to be applied to that. That was kind of some yardsticks. I think if you’re looking at this kind of thing now, it becomes much harder. And in the same way earlier that we were saying that to be a sell-side investment analyst, scale becomes more important and the job becomes harder. I think that’s also true if you’re a competition regulator, which I guess where that takes you, if you’re to say, “What does this mean for politics or for public policy?” is a really unfashionable position. Basically, it means you need to spend more money on people who’ve been derided as bureaucrats and pencil pushers, more money on their analytic ability, and be more willing to at least consider innovative approaches to how you do those kinds of things.

We shouldn’t use the intangible economy as an excuse to give up on doing just the basic stuff to make society fair.

[00:22:14.20] Ben: But it all becomes a bit less objective, doesn’t it? Because in the same way that… You know, a sell-side analyst you could sort of test in advance their ability to understand the company accounts, or you could test civil servants’ ability to understand a legal framework, or similarly, you know, financial information. It’s very difficult ex-ante to understand or to kind of determine how good people are going to be at those jobs, right? How much to pay them and so on, right?

Stian: Well, it becomes much more judgment-based. And one of the things that we know from, there’s, I think, a whole branch of Management Science, looking at this kind of thing, that if it’s harder to measure performance in these jobs and more discretionary and more judgment-based, that typically leads to higher salaries, and it’s a more costly process to run.

[00:23:03.07] Ben: But I think in the world of antitrust if decisions are taken more based on judgment, then I suppose they’re more open to legal challenges and so on.

Stian: Yeah, you’re absolutely right. I mean, it’s really interesting. We see that across the piece as a result of intangible, so it’s not just… I mean, we can come on to talking about this a little bit later, but this is also an implication of spillovers, for example. We are probably in a world where one of the issues of spillovers is businesses will invest less than is kind of socially optimal in stuff like r&d. If you’re in a world where you want more r&d investment, but businesses won’t do it, that probably means you need governments or research institutes to do it. Again, that’s quite a judgment-based process, so you’re sort of saying you’ve got to trust people in positions of authority to do this kind of thing, which is particularly challenging in today’s political circumstance. So that’s a real dilemma.

[00:24:00.21] Ben: Do we need stronger IPE protection? Because I guess that’s, again, a double-edged sword, which is, what’s the right balance to anything?

Stian: So I guess the things we’re trying to balance, the spillovers of intangibles would suggest that you want kind of tough clear IPE rules because you want to make sure that the stronger your IPE rules, the more the incentive to own IPE and to invest in it are. Now, the problem, the thing that complicates that is the synergy between intangibles. So, if you take a product like Spotify — it’s a great example of something born from the synergies of intangibles, because you’ve got music rights, which are kind of one intangible asset, you’ve got the software, and the network, and the customer insight that Spotify has. By combining those, they’ve created a really valuable product that many of us are very happy to use. Now, suddenly, what people at Spotify have always told me is that if the music rights industry had their way, if they had tougher IPE rules and kind of more political influence that Spotify would never have been allowed to get off the ground. They would have been sued and out of existence in their first year or two. Now, I guess that’s the kind of great example of if your IPE rules are too strong, you don’t have a problem with spillovers so people will very happily make lots of music because they’ll make lots of money from it. But you’ll never get an innovation like Spotify, because it will always get crushed. So, I guess this comes back to what you’re saying. You need to strike the right balance between the two.

One of the ways to tackling inequality in an intangible economy, surprisingly, is through a very tangible asset — it’s through housing. It basically means that making it easier to build housing, making it cheaper for people to move to places they want to move in, becomes even more important.

Stian: I guess one interesting — if we sort of say, well, what’s the current failure mode of IPE rules? I suspect there’s probably quite a range of IPE rules that would work okay. What doesn’t work okay is a set of rules where there’s a huge amount of opportunities for special-interest lobbying where things get very distorted. So I guess the US patent system is kind of notorious for this, where you’ve got specific jurisdictions where a lot of patent lawsuits take place because they’re particularly pro-rights holders. I think the East Texas courts for patents seem to be like that. Similarly, in the US, you’ve got quite a lot of uncertainty. So you might have come across the copyright lawsuit over Pharrell Williams and Robin Thicke’s song “Blurred Lines”. So there was a huge lawsuit where the estate of Marvin Gaye sued Pharrell Williams and Robin Thicke for basically creating a song that seemed very much like a song that Marvin Gaye had written. And what was really interesting about this case, is that Pharrell Williams says he actually set out to create a song that was inspired by the Marvin Gaye song, but didn’t breach copyright. And it turns out, you know, there is a whole industry of forensic musicologists who would advise you on whether your song breaches copyright or not. And what was interesting is, in this case, the case went to court and I think it was a jury trial, weirdly; the jury just came up with a totally unexpected ruling in favor of the Marvin Gaye estate, even though everyone thought what was going on was kind of probably okay, with the result that the music industry is still talking about this. They’re saying, “Oh, well, you know, in light of this trial, what are we allowed to sample? What are we allowed to be inspired by? So that’s a kind of example of where an unexpected, quixotic interpretation rule is especially damaging. In the same way that, you know, if your business owns a factory, and it is possible to repossess that factory, sort of, you know, 5% of the time based on the phase of the moon or something like that, it would create a lot less incentive to invest in fixed assets.

Stian: So I guess what that means, probably matters less about precisely how strict the rules are, as much as making sure they’re clear. It also means that if you’re a government, you need to spend quite a lot of effort resisting the efforts of either rights holders or lobbyists to make little exemptions and carve-outs in the rules in their favor. Having been on the other side of the table working for the government on IPE policy, it’s really difficult to do that. IPE lobbyists are really smooth, they’re very kind of effective, they’re very highly paid. So that’s a challenge.

[00:28:17.19] Ben: Okay, I want to move on next to inequality. Let’s start with the inequality between people, right? So you’ve already alluded to this that where you have the right skills, the payback is going up, remuneration is going up. What are the kinds of skills that are most in-demand in an intangible economy? The most valuable.

Stian: Some of them will be the skills that are probably obvious — the tech skills; if software and algorithms are really valuable, the ability to code, the ability to manage teams of coders, or the ability to kind of manage big scientific projects and research projects. Those are clearly going to be more important. But that’s probably obvious, everyone knows that. The things that may be a little bit less obvious, is that in a world where the spillovers really matter, where it’s really important to combine synergies, the ability to bring those things together, also matters a lot. And those are often kind of soft skills. They’re often skills of hustle and entrepreneurship or social skills, things like the famous reality distortion field that Steve Jobs was famous for creating. Those things potentially become even more important in an economy like this. The other thing that I guess is potentially troubling about this is a world where who owns these assets and who has the right to use them is less clear. You could be in a world where political influence or even soft social influence becomes more important — whether that is retired politicians taking on high-profile jobs, whether it’s Instagram influencers, those general soft skills probably become more financially valuable than they were worth 40 or 50 years ago.

[00:30:02.09] Ben: Who loses out? What skills are less valuable, less solicited in this new world?

Stian: Well, one direct effect is that in some cases, these intangible assets directly relate to making some more routine jobs even more routine than they already were. Kind of the proverbial example here is, say, working in an Amazon warehouse, where, compared to a traditional warehouse job, intangible assets allow you to be more monitored, they generate a quicker work pace, which I think most people say this makes these jobs less enjoyable and less well-paid than they would otherwise be. So there’s a kind of direct effect there. But I guess there’s also an effect where if what you’re seeing is social status, social privilege, educational opportunities become more important, the flip side is that the pain of not having those things gets higher. So, you know, if you are more socially excluded, if you’re in a place that doesn’t have these job opportunities, it’s kind of not surprising that you will feel more left behind and that your sense of social exclusion — which, you know, there has always been kind of a divide between the big city and the kind of small town or the countryside; that’s always been there culturally. But the fact that cultural divide gets kind of underpinned now by an even bigger economic divide, is kind of… You can see that playing out in our politics and our current society at the moment.

[00:31:24.22] Ben: We definitely see that bifurcation of society in things like the Brexit vote. 14–52. Are we seeing, do you think, in a way, more losers than winners? I mean, relatively speaking, right? Because, you know, we don’t see massive rise in unemployment but what we do see is potentially a big bifurcation in the quality of the employment and the remuneration of employment. And I’m just wondering, you know, since we can see inequalities rising, is that because, you know, there are increasingly a small number of winners, if you like, or big winners, and then the overall population is tending downwards, in a way, in terms of, you know, real income?

Stian: Yeah. I mean, I think it’s always hard to say what’s ultimately driving inequality, because you can always, even if you have an employment system that’s creating a lot of inequality, you can always tax, you can always redistribute to generate more equality afterwards. I guess the kind of an optimistic way of looking at this is that this intangible economy, as well, is generating some of these superstar jobs that are really prestigious and really highly paid. It also generates a lot of jobs that are potentially more satisfying, more fulfilling for people to do than your kind of traditional job 50 years ago — even if they’re not as highly paid. So, you know, there’s a lot of jobs in the creative industries that are not particularly highly paid but all the research that has been done on well-being suggests that people actually like doing these jobs much more than potentially some jobs in traditional manufacturing. So I wouldn’t be totally pessimistic, but it’s definitely something that we need to be aware of this bifurcation between these elite jobs, and the kind of more socially-excluded mass.

[00:33:09.24] Ben: What do we do about inequality in this way? Because we have, I suppose, a small number of superstar firms, a small number of superstar individuals earning, sort of excess rent, if you like, or whatever. Excess returns on their skills? Is the answer to tax that and redistribute it? Or is that an industrial age policy idea that doesn’t hold someone in the digital age?

Stian: I don’t think we should give up on tax redistribution yet. I think that is pretty important and is still worth doing. And, you know, for all the people who talk about international tax-avoiding companies, I think there’s still quite a lot of low-hanging fruit there. In a country like the UK, you can just employ more tax inspectors. And, you know, we kind of under-invest in that. There is probably a low-hanging fruit in just basic compliance. So we shouldn’t use the intangible economy as an excuse to give up on doing just the basic stuff to make society fair.

Stian: I guess what you then get is, I think there have been some interesting angles where aspects of the intangible economy maybe exacerbate unexpected problems of inequality. So, one thing that there’s been a ton of research on looks at the cities that do really well out of the intangible economy — researchers were both in the US and in the UK. One thing that’s really interesting, if you take the Bay Area, Northern California, a great example of a place that’s been very successful because of intangible assets; not just computers, even before that. And what research shows is that once upon a time, housing in and around the Bay Area was pretty cheap. It was easy to build more housing when you needed to, and therefore the cost of renting or buying a house nearby was kind of somewhat affordable. And what that meant is if you had people making a lot of money in, say, San Francisco, that money somehow got spread around, because it was easy to move from a poorer part of the US to San Francisco, even if you didn’t have high skills, and you could take a low-skilled job but because you’re in a place where there were lots of people making a lot of money, you would get a pretty high wage relative to what you would have got had you stayed where you were.

Stian: And what people like Enrico Moretti, an economist who looks at these things and documents it, is that that’s kind of changed because it’s become much, much harder to build new houses in places like San Francisco; it’s definitely true in the South-East of England as well. And what that basically creates is that creates a really hidden unfairness because if you grow up in a place where there aren’t a lot of great jobs, and for whatever reason, you’re lucky enough to have a good education, to have the skills where you can take advantage of the intangible economy, you probably have a high enough salary to make it worthwhile moving to London or San Francisco. You can afford the crazy rents, your landlord will suck up a lot of money. But it just makes sense and you can grow there. But if you aren’t in that position, you’re stuck where you are. So, the old world where — and it’s very unfashionable to talk about money trickling down or trickling out — in the old economy, it did that much more than it did now. And the real barrier, one of the real barriers was rent. So I guess what this means is, one of the ways to tackling inequality in an intangible economy, surprisingly, is through a very tangible asset — it’s through housing. It basically means that making it easier to build housing, making it cheaper for people to move to places they want to move in, becomes even more important.

[00:36:38.08] Ben: Yeah. So, I guess you can’t have social mobility without geographical mobility, or it’s much harder.

Stian: Well, it’s interesting. I mean, there was a very widely talked-about book a few years ago by David Goodhart, who talked about the idea that the world was divided into somewheres and anywheres and the anywheres were the kind of Metro elite who kind of went from New York to London and just kind of didn’t care and somewheres were kind of rooted in Pittsburgh or Grimsby or wherever, and kind of loved their city. But I think there’s another way of looking at that, which basically says, it’s not that people who David calls somewheres are unusually in love with one place and hate moving; it’s that we’ve made it so that even if they want to move, they can’t afford to, so mobility has become something that only the very privileged who are going into these high-paying jobs can ever hope to do. And in a world where a lot of this intangible economy is happening in particular places, that’s a very damaging burden to inflict on a country.

[00:37:41.21] Ben: Yeah, and I think you probably have great statistics on this but it seems to be also that the intangible economy maybe doesn’t throw up as many jobs as the tangible economy. And a lot of the job growth is in what we might call proximity jobs. And therefore, we’re sort of holding back the growth of those types of jobs by, again, not allowing geographical mobility,

Stian: Yeah, you’re totally right.

[00:38:05.08] Ben: It’s becoming more and more difficult for traditional lenders — you know, universal banks, corporate banks — to lend to corporates because it’s really difficult for them to get enough comfort over that kind of loan, where it’s made in the absence of collateral — you know, physical assets that a company can pledge to the bank in order to secure that loan. And I think, again, there’s another brilliant graphic in the book, where you show that, you know, despite everything we talked about the growth of intangible assets versus tangible assets, actually, the lending is going up against tangible assets versus intangible assets, which just seems perverse. Right? So is that the root of it? This absence of collateral?

Stian: Yeah, that’s right. So, I mean it’s been called ‘the curse of collateral’, the fact that banks, ideally, want assets that they can take a charge of if a business fails. That is the way debt finance works and most businesses in the economy rely on debt finance, most financial institutions provide debt finance. You know, if we talk about stock market or venture capital, those are modes of finance that apply to a very, very small minority of businesses. So, there’s a kind of real challenge here. On the one hand, how do you develop institutions to provide more equity-based finance to a greater range of businesses? But also, how do you make a rule system that doesn’t discriminate against that because obviously, the first rule of financial structuring for a business is that debt interest is tax deductible, but payments to shareholders are not. So, you know, you’d want to finance a business with that.

[00:39:45.17] Ben: So okay, there’s a lot to unpack. So the first question is, you know, should we change that? Should debt not be tax deductible?

Stian: The kind of wonkish answer, the ideal world answer is, yeah, you want to change that. You want a world where debt finance and equity finance are placed on the same footing. And, as I said, this is quite wonkish. This is something where economists and tax policy wonks have come up with 1,000,001 proposals for exactly how you do this and all the things like equity tax credits. The problem is this, politically, would be a really hard thing to do. I mean, if you were to try and change the economy like this, you’d immediately have the private equity industry up in arms, you would create a lot of challenges for the banking system, it would be a big change. So, you’ve got to think not just about what’s the ideal end-state, but also what’s the institutional basis for it and how do you get there without totally causing lots of unintended harm to the economy.

[00:40:45.20] Ben: Exactly. Because you then form policy in a vacuum away from all the subpart dependencies. But maybe a better question might be, then, how do we get more VC-type capital flowing to the economy?

Stian: So I think that’s a really good question. Germany is an interesting example here because if you look at the way German banks do business lending, they very often will take equity warrants in small businesses, which is effectively like a way of making your debt finance more equity-like. And one of the effects of that is, if you look at, say, a British small business lender — you know, British High Street bank making loans to small business — almost invariably, they will look to take charge on the owner’s or director’s house. And that caters to the idea that the owners own their own house, which is obviously quite an assumption anyway. So it kind of skews you towards lending to a certain type of person. Now, that’s basically a way of getting tangible collateral, in a business that’s mostly intangible because a house is kind of pretty tangible. Now, in Germany, probably partly because homeownership rates have always historically been much lower, and more people rent in Germany, banks are gonna have to find a way around that. So these equity warrants is something that they’ve always done. Now, it means the banks end up doing more due diligence into the businesses because you need to understand more about how the businesses work. But I guess, they figured that’s a worthwhile cost, because the upside of these equity warrants is quite high. So, I guess that’s one example of it being done well. I mean, if you look on the fringes of the venture capital sector, it’s really interesting to see different types of more kind of growth-oriented venture capital branching into more markets and I think it’s really interesting from that point of view. So, I think we’ll see a gradual growth there. But this is really hard. This is a 10-year project, and will probably require governments to get behind it, too.

[00:42:40.18] Ben: Now, a lot of these intangible businesses have become a bit better understood. And, you know, so you see people lending, for example, or putting debt into businesses that have SaaS revenues, or you see people putting debt into businesses where they understand the mechanics of a game, for example — you know, they know the points of which a game is going to get large pickup, and they’re happy to invest to allow the games provided to invest in paid advertising on Facebook or whatever. So I think maybe the idea that debt no longer works is perhaps too simplistic and maybe just debt needs an upgrade.

Stian: That’s definitely true. And I guess, obviously, you know, as anyone involved in that markets will know, some lending is against collateral, but actually, you know, a ton of debt is lent against cash flows and expectations of cash flow. But I guess, to your point, what that does, it requires a greater understanding of what those cash flows look like. And, again, this is another one of these things, where it advantages the smart money. If you can understand these streams of cash flows and get enough certainty to be able to lend against them, then knowledge is unusually valuable.

[00:43:49.14] Ben: Something that’s only really occurred to me lately, since I started a business, which is, if I invest capital on the stock market — this may vary jurisdiction to jurisdiction — I face a capital gains tax of x, right? And that capital gains tax is the same as if I take a much more risky stance of investing in a business that creates employment, generates intangible assets with spillovers. So do you think we need a separate treatment of people, depending on where the gains from capital come from?

Stian: That’s really interesting. We’ve got some kind of limited examples of that already. You know, there are some tax breaks for providing risk capital either in the UK — things like the seed enterprise investment scheme, venture capital trusts, and so forth. So, that principle is there already, but it’s a really interesting question. I think, broadly speaking, you know, if the spillovers are good, then ways of subsidizing those — whether that’s through direct funding or tax breaks — it seems like there’s a strong economic case of that.

[00:44:54.06] Ben: And then the last question I wanted to ask you in this section was really around the role of government here because you’ve probably seen it — you know, there’s Mariana Mazzucato. In her diagram where she said the constituents of the iPhone and how many of them were spillovers from government fundamental research. And I’m just wondering, you know, there’s been, I would say, a reduction in government fundamental research in lots of countries, right? Because, you know, there was this sort of ideology of that crowding out public, private sector investment, and so on. But do you think we should maybe shift the balance there and the debate and push more money towards fundamental research?

Stian: I think there’s definitely a really strong argument saying the government should be funding more things like r&d, because they have these spillovers. If you just leave it up to business, you will get less of that than you would otherwise get because businesses can’t be sure they will internalize the benefits. And I think one of the really important things that kind of Mariana’s book really made the case for that in a kind of very powerful way, which is really important. I think there’s a lot of questions on how you do that, what the best way of doing that is, and particularly doing it in a way so that businesses also invest alongside because obviously, what wasn’t told in that story of the iPhone, is that alongside lots of fundamental research, there was also a ton of often quite unrewarding r&d done by businesses, whether it’s gonna join Magnetoresistance, which is how you got the kind of hard disks that these devices rely on, to the actual turning these things into useful consumer-friendly products. All of that requires a lot of investment as well, which often has quite high spillovers. So, public investment, yes, we absolutely need more of it. And it’s quite well that a lot of governments, I think, are moving in that direction. It also becomes even more important to work out how it may not mesh well with what businesses want to do.

[00:46:44.17] Ben: So many people talk about this sort of K-shaped economy, where everything that was analog is really suffering and everything that was digital or intangible is kind of accelerating. And I’m just wondering, is that a too simplistic read of the situation? I wanted to start with how intangible assets fare during the lockdown, for example, because I’ve read a piece that you wrote on Medium where you made this somewhat counterintuitive argument that actually intangible assets might not be faring as well as you might think, during a lockdown.

Stian: Yeah, absolutely. I mean, I think the pandemic was very interesting from the point of view of what you said for the intangible and the tangible economy, because when it started out, I think there was a huge focus on whether we’ve got our tangible asset response right, the way I would describe it. So people sort of say, you know, “Can we build enough hospitals? Do we have enough ventilators? Do we have enough factories making personal protective equipment?” And you know, everyone was very impressed when in Wuhan they built this huge new hospital, and we would say, you know, “Will the UK be able to cope? Will the US be able to cope?” And then we built the Nightingale hospitals, this is great. Wow. So this was all about tangible assets, you know, physical things. But I think what people kind of rapidly realized is that, actually, that wasn’t the real challenge and it wasn’t the thing that people struggled with, because actually, what people came to realize was really important was what you could call intangible assets. So, first and foremost, it was, “Can we develop vaccines that are effective? And can we put in place the supply chains to get them out there?” Both classic intangible asset problems. “Can we put in place tests and trace systems?” Test and trace systems are made up of software, they’re made up of processes, they’re made up of data? You know, those were classic examples of intangible assets. And some countries did them really well and some countries did them maybe not so well. And I think if you look at the differential mortality rates in different countries, it was, in some ways, the intangible response that really, really explained the bigger gaps much more than the tangible assets. So, I think that was kind of one interesting aspect of how the focus changed. I guess another really interesting question here is the move on what many people’s part remote working has done. So, certainly, in the UK, the latest statistics, 35% of people are now working entirely remotely. The historical figures for that before the pandemic struck have been less than 5%. So, that’s a really big change. And of the 65% who are not wholly working remotely, a fair chunk of those people are doing some remote work. So although this isn’t the majority of the population, it’s a really big chunk of people, it’s a really big change.

[00:49:38.17] Ben: And what happens to spillovers in the world of remote work? Because, you know, I think, again, it was in the same article, which I very much recommend to people — it’s on Medium — which is you talk about how during Prohibition you could trace a reduction in the number of patents because people needed to meet in bars to come up with some really brilliant creative ideas. And I think there’s some element of that, which is, you know, even though, ostensibly, we’re still interacting with our colleagues in a very collaborative manner, it’s different, right? It’s different if you’re remote, and you can’t go for a beer or coffee, whatever, and have those brainstorming moments, those moments of serendipity. Is it your hunch that this is going to lead to fewer spillovers.

Stian: So I think this is the $64,000 question. So, no one really knows and I think, to some extent, it’s probably up for grabs. It’s almost certainly true that it’s going to have some effect on spillovers, because you’re not getting these, as you say, these casual interactions that maybe some ideas depended on. The question is, you know, to what extent can we replicate them? To what extent, maybe, can a lot of remote working work well? And to what extent can we come up with ways of doing more remote working that gives you just enough of what you need? I mean, there was that famous saying, where, I don’t know who said it, but it was, “50% of my advertising works, I just don’t know which 50%.”

Ben: Oh, yeah.

Stian: It’s probably the same. You kind of think, well, you know, there’s probably some really important part of the time you spend in and around the office with people but it might actually only be 10% of that time. And the question is, can you work out what that is, and focus on that more effectively? So I think if we can do that, there’s a huge benefit, because remote working is incredibly good for productivity. But you know, it’s a big forced experiment.

[00:51:34.29] Ben: Well, I think the thing is the experiment is going on for a very long time now. So I’m sure people are starting to codify some of those things that there’s moments of serendipity and putting them into the way that we do remote working. Because in the beginning of the pandemic, it was very much kind of everything just moved to Zoom. And now I think people are realizing, for example, that, you know, just doing things synchronously through Zoom is not great, and Slack sometimes can be a better medium, for example. I think people are sort of now adapting the way they do remote working.

Stian: I think that’s totally true. And it’s interesting, you know, there are some industries that have been doing this for longer. So, you know, huge parts of the tech industry have been very comfortable with aspects of remote working and having remote development teams, as you say, using asynchronous communication and text communication much more than video conferencing. And I guess the real question is, can we work out the lessons for that? And can we scale them up quickly? Because that could be really valuable.

[00:52:28.15] Ben: You started to talk about San Francisco earlier on, and I had to hold myself back from delving into that. But on a few podcasts ago, we had Ian Hathaway on, and he was talking about his idea that, you know, smaller and smaller cities, if you like, can learn from San Francisco to some extent — you know, replicate the playbook. And I’m just wondering, does that diffusion of the magic of Silicon Valley happened faster now? Because maybe that was less important than it was to be in physical proximity?

Stian: Yeah, I think this is a real opportunity for anyone that wants to compete with Silicon Valley to make the most of it, partly because it’s about getting new norms in place that will help these areas. So, if we can get more comfortable with remote hiring, if we can get more comfortable with remote VC funding — something that’s often driven proximity — then this is a sort of an opportunity, as you say. There’s a kind of two-year window where some of these new practices could get trenched and people could realize their worth. That’s a huge opportunity to make a step-change. I mean, I guess the other dimension talking about San Francisco — San Francisco has kind of an interesting story. So, you know, I worked in Silicon Valley at the beginning of the 2000s. And San Francisco wasn’t really a part of the Silicon Valley ecosystem back then. The idea that this one big city is kind of the epicenter of tech is, as far as I can see, kind of something that it’s the kind of last-decade phenomenon. Silicon Valley for a very long time was just kind of the suburbs of Palo Alto and Mountain View, and places like that. And so, there’s kind of an interesting question. Well, you know, maybe the move to really core cities — maybe we might take a step back from that. So I definitely think it’s a lot to play for. You know, if you’re a city leader, or you’re someone who wants to kind of build a cluster somewhere other than San Francisco or New York, or London, then this might be a big opportunity for you.

[00:54:35.14] Ben: One of the things I thought was interesting in that article you wrote is you said that a tangible asset during lockdown doesn’t get used, right? And therefore, the productive capacity of that asset is kind of frozen. And then once things get back to normal — whatever that normal looks like — it then becomes productive again. What you said about some of the intangible assets is they degrade much faster in the absence of being used, right? And again, it was something that I thought was quite interesting because I think there’s been this assumption that everything intangible is benefiting and everything tangible… You know, you wouldn’t want to be an airline. And it was just a more nuanced kind of view of tangible versus intangible assets.

Stian: Yeah, you’re right. I mean, there’s this kind of question we were thinking about what’s the economic cost of leaving an asset, a business unused for a while, and we were speculating that maybe for a very physically-intensive business, that cost was lower. So it was easier to kind of mothball a factory and turn it back on, again, than it is to mothball an advertising agency and turn it back on again. But that’s very speculative and I think that’s something that I don’t think anyone knows the answer to that. So, there’s lots of real-time economic puzzles kind of going on right now.

[00:55:51.10] Ben: Okay, and this is the only political question I will ask you, which is, do you think that the pandemic is kind of giving a backdrop, or a unique set of circumstances in which somebody like Joe Biden could introduce a massive set of policy initiatives — a new deal, if you like? Because one of the things that we’ve talked about, every sort of policy initiative we’ve talked about: we’ve talked about some really difficult politics around it. For example, you know, opening up planning restrictions, I’d imagine is a very difficult political thing, changing the tax relief on debt would be a very difficult thing politically to introduce. So, does it give the pretext for more ambitious political maneuvers?

Stian: I think there is definitely the need. You know, there is a platform of policies that would be really great to put in place, whether that’s more investment in r&d, planning reform, making sure that we create opportunities for people to take on these new jobs, investment in education. There’s definitely a need for that. I think the really difficult thing is that in an age of populism, all these things get harder to do. So I talked to you earlier about when we were talking about the competition policy, that really actually what you need is, you know, more bureaucrats, more pen pushers, and to give them more power. Now, that is a pretty hard sell in the age of queueing on and, you know, ramp and populism in most countries. So you have this kind of weird situation, the need for this kind of institutional reform is greatest at a time when the political dynamics push you in the opposite direction. You know, if you want to sort of say, “Let’s spend more money on r&d, because that will lead to good business opportunities and create economic growth and more jobs.” What does it mean, when you say, “Invest more in r&d”? It means you’re going to tax people more, and you’re going to pay that money to kind of liberal elite scientists. That’s the kind of paradox and I think it’s really interesting to see different people trying to negotiate that in different ways.

[00:57:53.25] Ben: And you don’t think that the pandemic gives kind of enough political capital to unlock the paradox? So you think it’s not as simple as that?

Stian: It might be, you’re right. You’re totally right. Maybe the pandemic will give the opportunity to do this. And maybe it’s the kind of thing where even if you can’t do the big push, you can get some of the way there and that will still make a difference. It’s definitely tricky, because the politics and the policy push in opposite directions.

[00:58:23.04] Ben: Would you mind sharing with us one of your favorite books?

Stian: A really interesting book I read recently, is a book called “The Hungry Empire” by Lizzie Collingham. And what’s fascinating about it is it’s basically a book about the history of the British Empire seen through the history of food. And what’s so interesting about this, it obviously speaks to a lot of issues around global history, around race, around the relationship between Britain and the rest of the world, all of which is super topical at the moment. But it does it through a prism that I think will be really interesting to anyone who’s interested in technology, in kind of economics, in kind of the business of how the world works. It’s a long way from technology, but in some ways, it’s a book that’s very much about technology and a lot of issues in the world today. So, it gets a strong recommendation from me.

[00:59:12.19] Ben: Okay, I’m gonna read that, and, for the listeners, we’ll share the links to all of these on our website. So the next one, a favorite recent article.

Stian: For me, I think something I would absolutely recommend here is the work of Enrico Moretti on cities. We talked a bit about it earlier, but he wrote a great book called “The New Geography of Jobs” and a few articles based on that where what he looked at was the way that we live in a world where great cities, dynamic cities are increasingly economically important. But one of the problems that we have is that the ability to live there, to afford to pay the rent there or move there is unequally distributed because we make it harder and harder to build in these cities. And he effectively made the case that it is totally kind of countercultural range where we like to talk about somewheres and anywheres but he talked about the fact that actually what lies at the heart of our problem is the fact we’ve made it harder to move. And this is not something that people actually want. There’s not something that makes people happy. So to me, it’s a very important and topical article right now.

[01:00:15.02] Ben: And then, the next one is a favorite thinker, somebody whose essays and articles you regularly turn to.

Stian: This may be — I don’t know if all of the people you have on say this, but I’m addicted to the blogger Scott Alexander, who used to write Slate Star Codex. He’s now gone on to Substack and the new version is called Astral Codex Ten. You may know, he’s a US-based psychiatrist, he’s kind of very involved in the rationalist community. He writes about technology, economics, psychology, about kind of almost anything. He has an absolutely incredible writing style. Everything he writes is an absolute breeze. But he does it with a kind of an incredibly good nature. So a strong recommendation from me.

[01:01:04.17] Ben: This is exactly why we ask these questions because I confess to not knowing Scott Alexander.

Stian: It’s amazing.

[01:01:11.03] Ben: Okay, the next one: a productivity hack, something that enables you to operate at scale in the intangible economy.

Stian: This is a very weak productivity hack because I’m very bad at it, but I do try and do 10 minutes of mindfulness meditation at the beginning of every day, and I’m probably the worst meditator in the world but either because of some kind of placebo effect or because it’s useful, it does make me feel a little bit more on top of things.

[01:01:39.28] Ben: Okay, and then the last question is a favorite brand.

Stian: My surprise favorite brand I think it would have to be Bovril. I rely on Bovril for my protein needs. It keeps me going in home working, kind of always have a mark of it on the go. It’s a remarkably nutritious food. And it’s got a retro appeal in the sense of it’s something that was very big 100 years ago, but has kind of come back into popularity in an age of high protein, low carb eating.

[01:02:09.29] Ben: Yeah. And I think it’s something that’s quite polarizing. So it’s good that you’ve taken a slightly controversial position there. That’s good.

Stian: I’d like to think so.

Ben: I guess many people that listen to this will not know what Bovril is. So that’s gonna be interesting to see and googling.

Stian: Yeah. A very affordable, a very accessible product as well.

Ben: Great. Stian, this has been an absolute pleasure. Thank you so much for coming on the podcast and sharing your insights around this structural shift from the tangible to the intangible economy.

Stian: Thanks so much, Ben. It’s been a real pleasure talking to you about it.

A Long View of Banking Industry Disruption (#36)

Structural Shifts with Marc RUBINSTEIN, former hedge fund partner and author of the Net Interest newsletter.

We sit down with Marc Rubinstein, a former analyst and hedge fund manager who currently authors Net Interest — a weekly insight and analysis newsletter on the world of finance. Each note of his newsletter explores a theme currently trending in the sector, whether it’s FinTech or economics, or investment cycles — and today, you are going to hear about a little bit of everything. Marc and Ben Robinson discuss the history of equity research and where it’s at now, whether current regulation is tilted too far against banks, the twofold challenge facing challenger banks, the past and future of embedded banking, the four key differences between investing in private companies versus public, the potential financial services game-changers that could happen this year that people are not talking enough about, and more. 

Full transcript
Structural Shifts with Marc Rubinstein

There’s a lot of overlap between what a very, very good equity analyst does and what an investigative reporter does.

[00:01:26.21] Ben Robinson: So, Marc, thank you so much for agreeing to come on the Structural Shifts podcast. We’re a really, really big fan of Net Interest and so, we feel very, very privileged to have you on the show. If you don’t mind, can we start by you just briefly introducing yourself and giving us a short summary of your career so far, just because I think that will be relevant. I think we can use parts of your career to frame some of this discussion.

Marc Rubinstein: Sure. Well, no, thanks, Ben. It’s great to be on. I’ve been in the realm of financial services for 25 years. I started as an equity research analyst, analyzing banks — I spent 12 years doing that — I spent 10 years investing in banks as a partner of a hedge fund exclusively focused on financial services, stocks globally, publicly-traded, long and short. And then since 2016, I’ve looked at financial services out of sheer interest. It’s something that it’s difficult to shake off. And so that’s basically it in a nutshell.

[00:02:22.07] Ben: Good. Okay, so we’re gonna pick up on different aspects of that. But I wanted to start with the equity research part because one of the newsletters I’ve most enjoyed — I mean, they’re all brilliant, but one of the ones I’ve most enjoyed just because it had personal resonance for me because I was once an equity researcher — was the one where you talked about the history of equity research. If you don’t mind, maybe you can just talk a bit about how sell-side equity research works, because it’s kind of a strange model where, you know, fund managers have access a lot of times to internal research, but yet they source it from a third party; that third party doesn’t charge directly for that research. So it’s kind of a strange model. So if you don’t mind just talking about sell-side equity research, and also how it’s changed, right? Because I think, you know, if I were to put it crudely, it’s gone from a really well-paid, really highly-solicited job to something which is not that anymore, right?

Marc: So, I started out as an equity research analyst in the mid-’90s. And I was not particularly familiar with it as a professional opportunity. It wasn’t something that I, at college, realized that it’s something that I wanted to do. I wanted to go into finance and I participated in a graduate training scheme at a bank — Barclays Bank — it was an investment banking subsidiary of Barclays at the time; and went through various placements across the bank, not dissimilar to the way graduate training programs work today. I do need to say though, any listeners that have watched the series industry, it was nothing like that. But I ended up in equity research and spent, as I said earlier, 12 years there. Now, the way equity research was conducted then was very, very different from the way it was conducted prior to that, and the way it’s conducted today. Equity research emerged in the 1960s, 1970s as an add-on to the core brokerage business that brokers offered their clients. At the time, commissions were very, very heavily regulated and the only way to compete was through ancillary services. And so, brokers offered equity research as one of those ancillary services. They gave it away for free. It was a marketing device in order to attract brokerage business. And that was the case when I entered as well. At around the time — so, we’re going into the ’90s, into the late ’90s and early 2000s — another side of the investment banking business was booming, and that was M&A — an equity underwriting. It’s very topical now to go back 20 years and look at the tech boom of ’99–2000s, given the conditions we’re currently seeing today. But the way it worked back then is that companies would want to IPO and they would choose their investment banks, not dissimilar today. And one of the features that they would look for in selecting their investment bank was the quality of the research that that investment bank produced. And so, rather than exclusively being an ancillary business to the trading business — which was the case, historically — increasingly research became an ancillary business to banking, as well. And as a result of that, equity research attracted a new revenue stream and was, therefore, able to grow. And in the late 1990s, this business of equity research grew, costs increased, a superstar culture emerged.

The markets are not efficient, and Signal and Zoom are great recent examples of that. And to the extent that they’re not efficient, research does have value and those inefficiencies typically emerge the lower down the market cap curve one goes.

Marc: The piece that you referenced, I talked in there about a telco analyst who worked at Smith Barney in New York, called Grubman, and he wrote on telco stocks like AT&T, and he was coerced by his boss, Sandy Weill, who was the Chief Executive at Citigroup, to rethink his view — it’s kind of a euphemism for upgraded to a buy — on one of the stocks under his coverage. The 2000s came along, Eliot Spitzer, who was the Attorney General in New York, took a view that actually there was a massive conflict of interest at play here and he tried to dismantle that construct within equity research. The problem is that the cost base was still there and the cost base didn’t have now a revenue stream to attach to. And so, you had like an orphan kind of wandering around looking for kind of a foster family; this cost base was looking for a new revenue stream. For a short period, it stumbled upon proprietary trading. So, the period between 2001 probably, 2006, 2007, investment banks built very large prop trading businesses, internally, and equity research was a feeder mechanism for some of the ideas that they would put on. And then, the financial crisis happened and that business disappeared as well. Ultimately, that was also dismantled by regulators through Volcker amendment to the Dodd-Frank Act of 2010.

Marc: So, throughout this entire history, you’ve had this kind of valuable resource — inherently, experts looking at companies and issuing investment recommendations through the process of research on those companies. Yet, in and of itself, it was a business that found it very difficult to reflect a model that was able to pay it sufficiently. Which brings us to today and you’ve had another bout of regulation — this was in Europe about three years ago — in 2017, you had MiFID II, which required an unbundling going all the way back to the ’60s, where this process started, where research was ancillary to trading, regulators in Europe came along and said, “Actually, there’s a conflict inherent in this as well.” Certainly in the degree to which it paid for by institutions, and yet again, the business has gone through a kind of an identity crisis. And that’s really where we are today.

[00:08:35.08] Ben: If you like, it’s been sort of hammered by three waves of regulation, right? So, first, Eliot Spitzer, then Volcker, now MiFID II. One of the things that’s changed is you said, I think in your newsletter, you talked about how much Grubman made, right? I think he made like $50 million or something in the space of a few years, which would be unheard of now. So, you know, payback has gone down. But the other thing that’s notable is the amount or the volume of equity research, which has dramatically changed. I mean, you talked about go-to Credit Suisse, an investor meeting, they were like, you know, hundreds of analysts there. I remember, you know, going to SAP investor meetings, there would be 100 plus analysts in the room. And so, clearly, we went from a situation where there was oversupply — do you think we’ve tipped to the opposite situation where there’s a lot of undersupply, particularly of smaller cap stocks?

Marc: For sure there is an idea that there’s an undersupply research out there, that a lot of it is being certainly a shakeout within the industry. Now, it was arguably overpaid, to begin with — and certainly Grubman, did he merit the millions of dollars that he accrued? Probably not, almost certainly not. Possibly not from a compensation perspective, but from a resource allocation perspective to the industry, we may have under shored on the other side. And it’s not dissimilar. Maybe the analogy here is the media, is the press and actually there’s a lot of overlap — and I draw this out in that piece — between what a very, very good equity analyst does and what an investigative reporter does. And there’s a public service here, there’s a public good here. You know, certainly what the research analysts were doing — so Wirecard, very well-known fraud. Interestingly, the credit, rightly so, for uncovering that fraud has gone to a journalist, Dan McCrum from the Financial Times. But there are other cases, and certainly, there were a couple of analysts. Some of them didn’t cover themselves in glory, but there were a couple of analysts who also got that right. And there’s kind of a public service to looking independently, without being influenced by the companies themselves and the management of those companies, nor by other constituencies, for putting out independent research on companies, for doing their job.

[00:10:49.16] Ben: It’s interesting that you call that public good, because it suffers from the same shortcomings of a public good, in the sense that it’s difficult to exclude access to that research once it’s in the public domain. And it doesn’t stop you from consuming. In many ways, it does have the properties of a public good, which means it suffers from the free-rider problem and in general, sort of under-provision.

Marc: Absolutely right. And in addition, it’s difficult before the fact to know if it’s any good or not. Clearly, the analyst report that said that Wirecard was a fraud, after the fact we know was very, very valuable research. The report, which would have arrived on the same day, on the client’s desk which said, you know, Wildcard is a great company and it’s got huge upside — again, after the fact we realized it’s got negative value. But at the time, the decision rests on the recipient to discern between those two. And that’s not easy. And it’s not easy as well, to know ultimately, where the value is, in this. There’s a lot of noise out there.

[00:11:53.12] Ben: I want to come back to Wirecard in the context of, you know, bank regulation, and whether it’s a level playing field. But just on this idea of, you know, perhaps under-provision of research. Do you think that creates arbitrage opportunities? So, for example, do you think it’s now easier to create alpha investing in small-cap stocks? Because there’s a high return on doing that research yourself, whereas before, that was not the case.

Marc: I think, yes. So actually, just recently, there’s two companies called Signal — Elon Musk tweeted quite recently that one should be buying Signal, he was a big proponent of Signal; readers picked up the wrong Signal. Actually, early on in the pandemic, the same thing happened with Zoom, there were two Zoom companies. The point here is, you know, the markets are not efficient, and Signal and Zoom are great recent examples of that. And to the extent that they’re not efficient, research does have value and those inefficiencies typically emerge the lower down the market cap curve one goes.

It’s incredibly difficult for any investor to change their mind.

[00:12:57.18] Ben: There’s a quite high proportion, certainly relative to, in the past, small caps that no longer have any sell-side equity coverage, right?

Marc: Yeah, that is right. And it’s not great, either. Now, the flip side is that some of it has shifted over to the buy-side themselves. That was a trend that was already in place from the institutional perspective. But what we’re now seeing because of the ability to share ideas more freely, through the internet and platforms like Twitter, and also dedicated platforms, like Sub-Zero, and the ability for individual investors or smaller, emerging institutional investors to get access to infrastructure — maybe they can’t afford Bloomberg at $24,000 a year, but they can afford other apps and other facilities — more research has been generated. And you know, actually, this brings us back to the model, it is quite interesting. So, the old research model was ‘we’ll give it away to everyone for free and we’ll attract some revenue dollars through trading commissions’. More recently, post-MiFID II, that translated into, ‘we will just service, say, the top 100 customers who are prepared to pay for it’. There’s a trade-off now between generating thousands of dollars from 100 customers or via the internet, particularly where the market might be individual investors who… And whether this is cyclical or secular or not, at this stage, I don’t know. But certainly, retail engagement in the market is increasing. They’re not going to pay thousands of dollars for institutional research but the quality of what’s available on the internet is very, very high, and maybe they’ll pay $20, $30 a month, and tens or hundreds of thousands of those… You know, there’s a good newsletter writer called — there’s a number of good newsletter writers out there, but a number of them, they offer, in my view, institutional-grade research, particularly in the technology space, and they charge $10, $20 a month for it. But they have hundreds of thousands. And I actually would be interested to see their p&l against a traditional equity sell-side research business, given lower costs and broader reach.

[00:15:21.13] Ben: I was actually gonna highlight this as a second arbitrage opportunity, which is one might be there’s more potential to make money from small caps than there was in the past, but the other one is, I think — you know, I don’t want to suggest that this is the model for Net Interest, but a bit where you can almost crowdsource almost as good or maybe even better, in some cases, research from the internet, which is, you know, the sort of the bottom up, you know, kind of organic production of research to fill the gap. Because, I agree, and you see the same thing also in investigative journalism and other content areas, which is, you know, your choices are either to pay a subscription for the FT or to subscribe to newsletters, right? Because these things are sort of mushrooming. And, you know, I mean, that’s another phenomenon in the way that you’re embodying, which is you publish your newsletter on Substack, and in some ways, you’re kind of contributing to this gap that’s been left as equity research has become or is provided to a lesser extent than it was in the past.

Marc: Yeah, I think that’s right. And, you know, it comes from just this, I don’t like the word ‘democratization’ that people use, but it certainly plays into our theme. You know, clearly, the advantage that… And I remember when I was an equity research analyst, it was at BZW, which you mentioned, which was a subsidiary of Barclays. And I was looking at Swedish banks in 1996. They kind of emerged from a crisis, they’ve been re-privatized, they’ve been re-IPOed, and there was kind of a recovery theme in a way. And I stumbled upon — it was kind of the early days of the internet, we had access to the internet, but what was on there was difficult to find. There was no search, it’s kind of the days before Google. And I kind of stumbled across a document written from the Central Bank of Sweden, the Rik Bank, which provided very interesting data on kind of banking volumes. It was faxed to me by somebody in Sweden. I literally, I was working at home, it was a Saturday, I was working at home. I couldn’t read it because it was Swedish. Google translate didn’t exist. I ran around to my local bookstore, bought a Swedish-English dictionary, translated this thing, put out a piece of research on this finding that actually loan growth in Sweden, based on this data was greater than anybody anticipated. And it was it. I stumbled across something purely informational. And clearly, the friction to getting that information now is just non-existent. Everybody has all of the information all of the time hence, there’s no arms race in place to get new sources of information. Kind of alternative, dangerous nets. But you know, that’s all done. What’s happening now is the same thing is happening to analysis. Now, people, again, through the ability to meet in the market square via whether it’s Twitter or any other kind of platform, there might be a great analyst who’s based in… I mean, I know there’s a great equity research analyst, who I read called Scuttleblurb, he is based in Portland, Oregon, far from Wall Street, and there are people just all over the world in India, in small towns in England, all over the world, all analyze it. So, they’ve got the base level of information and the degree of analysis they’re doing now is institutional grade, and it’s accessible.

[00:18:50.08] Ben: It was just before the financial crisis that you switched from being a sell-side analyst to working for a hedge fund, if I’m right. Presumably, that was a great time to have the ability to go short on banks. And I just wondered, you know, when you were living through it, how evident was it in advance of the crisis that it was coming. Could you presage that, you know, we were gonna have this big crash, or was it really as sort of sudden and unexpected to you as it was for the people that weren’t as closely following that?

Marc: It’s a really interesting question. It would be easy for me to say yes. I would say the way I would finesse it is yes, we saw elements of it. But it’s important to remember, somebody once said, ‘causes run in packs’. There’s never a single cause. I think it’s lazy analysis. And I see it and often politically motivated for people to say the financial crisis was caused by x — and x typically correlates with one’s political inclination. X could be, you know, greedy bankers, or x could be people borrowing too much or x could be sloppy regulation or x could be too much leverage at the banks or whatever it might be. There’s a whole range of reasons. And ultimately, it was the confluence of lots of those things that happened to create the crisis. Although we — me and my colleagues — identified some strands of it to have predicted the degree to which it all coalesced, you know, in kind of, you know, let’s say, October 2008, I think that was difficult to predict. But that’s never… There’s complex reflexivity to it. It happened, I remember watching, I vividly remember watching the debate in Washington around passing the torpid. It was controversial. And I remember specifically it went down. But because it went down, the market went down, and so, reflexivity because the market went down, then when it came back for another reading because the market had gone down, incentives have shifted. Predicting kind of reflexivity in advance is difficult. Having said that, the worst things we saw. So back in, you know, we were short. I mean, back in 2006, we were short some subprime companies. I went back through my — I’m not a Facebook user anymore but when I canceled Facebook, I downloaded all of my posts, and there was one post in July of 2007, where I cautioned about an impending financial crisis. We were short, Fannie and Freddie, and all the rest of it. Just an observation about investing broadly, and, going into more detail on the crisis, but investing broadly, it’s incredibly difficult for any investor to change their mind. And I think there were a number who were negative; a lot stayed negative beyond March 2009. But the fascinating thing to me is those that there were kind of negative, and then they switch positive. And just taking a step back away from financial services, but generally, investors’ ability — the very, very best investors, their ability to adapt to changing conditions like that, continually, it’s very, very difficult. And I think, you know, history is littered with investors who have got two or three calls right, but to be able to retain an element of persistence, through those changing dynamics, it’s very, very difficult.

[00:22:38.06] Ben: Yeah, I think it could be a rabbit hole but I would argue almost that potentially the greatest of all investors, Warren Buffett, has not been able to adapt this strategy to some extent to the digital age, because he’s still buying sort of, you know, asset-heavy companies with a lot of supply-side, economies of scale, and so on. So I think it even happens to the best when there’s a paradigm shift.

Some of the consternation of bankers right now is that tech companies are getting away with stuff that they just wouldn’t be able to get away with.

Marc: True. And to our conversation earlier about small cap, large cap, I mean, certainly, his performance hasn’t been as good in the recent past, compared to prior periods in his history. And he’s got longevity, very difficult to compare him to any other investor, because I’m not sure there’s any track record out there that’s as long as his. But he made the point recently — he actually made it ’99 — he made the point, there’s a great quote in ’99, where he was talking about if he had a million dollars to invest, you know, he’d crush the market because of his ability to access small cap, but it could be a reflection on your point as well.

[00:23:36.10] Ben: It might be both because you actually wrote another great newsletter about the curse of managing too much money — it becomes harder and harder to achieve a return on much bigger sums.

Marc: Yeah, exactly. That’s another curse — I call it the Zuckerman’s curse. Gregory Zuckerman, who’s a great writer, has written a number of books about — he’s written two, in particular — hedge fund managers. And they’ve been published. Clearly, he’s been attracted to them because of their profile, and their profile is a function of their performance. And therefore, there’s a direct line between them showing good performance and him writing a book. Actually, there’s more nuance to that. It’s not them having good performance, is them having good performance and being big enough for him to notice. One of my favorite investors out there is Hayden Capital. A guy called Fred Liu, based in New York, was up 222% last year, but he’s small, nobody knows of him. And the curse is that over a certain size it’s difficult to sustain that performance on an ongoing basis. Actually, it’s worse than that because typically, after a good year, the money then comes in. And investing isn’t mean reverting but certainly, there’s an element of… It’s only as difficult to sustain very, very good performance across multiple time periods.

[00:25:05.17] Ben: Do you know what Zuckerman’s next book is about? Just so we know in advance.

Marc: That’s a good one. I feel bad because I’ve read them all. I mean, they’re great books. It’s the writing on the wall.

[00:25:20.11] Ben: I’m gonna ask you, a bit like the financial crisis question I’m gonna ask another question, which is gonna be, I think, impossible for you to answer in retrospect, without any sort of cognitive biases, and so on. But you wrote another newsletter, which I really, really liked, which was called “The End of Banking”. How obvious was it now, in retrospect, that post-financial crisis, financial services was just not going to be the same again, right? Because their profitability is not the same. It doesn’t represent anywhere near the same size of, you know, as the composition of the index in which it sits. And so, it just seems like the financial crisis in a way was like, you know, the peak. And you know, maybe as you said, this may be cyclical, it may be that in the future, it becomes as big as it was and as profitable as it was. But certainly, it seems much more structural, for the reasons I think we can talk about now. But when did it become evident to you that the sector becomes structurally less sexy in a way?

Marc: I’ll be honest with you, it took me a long time. My mental model — I mentioned Swedish banks earlier — my mental model was that banks — and this has been true historically, and in my working memory through the Swedish banks, they went through a period of crisis, they’d be recapitalized, they’d come back to the market. Typically, they’d be a lot more conservative and so, underwriting would be tighter. They would then generate huge amounts of capital and then recover. There was a singularity inherent in the industry. They would crash, they’d be recapitalized and then recover. And that was my mental model. I remember at the time being told — we talked about the tech boom from 20 years ago, ’99–2000. We’ve talked about that already. I remember in 2010, 2011, a strategist who’d experienced the tech boom — I mean, I experienced a tech boom as well but I wasn’t directly involved in it — I remember a strategist at a bank saying to me, “The market has to cycle through a generation of investors to forget what happened, to forget the scars of the previous crisis for any kind of return to normality.” And I didn’t believe it. I said, No. You know, so I was sanguine about the extent to which the market recovered. I underestimated a number of things. I underestimated one, how low-interest rates would stay for how long. Two just the… You know, and I often think, actually, for the investment banks, worse than 2000 for them, and their long-term from a strategic perspective, worse than the experience they suffered in 2007–2008m how well they performed in 2009, hurt them longer term from a strategic perspective more, because the backlash was then huge. It was kind of the political disgust, they made so much money in 2009, and that increased the scope of regulation, which muted them for many, many years after that. So, I underestimated regulation, and then we can talk about disruption. It’s difficult. I’m not sure I underestimated that but that was clearly another factor.

[00:28:45.28] Ben: Maybe let’s unpack those things because I think interest rates, I think, you know, we won’t know for a long time if this is a structural or a cyclical factor. But it seems like the re-regulation of the banking is a much more structural thing. As is this one other thing which I don’t know if it’s permanent or not, but you talk about it as governments inserting themselves into the cap table of banks. This idea that they become almost like an arm of government in some ways, right? Because, you know, particularly during the COVID crisis, you know, that we used the direct funding and also, you know, they just don’t have the same control they used to have over capital allocation. So, again, I don’t know if that’s a structural or a temporary phenomenon, but certainly, one of the things that’s been so weighing on bank valuations. But the re-regulation part, I think is probably much more structural. And the question I wanted to ask you about that is, you know, I think we could probably talk about regulation in different buckets. So part was about making banks safer, part was about some introducing more transparency, but the part that I think is now looking a bit kind of controversial in a way is all the regulation is aimed at introducing more competition to banks. You know, so, a PSET, for example, almost seems like that was mistimed because I think what the regulators perhaps hadn’t appreciated because the lag, was that there’s just been so much new competition from non-banking players, right? So I wonder almost in hindsight whether regulators would still introduce some of the regulation they’ve done to introduce more competition into banking because it seems like almost now, not necessary. And potentially unfair. You know in your last newsletter, you talked about that letter from Ana Botín to the FT. And, you know, some of that I thought was quite justified, some of that criticism of recent regulation and the absence of a level playing field. So, it’s a long question, but do you think almost like some of the regulation are tilted or was too far against the banks?

Marc: Yeah, I think it is. I think it’s a truism that regulators typically fight the last battle. And not just regulators. I think it’s a response to, you know, I mentioned earlier, you know, my mental model for the period after the financial crisis was dictated by the last battle, which was the Swedish banking crisis of mid-1990s. So for regulators is the same. They are very, very focused on fighting that battle. And equally, I think it was a truism that whatever the cause of the next financial crisis, it was never going to be the same ingredients to the one in 2007, 2008 to 2009. By the same token, we’re not talking about a financial crisis, here. We’re talking about as you put it out, a playing field. But certainly, the combination of low-interest rates, and a playing field that’s not level was very, very negative for the banks. And there was a degree to which maybe regulators understood that, maybe they didn’t. If they understood it, certainly there was no political motivation to circumvent it, because there was this culture about wanting to punish the banks. But you’re right, you know, this point about they insert themselves, the role of any chief executive of any company, pretty much exclusively is capital allocation. And from an investor’s perspective looking at banks, if they don’t have the capability to manage their own capital allocation because regulators can come in… I listened to a debate recently, between some sell-side analysts, and market participants, and representatives from the Bank of England. And the view of the Bank of England — and I don’t think they’re unique here. I think it’s a view of many regulators that prevented their banks from paying out capital, in March of 2020 was only temporary. But you’ve spoken about scars and the degree to which scars can be left, and from now on, any investor that is investing in a bank understands that at any point, particularly given the capital framework that was put in place to protect banks from unknown. I mean, clearly, a pandemic was an unknown, but that’s what capital is there for. It is there to protect against the unknown. It is not there to protect unknowns, except for a pandemic, or unknowns except… All unknowns, whatever they might be. And so, even with that in place, for them to come in and say, “Actually, we’re going to take charge here of capital allocation” that sends out a very negative signal.

One could have made an argument 10 years ago that banks have got more data, more valuable data. I guess Amazon has got shopping data, Google has got search data, Facebook has got social data, and some overlap between them. Banks have got financial data, and what data is more valuable than financial data? And yet, they’ve been restricted, rightly, from their ability to monetize that.

[00:33:26.20] Ben: Plus, they’d already introduced regulations to ensure that there were more buffers, that you had to protect against losses earlier in the cycle. And so, to some extent, it was almost like a double hit on their ability to allocate capital, right?

Marc: Exactly. Exactly. So we’ll see the extent to which… There’s a view out there that we haven’t seen the worst, that maybe over 2021, when things begin to recover, small businesses will see unemployment. And there’s a view out there. The other thing is, again, a competitive point of reflexivity. Back in March, the regulators didn’t anticipate — to be somewhat fair to them — the degree to which monetary policy would come in, and fiscal policy would come in, but once they had come in, there was a degree of caution that was maybe unwarranted. And again, they might argue, who cares. We’re hurting some bank investors here, but who cares? But ultimately, from the perspective of a bank investor, there’s some long-term issues here. And actually the ultimate bank stop, and it worked in 2009 is that investors, the private sector bails out the banks, the private sector puts more money in because it knows that actually, at this point in time, we can draw a line and that future returns for that bank look positive. It would have been difficult actually, for that to have taken place in 2020, given what had gone on before it and given the things we’ve discussed about regulatory intervention. I think it would be very difficult. The banks have raised capital in the private markets, and that would have been very negative.

[00:35:19.18] Ben: Do you think maybe things might change from here? This is where I wanted to bring in Wirecard because the banks are so heavily regulated now and so closely scrutinized that a lot of the scandals and fraud and impropriety is happening outside of the banking sector in tech companies or shadow banking or areas of shadow banking. Do you think at some point that the regulator is now going to change the direction of, or at least move its focus to all of those companies that are doing banking, but aren’t banks?

Marc: Whether it’s going to happen or not, I don’t know. And actually shadow banking, I mean, I said earlier, I’m going to contradict myself now talking about fighting the last battle. But some of the ingredients of that last battle were in the non-banking sector, were in the shadow bank. Subprime companies weren’t regulated and in the US, different regulatory requirements for thrifts, such as Washington Mutual, who played a game of regulatory arbitrage, choosing to be regulated by one regulator rather than a broad financial services regulator. The investment banks weren’t regulated as banks. Lehman Brothers was regulated separately from… And as a result of the crisis, Goldman and Morgan Stanley became bank holding companies and became regulated as a bank. So shadow banks, this kind of regulatory arbitrage was going on anyway. But you’re right, is going on now. And these payments companies, to all intents and purposes, what a payments company does is not dissimilar to what a bank does. And we saw that with Wildcard, actually. And hence, you know, you mentioned Ana Botín’s FT piece. Some of the consternation of bankers right now is that tech companies are getting away with stuff that they just wouldn’t be able to get away with.

Nobody wants a mortgage, they want a home.

[00:37:23.05] Ben: in every sense, right? In the sense of the same scrutiny, but also, you know, they don’t even have the same level of capital, for example, to do the same business. It’s not just more scrutiny, it’s not just the supervisory level blame for this; it’s actually an operating level blame for this as well.

Marc: Yeah, that’s right. That’s right. That’s right. And the issue here is not about financial stability, per se. It’s about the specific issue that Santander has, and Unicredit has mentioned it, and Jamie Dimon at JP Morgan has hinted at it as well, which is about data. And one could have made an argument 10 years ago that banks have got more data, more valuable data. I guess Amazon has got shopping data, Google has got search data, Facebook has got social data, and some overlap between them. Banks have got financial data, and what data is more valuable than financial data? And yet, they’ve been restricted, rightly, from their ability to monetize that. And I think the issue now is we’re seeing this convergence of data and this degree of consternation about the degree to which the playing field is not leveled.

[00:38:43.00] Ben: And the PSDs bit as well. It’s not just that they have to share data if the customer says that’s okay, is that they’re sharing data with companies that already have, in some ways, an advantage because they’re already more embedded in our lives, right? So, you’ve made the point many times in your newsletters, if you control distribution in the digital age, you know, you’re in a much better position to create network effects and to reduce the cost of customer acquisition and so on, than if you’re a balance sheet provider. And so it’s almost like, it’s a double whammy of sort of thinking you need to introduce more competition and forcing banks to share a really valuable asset with those people that are already better positioned to capitalize on data and distribution anyway.

that combination of Goldman Sachs’ back office, banking as a service infrastructure, with Apple’s consumer-facing distribution and brand value, could be a bigger competitor to JP Morgan than Chime or any kind of startup, FinTech, challenger bank.

Marc: Yeah, that’s right. And banks, certainly some of the starter bank, some of the challenger banks are trying to exploit that idea about distribution. But they don’t have the distribution right now, and that’s obviously an issue for them.

[00:39:41.03] Ben: I’m really pleased you mentioned challenger banks because one of the things I wanted to ask you is, you know how people are talking about this COVID economy is k shaped, right? And the idea that everything digital is booming and everything analog is suffering or faring really badly. And to some extent, you’ve seen that in the world of financial services and FinTech. You know, you talked about Square — which we’ll come back to in a second — as a company that’s really shot up and really found more customers and been able to benefit from the crisis. But challenger banks notably haven’t. What do you put that down to?

Marc: Well, some of them have, actually. So you’re right. I did write. Some of them have. Chime in the US has done very well through this period. But others haven’t. I think the biggest challenge, singularly, that these challenger banks face is their ability to acquire customers cheaply — and the right customers. There’s some question mark as to the quality of those customers, let’s say. And actually, to be fair to the company, the company has provided disclosure in the past as to what the unit economics are, on a customer that pays its salary account into its Monzo account, as distinct from a regular customer that maybe saw their friend has got Monzo, downloaded the app, and maybe actually isn’t even an active user. I guess a problem — maybe is why it’s different from other digital industries — is that there’s a life cycle perspective, whereby the customer becomes more profitable when he’s a little bit older. And yet, digital adoption tends to take place when they’re younger. So the challenge for the challenger banks is twofold. One is, as I’ve mentioned, it’s the ability to acquire customers cheaply. But the second, linked to the ability to capture revenue from them, is can they turn a millennial into — can they extract profitability, which is equivalent to what a typical bank customer profitability might be? Or do they have to wait until that customer gets a bit older, and kind of hits that profitability level, which would be typical in a lifecycle process.

[00:42:11.04] Ben: Let’s talk about customer acquisition cost, because I agree with you, the unit economics are really hard to manage, if you’ve paid loads and loads of money to acquire the customer. It costs a lot to acquire the customer. And then, the lifetime value is somewhat held up — in my view, at least — which is, you know, the ability to sort of upsell and cross-sell customers is hard in banking because we don’t actually spend very much time on the banking apps. And so, we still have this thesis that it’s gonna become much easier to embed banking and other channels than it is to build a really, really profitable banking business going forward. Because, you know, if you consider social channels, for example, or e-commerce channels, we spend a lot of time on those channels. And if you can introduce banking at the point of sale, or if you can introduce banking in a social way, then, you know, first of all, we have a low or even negative cost of customer acquisition, but then you also have the ability to generate very high lifetime value, because you have the customer spending a lot of time on the app, and therefore, you have a lot of surface area in which you drop-sell and cross-sell. Where do you stand on that whole embedded banking discussion?

Marc: Yeah, I think that’s right. I think that is right. I think one of the reasons why payment has been the most successfully penetrated area within financial services by startups and digital propositions is exactly this point that the frequency of payments is infinitely higher than the frequency of mortgage application. So that is right. And I’ve thought about this in the context of insurance, as well as banking, but in both cases, nobody wants a mortgage — there’s no tangible benefit, there’s no tangible value in the mortgage itself. Nobody wants a mortgage, they want a home. And secondary to that is the financing of it. And equally, nobody wants a checking account. Ultimately it is a payments mechanism and they want some facility to serve multiple jobs. One is to preserve their payments. One is as a store of liquidity. One is maybe as a conduit into savings — longer-term savings. But the tangible value of the thing itself is low. And, as you say, therefore, the appeal of embedded finance is very, very high. Now there are issues around regulation, and from a business perspective, the ability to scale, but from a consumer perspective, it makes perfect sense.

[00:44:51.15] Ben: And do you think this is, therefore, the biggest threat to banks over the long term which is, you know, it becomes easier to embed finance in channels that have engagement, than trying to create engagement in banking channels, and therefore, as you’ve talked about this sort of split between what we might call distribution financial services and the, I guess we could call it the manufacturing financial services becomes even more pronounced, and therefore, you know, profits go one way and the other becomes more and more of a utility over time.

Marc: It depends. So, one of the features of banking is that each market is distinct. There’s a path dependence because we’re going back hundreds of hundreds of years, banking has evolved very, very differently across different markets. You know, a mortgage in Switzerland is very, very different from a mortgage in the UK, for example. So Russia is an interesting case study. Sberbank, the biggest bank in Russia, has brand value that banks across countries in Europe and in the US would envy. They have phenomenal brand value. Sberbank itself has launched a marketplace where… Everything we were discussing earlier, it knows it’s got the data and it’s got the brand value. So it’s got the data and the brand value. So, it’s offering a marketplace to its customers via its app. So that’s one approach. Everything we’re nervous about big tech companies in the US and countries in Western Europe, everything we’re nervous about them achieving, Sberbank itself might be achieving that and is in competition to the tech companies in Russia because it’s forging its own path there. So that’s one market. It’s a bit different. But you’d be right elsewhere. You know, I often think about that. I’ve written this in one of the newsletters that Goldman Sachs plus Apple is probably the biggest competitor — that combination of Goldman Sachs’ back office, banking as a service infrastructure, with Apple’s consumer-facing distribution and brand value, that combination of both of those could be a bigger competitor to JPMorgan than Chime or any kind of startup, FinTech, challenger bank.

[00:47:18.01] Ben: Listening to you, it seems there’s a tendency to conflate retail banking with banking in general, because, you know, trust is so important. And as you say, once we move into wealth management, then you just don’t see the same level of tech or FinTech disruption. Once you move into wholesale banking, you know, you don’t see the same level of tech and FinTech disruption. So I wonder, you know, are we guilty sometimes for talking about retail banking, as if it’s whole banking? And then the second point would be because you’re such a student of financial services, I wonder, do we also fall into the trap of thinking that these things which look so disruptive, have actually played out many times before in different guises? Because I was reading your newsletter about Visa before and it’s almost in a way that, was Visa not embedded banking in a way? So I wonder, are we also guilty of thinking these are bigger trends than they really are and they happen quite regularly over the course of history, in cycles?

Marc: Yeah, it’s such a good point. I think 100% I agree with that. And there’s nothing new under the sun. A lot of what we’re seeing now we’ve seen before in various guises. So you’re right, I did a deep dive on Visa, recently. It’s a fascinating story. The founder of Visa, Dee Hock was so far ahead of his time in thinking about payments and the way in which payments simply reflect — just to give some context, we’re talking about the 1960s, where, you know, computers were the size of buildings, and he was thinking about payments. And most of the payments at the time were done on paper that was shuttled between banks. And he foresaw this system whereby payments were — he didn’t use the phrase ones and zeros, but he talked about alphanumeric data — simply alphanumeric data. He has written about all of this. So, Dee Hock, the founder of Visa, is 92 years old today. He founded Visa in the late ’60s, let’s call it 1970. He was CEO until 1984. And he wrote a book in ’99 that was re-issued in 2005. And he questions the need for banks. He says, “If it’s just alphanumeric data, why do we need banks, and the payments?” And he, at the time, knew nothing about crypto, knew nothing about digital currencies. But presently, he talks about a global currency, he talks about payments just taking place directly between consumer and merchant, much of the functionality that Bitcoin potentially offers — or crypto more broadly potentially offers today. And he was talking about this in the ’60s and ‘70s.

Marc: Just to come back to your question, similarly, equally, he allowed JCPenney, which went bankrupt last year, it kind of came out, it went through a bankruptcy process in 2020, has come through with that now. But back in 1979, it was one of the three biggest retail merchants in the United States. It was so big, he said, “Well, let’s introduce embedded finance, let’s bring it straight into the Visa ecosystem”. But even before that, interestingly, it was companies like JCPenney, that actually invented the credit card in the way now that… So now we think about kind of Shopify, and everything that Shopify is doing with Stripe to embed finance at the point of sale in merchants. This was a big merchant’s… I guess, what’s changed is that you don’t have to be big anymore, that because of these providers, because the cost of everything has gone down — the cost of storage, the cost of underwriting, the cost of everything has gone down — it’s become more accessible for smaller companies to offer these things that the big companies have been offering since the 1950s and 1960s. So yes, there’s nothing new under the sun. The same with challenger banks. AG was a challenger bank that merged in the UK with a not dissimilar model to the model of many challenger banks today, 20 plus years ago, 25 years ago. A lot of these models have appeared before and one of the things that I try and do in that interest is look back through history — as you said — as a student of financial services, to learn from them and apply them to the situations we find ourselves in today.

[00:51:54.04] Ben: Having said that, there is nothing new under the sun, I just want to get you on digital currencies, because actually, it does seem like something which is more transformational. If you don’t mind, can you briefly just describe what digital currency is because, you know, one of the things that, you know, when we talk about digital currencies, people get, I suppose, a bit confused about is, you know, if I were to pay you some money now, and I would just transfer it to you, that’s in a way digital money. So what’s the difference between just an electronic transfer of Sterling versus digital Sterling?

Marc: There’s three types of digital money broadly. One is crypto. So, basically, it’s got its own infrastructure and its own coin. So, like Bitcoin. Two is we can talk about stable coins, which have their own infrastructure. So Facebook looks like it will launch any week now, actually, its own stable coin. It’s got its own infrastructure, but it’s stable in the sense that it’s not its own coin, it’s a US dollar or some other currency. And then the third type is a Central Bank Digital Currency, which is, the central bank maintains the infrastructure. It is also an existing currency — call it the US dollar. So these are the three types. And the difference is… So, if we’re talking about your question referred to Central Bank Digital Currency, the difference is, you know, if I give you a 20£ note, it will have a serial number on it. So, when I’m talking about a digital currency when I’m paying you online, it won’t have that serial number on it. So basically, I’m digitizing that 20£ note. I’m digitizing that 20£ note such that if I was to pay you 20£, it would have a serial number attached to it, such that the regulators, the central banks could then audit the trail of that currency the way they do with cash right now through a digital system.

[00:53:56.06] Ben: But isn’t that the most important point for Central Bank Digital Currencies, which is about that ledger? And therefore, it really goes into the question the extent to which you need banks to intermediate. Because if you can have your wallet directly with the central bank, if the central bank can disperse money to you directly, does it to some extent take away that role of banks as creating money supply? Because I suppose, to the earlier question about, you know, if we are going to see an increased split between the distribution of manufacturing financial services, and the central banks kind of rising up to take a bigger share of the manufacturing — or I don’t want to call it manufacturing, but if the balance sheet aspect of financial service because more will just sit directly on their ledger. Does that again squeeze the traditional banking sector?

Dee Hock, the founder of Visa wrote a book in ’99 where he questions the need for banks. He says, “If it’s just alphanumeric data, why do we need banks, and the payments?” And he, at the time, knew nothing about crypto, knew nothing about digital currencies. But presently, he talks about a global currency, he talks about payments just taking place directly between consumer and merchant, much of the functionality that Bitcoin potentially offers — or crypto more broadly potentially offers today. And he was talking about this in the ’60s and ‘70s.

Marc: Yeah, absolutely. And one of the reasons why the central banks are being so cautious in rolling out Central Bank Digital Currencies — everybody’s looking at China — China is trialing Central Bank Digital Currencies right now. They’ve suggested that those trials will continue up until Beijing Winter Olympics in 2022. So, we’re not going to see anything launched until at least then. And that’s in China. And similarly, Europe and various other central banks have said that they’re still studying it. And one of the things they’re studying is exactly that, is that what would differentiate between retail central bank digital currency, and wholesale. And one extreme would be retail, which is the picture you paint, which is that you and I have an account with a central bank, the same way that UBS has an account with the central bank, or Barclays has an account with a central bank. We have an account with a central bank and are therefore able to conduct ourselves without the need for banks.

[00:55:48.18] Ben: Because I can just send you money through my wallet to your wallet, right?

Marc: Exactly. And it’s insured. The way bank deposits are currently insured. All they do at wholesale, and actually, they maintain the role of banks. And again, it goes back to this idea of path dependence. It is quite interesting. Dee Hock, when he thinks about Visa, he’s got this framework for looking at the world. He says, you know, “To understand anything, you have to think about the way it was, you have to think about the way it is, you have to think about the way it might be. And you have to think about the way it ought to be.” And when he was thinking about Visa back in the early ’70s, and say today, actually, he’s made this very clear in his book, that Visa had been created through his kind of organizational principles. It’s not a panacea, and he lists in his book, and I quote him in my recent piece, some of the issues, some of the drawbacks some of the flaws in the Visa model. And to come back to what we were talking about, the point applies here as well, is that there’s a path dependency that, you know, maybe on a blank sheet of paper, we can devise this phenomenal new financial system. And they did that in China. You know, China didn’t have credit cards, they went straight from cash. So they didn’t need credit cards. They went straight from cash to a digital wallet, and you cut out the middleman. That’s very, very difficult when you’ve got vested interests that are cultural, political, data, that when people are used to a certain way of doing things as they are in Europe, in the US, you might be right, from a blank sheet of paper, if we could devise a financial system, we do it like this. But that’s not, to use Dee Hock’s framing, that may be the way it ought to be but we can’t neglect the way it has been and the way it is. And therefore, it probably won’t pan out like that.

[00:57:49.16] Ben: I was going to ask you this question at the end, but I feel I need to sort of preempt it now. Which is, you talked about Libra. And I just wonder, you know, if you look ahead at 2021, what’s the most potentially game-changing thing that’s going to happen in financial services that people aren’t talking enough about? It feels like that might be Libra, because, in a way, they’re going to roughshod over all those vested interests and introduce something that’s going to potentially have the adoption of every Facebook user, which is I don’t know how many billion people and it’s kind of outside a single country jurisdiction and it just seems massive. I’m wondering, you know, are you going to write a newsletter on Libra? Because it just seems such a big phenomenon?

Marc: Yes, I agree. I think it will be a big story for 2021. Riding roughshod. Interestingly, they already watered it down. So initially, they put together a consortium, which included financial service companies, there was a backlash from regulators. And so, they watered it down and the result today is something a little bit different. But I agree with you 100%. I think it’s gonna be a big story of 2021.

[00:58:54.13] Ben: But it’s still a currency that might be used to intermediate peer to peer and other transactions. You know, and even all the vendors that sell through Facebook, right? Within the Facebook network, you might have a currency that sits independently of any fair company, or is that not?

Marc: So again, I mean, anything I would say, the regulators do still have the capability to insert themselves. And we saw that too in Brazil, WhatsApp, which is part of Facebook launched a payments mechanism. And they spent a lot of time preparing it, launched it, presumably at launch they’d had the approval of the central bank because they’d spent a lot of time preparing it, but nevertheless, the central bank once it saw it, changed their minds and shut it down. So, regulators still do have this power, which is, I guess, classic disruption. Bitcoin has been operating at the margin and interestingly it never really became a payment coin. So, Coinbase, which is going to IPO this year, started out as a payments system for Bitcoin. And there’s a book that was released in December, called Kings of Crypto, about the story of Coinbase. And in it, they talk about hiring somebody in order to acquire merchants that will accept Bitcoin. And they did a great job, he got all these merchants, he got multiple billion-dollar revenue companies, lots of merchants, all lined up to accept Bitcoin. But consumers didn’t want to spend their Bitcoin. And so, they pivoted to a broker and Bitcoin became less of a payment mechanism, and more of an asset class, more of a commodity. But clearly, that can change. But as I said, it’s tangential, classic disruption. So they operate margin, and it can become mainstream.

[01:00:58.23] Ben: Yeah, if I understand what you’re saying, Libra, first of all, you know, whatever way in which it’s envisaged that it will be used might change because the use case is different from the one that was a bit like Bitcoin. I want to move on to a different topic now, which is private versus public investing. Because, you know, to get to the latter part of your career, I think one of the things that you’re doing now is you’re doing some angel and private investing. I just wonder if you have any interesting observations about the difference between investing in public markets versus investing in private companies? And I suppose we’ll come back to it as well. But you know, I think it’s relevant because companies seem to be staying private for so much longer than in the past. And it’s almost like being an expert in private investing is a more important skill set than it was historically, we could potentially argue. So I wonder if you’ve got observations around that.

Marc: Yeah. So, interestingly, three months ago, I might have agreed with your point about companies staying private for longer. I think what we’ve seen recently through the rise and the emergence of SPACs…

Ben: You’ve preempted that because I was gonna ask if the SPAC is the vehicle to get companies from private into public markets faster?

Marc: Yeah. I think yes, they are.

Ben: Let’s break this down into three sections, if you don’t mind. So, first of all, maybe everything we’ve got on the data shows it’s changed yet, but why weren’t companies staying private for longer? Because it must have been because it was difficult to realize the value in public markets. And how do SPACs do that? Why would a SPAC or a company taken to market through a SPAC, have a higher valuation than a company that would have gone through an IPO process?

Marc: Yeah. In the short term, maybe that’s an inefficiency in the market. Long term, it’s not clear that the mechanism through which one comes to market has a bearing on one’s long-term valuation. But having said that, there are some structural differences in the process. The key one here being that when, through the IPO process, management is not allowed through SEC guidelines to provide any projections on the future. And coming back to what we were talking about earlier, in terms of equity research, one of the roles, one of the jobs that equity research analysts used to fulfill was to provide equity research at the time of the IPO. Now, it wasn’t always independent, which is one of the issues why it was shut down. But there was a service provided nevertheless. Now, that’s not allowed. So now, what will happen is the company will provide its own filing and the institutional investor will have to peruse that filing, do their own due diligence, do their own work in order to take a view, but they’re given no steer as to what the projections are.

[01:04:08.23] Ben: Do you mind, just because I’m not sure everybody knows what a SPAC is. I mean, I love the phrase that you put in your newsletter, you said, “The SPAC is a bit like the wardrobe, is the portal to Narnia, complete with unicorns on the other side.” So what did you mean by that? If you don’t mind just spending a minute on what it is because it’s such a new phenomenon. Maybe many people don’t know what it is.

Marc: Sure, that’s fine. So a SPAC is a Special Purpose Acquisition Company. And what it is, it’s a pool of money that is raised by a sponsor. Typically, a well-known sponsor will raise several hundred million dollars in cash. And the purpose of the cash and the role of the company that the cash sits in is to do an acquisition with a private company, to find a private company — hence the analogy of Narnia. So public investors clearly are restricted to investing only in public companies. But if they were to buy a share in a SPAC, it’s just a pool of cash. If they were to kind of hand some cash to the sponsor, the sponsor will then go through the wardrobe, into the land of the private companies and find a private company to merge with, bring it back out. And then, all of a sudden, you now, through the merger process, have got a share in a private company.

[01:05:31.21] Ben: That is a great analogy, by the way. That’s superb to describe what a SPAC is.

Marc: And just to finish off what I was talking about earlier, the difference is — and it’s slightly arcane, it’s kind of regulatory — but the merger process enables the company to provide projections. So the guy on our side of the wardrobe, when the sponsor comes back out with his private company, can say, “Well actually, in 2022, ’23, ’24, these are our projections. What do you think?” And at that stage, he can either kind of roll with it, or he can sell because maybe it wasn’t what he wanted as a public market investor, so he can sell but he’s kind of got that right.

[01:06:14.17] Ben: So you think this sort of recent last 20-year phenomenon, with more companies staying private, is maybe addressing this fact? Because it does two things, essentially, if I understand rightly. Firstly, it reduces a lot of the friction and the cost of going public because I can’t remember how much an IPO costs, but it’s a lot, right? You pay your fees, I think it’s like four or 5% that you pay to the investment bank?

Marc: It could be even higher, actually. Yeah.

[01:06:35.04] Ben: So yeah. So there isn’t that big cost, there isn’t the sort of, you know, I don’t know how many months it takes to IPO. But it reduces the friction, the cost, the time to go public plus also through being able to share projections with the market. Arguably, and I think this is the bit you’re talking about, there isn’t the data, but arguably, it enables you to achieve a higher valuation. Because I guess there are two reasons why people stay public for longer, right? One, they didn’t feel they could achieve the valuation that they deemed appropriate in the public market, or they were just put off by the time and the cost and the friction.

Marc: Yeah, that’s right. And also the third reason is the private market was rich with capital. So, why would they…

Ben: But that bit hasn’t changed, has it?

Marc: That hasn’t changed. But you’re seeing even in the public… You know, interestingly, recently… So Lemonade is a FinTech, it’s an insurance company that was founded on a kind of a digital platform. And it was SoftBank. So the SoftBank vision fund is one of the biggest venture capital backers out there, it was an investor in Lemonade. It went public in July of 2020. Actually, recently, already in 2021, it’s raised fresh capital in the public markets, at a valuation much, much higher than when it went public in the summer. Typically, normally — and that’s an unusual occurrence — in the public markets, normally, that would take place in the private markets to be a funding round, even six months after the last one. It’s more unusual in the public market. There was kind of a convergence between… I mean, maybe it’s cyclical just because of where valuations are. But it feels as it was kind of convergence between some of the behaviors that were typically the case in private markets and in public markets.

[01:08:23.10] Ben: I suppose you could argue companies like Tesla wouldn’t achieve a richer evaluation on the private market than they could in the public market. But do you think also, there’s some of the stuff that couldn’t IPO because it didn’t come under the same level of scrutiny would do so through a SPAC?

Marc: Yeah, I think that’s right. I mean, some pushback about SPAC is people have talked about as being a SPAC bubble. And, you know, inevitably, there’ll be a lot of poor companies that are coming through that wardrobe, sneaking through that when the, you know, as Buffett says, when the tide goes out. Yeah, we’ll say who’s swimming naked.

[01:08:59.29] Ben: I think probably we’ve run out of time to talk about Robinhood, and that whole phenomenon of the gamification of the stock market investing. But I just wonder if you had any other observations just from your practice as a public and a private investor. You know, the kinds of things you look for in companies that you didn’t historically, or whether it’s very similar.

Marc: It’s really very different. It’s very, very different investing in private companies, from investing in public companies. For one, probably four key differences. One is the level of transparency, which is much higher on the private side than on the public side. Two is — and this is an interesting point — two is volatility. So, a lot of people inherently don’t like volatility. And I think one of the attractions of private market investing is that they only get revalued when there’s a funding round. And so, kind of right now it’s not an issue, because, in the markets, we’re only seeing upward volatility with everything getting up. But I think there was a kind of a degree of, think back to March, April of 2020, when there was a lot of not such good volatility in the markets. I think there was a degree of comfort around private holdings, which, you know, whether it is Robinhood app, or whatever broker one is using, one’s not seeing kind of the daily volatility of valuations in private holdings than they are in public. That’s a big behavioral difference. The third difference is the structure. It’s very, very important as a private investor to be comfortable with the structure of the holding. You know, when you buy a share in Apple, it’s a share in Apple. It’s pari-passu with all the other shares in Apple. That’s not necessarily the case with private companies. Well, they are different classes of shares so it’s something that as an ex-public investor gone private, I suddenly have to learn about. And the final point is just that you’re in the room. I mean, I can write a newsletter about Jamie Dimon at JP Morgan, he may or may not read it, he may or may not do anything about it…

Ben: I think he subscribes to that, doesn’t he?

Marc: Probably he won’t do either. But it’s just a great experience being involved in a private company.

[01:11:31.05] Ben: Yeah, I think is that last point, which is, you know, you have the ability to make your own weather in a way, right? Because I always thought, for me, that’s the key advantage of angel investing, which is, you don’t just sort of invest the money and hope for the best. You can actually get involved and materially affect the return on that investment that you make.

Marc: Yeah, exactly. Exactly. Exactly.

[01:11:51.10] Ben: One question I wanted to ask you, which is the big downside, obviously, of private investing, is liquidity. And it just amazes me that we haven’t seen more people enter the space for the secondary market for private investing. Why do you think that is?

Marc: There are some crowdfunding platforms in the UK — it was one crowdfunding platform in particular in the UK — was Seedrs, which offers secondary trading of its companies that is crowd equity, crowdfunded for. But probably is difficult, actually, because of the fact that, coming back to the point about structure, different classes of shares. You know, I did another newsletter on fixed income markets — electronic trading and fixed income markets — which is much less developed than electronic trading in equity markets. The reason being is there are multiple fixed income instruments out there. Whereas there’s only one equity for most companies, there’s only one equity. And it’s the same here with private, there’s two different classes of shares with too many different terms. But there’s no standardization.

[01:12:53.08] Ben: So, I have two quick follow-on questions for you. One is, what’s getting you really excited beyond Libra looking into 2021?

Marc: I think what’s happening in embedded finance is fascinating. I think what’s happening broadly, just the acceleration we saw in 2020 around digital, I think what’s happening broadly, through payments mechanisms, and beyond payments, not payment as the hub. It used to be that the checking account was the anchor product for most banks, or potentially, the mortgage actually, increasingly is becoming payments. And that I think has all sorts of implications, whether it’s around crypto or Libra, or embedded finance. It’s basically the common theme across all of those things.

[01:13:40.06] Ben: And then the last question I wanted to ask you, which I think is gonna be difficult, you may have to come back to us, which is, what’s the best book that’s ever been written about the financial services sector?

Marc: Liar’s Poker.

Ben: Yeah, that would have been my pick. Yeah. Okay, good. So if anybody hasn’t read Liar’s Poker, you really, really should. Great. Marc, thank you so much for coming on the podcast. It was a great discussion, and I really appreciate you taking the time and keep up the good work with Net Interest which is awesome. And if you didn’t subscribe to Net Interest, you really should. One fantastic deep dive into an aspect of financial services every Friday. So subscribe. Marc, if people want to subscribe, where do they find it?

Marc: Yeah. So netinterest.email is the page.

Ben: Thanks so much again.

Marc: Thanks, Ben. Great to be on. Thank you.