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He Studied the Financial System for Decades | Marc Rubinstein on Where the Real Risk Is
01:03:32
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- [00:00]
A
I regularly speak to people still managing money and many of them say that they don't recall a time when they've been as confused as currently. One of my kind of axioms of financial analysis is that growth is bad in finance. One thing we learned from the financial Crisis back in 2008, 2009 is that the biggest source of risk is emanates from the place where you're not looking increasingly mass affluent investors who in many cases have been put into these funds by advisors. And there are various incentive structures around that who probably should have read the small print. Don't assume that there's no correlation. Often correlations will spike when you least expect them.
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B
You're watching Excess Returns, the channel that makes complex investing ideas simple enough to actually use or better questions lead to better decisions. I'm joined today by the author and creator of what has to be the must read financial plumbing newsletter in all of finance. That's a comment he's been on fire lately with private credit some tech company takes. And yeah, we might even talk insurance, which only he can make insurance as interesting as he does. Creator and author of the Net Interest newsletter on Substack, Mark Rubenstein welcome to Access Returns.
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A
Thanks Matt, great to join you.
- [01:31]
B
Straight, straight to the deep end before your World cup visits. You can be critical of the Fed I think for a little bit longer. So they said that private credit redemption risks are limited and manageable. You've been writing about for a while. What do you think the Fed's seeing? Why are they saying it? What are they missing?
- [01:49]
A
It's reminiscent, isn't it, of subprime being contained, but they know that. So they are not going to be making as bold a statement having not done the work. And I think on this occasion what they are saying is that the amount of money ultimately that's invested in private credit on terms that limit redemptions is tiny in the context of the overall financial system and the fact that these gates are in place, that these redemption limits are in place, it creates headline risk, it creates reputation risk for the providers. And we can talk a little bit about that potential liability risk for the providers. We can talk about that. But it serves a purpose which is unlike deposits, you cannot get a run on the private credit firm and therefore the risk is largely mitigated. Now, if the holders of these private credit funds or institutions, then who cares, right? They are big enough to read the small print. They are big enough to withstand redemption gains. The question what kind of makes it a bit more topical over the past couple of years is that a lot of the holders of those funds are increasingly retail investors, at least not at least affluent investors. No longer just high net worth, but increasingly mass affluent investors who in many cases have been put into these funds by advisors. And there are various incentive structures around that who probably should have read the small print but more likely outsourced it to the financial advisor and have ended up locked in these funds that they now may want to be getting out of. And although it kind of feels watertight from a legal perspective, the, you can see, I mean we'll go on and talk about Blue Owl, which was one of the first private credit firms to put up Gates, but you can see the impact it's had on their share price and on their reputation and on the financial flexibility of their owners of their founders, who in at least two cases put up stock in Blue Owl as collateral for loans. Stock price collapsed. That created some problems for them. So there are knock on effects. They're not systemic, they're not the sorts of things that the Fed should get involved in, but they do create questions and at the margins they represent risks.
- [05:03]
B
So you did go quite deep on Blue L. Let's spend some time just talking about, let's talk about the firm, let's talk about the, the gates, let's talk about the, the request for 40% liquidity, putting up the 5, the investment. Give us kind of like the history of what's going on there, why this is such an interesting place to do such a deep dive at this time.
- [05:25]
A
Blue Owl, Blue Owl itself is an interesting company. It's not an old company. Few of these private credit firms are old. Apollo, which is arguably the pioneer, goes back to early 1990s. Blue Owl is a lot newer than that. It came to the market in a, in the form of a spacious merger back in 2021. It was slammed together with a GP stakes company called Dial, which we won't go into it now, but it takes stakes in other alternative asset management companies. Kind of like marriage of convenience really. These two companies had no common ground. They both operated in the alternative space but disparate parts of it. But through the merger they became large enough to come to the market. Virus back transaction. They've been publicly traded since 2021. Blue Owl runs a number of private credit vehicles. It runs some business development companies, BTCs that are not traded and it runs some that are traded publicly traded BTCs. The underlying fundamentals of those two types of structure are that dissimilar except for one important difference which is that publicly Traded ones have a stock price and can and often do trade at a discount to net asset value. So lots of closed end vehicles that are publicly traded, famously Bill Ackman runs a closed end fund listed in London. He recently listed one in New York as well. They trade at discounts to net asset value for various reasons that reflect the market's perception of the underlying value of the stakes held within that fund. And as well there might be some supply demand dynamics in that and also the market might take a view of future fees which it will discount. So frequently these vehicles trade at a discount to net asset value and that reflects the market clearing price for that bundle of assets. The privately traded business development companies, they trade by appointment. The provider acts as the intermediary and they will trade often on a quarterly basis. But net asset value. And so Blue Isle's got a kind of problem. It's got some vehicles out there which trade at a discount, some which trade a net asset value. It saw a big surge in redemption requests for its privately traded business development company. Company called Blue Owl Capital Corp. 2. They don't have the most interesting names. These are BDCs. Blue Owl Capital Corp. 2 saw a huge surge in redemptions beyond its promise to meet 5% of those redemptions. And so what it did back in February of this year was. Agreed to fund 30% payout to its holders by selling some of its assets. It was able to fund that, but then it told investors to sit tight and wait for the rest. So rather than stick with its quarterly tendering schedule, management agreed to return capital as and when it could. So that's what it did. Opportunistically, another fund run by Boaz Weinstein Samba came in and said well you know, we'll tender privately for anyone who wants to get out at a discount to net asset value. But it didn't receive sufficient demand to proceed with that. So that's what's been going on Blue Al. And it's become almost poster child for the problems faced by private credit today.
- [10:21]
B
Take us back because I'm interested in. You've been covering financials since we established this in our intentional Investor conversation. The 90s. Yeah, that when. So you've been following and tracking financials broad breaststroke at a global level for a couple of years now. Take me through just like the emergence of private credit. Take me through 2008 sort of like forward and what's gone on with lending and trying to make the system safer, make this operate better. Give me some background context on this.
- [10:56]
A
So the rules changed in 2009, 2010. And the objective of a whole swathe of new rules that was introduced by numerous regulatory bodies was to protect the banking system which had been at the epicenter of the crisis in 2008. So capital requirements were raised, liquidity requirements were introduced, whole series of new rules that hampered the flexibility through which banks could operate. As a result of that, many activities that banks had previously conducted flowed outside of the regulatory banking sector. And private credit is one of those, but it's is just one. So another of the features of the post crisis financial landscape has been the rise of trading companies like Jane street, which recently reported earnings for 2025 that exceeded the earnings of any of the market businesses for any of the major Wall street firms. In fact, if you slap together some of those Wall street firms, Jane street exceeded even the combined revenues of some of those firms. Citadel securities as well. Some of the large multi manager hedge funds have taken on a lot of the activities, a lot of the arbitrage hedging activities we'll talk about and treasury basis risk later. But a lot of those activities that investment banks traditionally used to do and were prevented from doing as a result of new guidelines and regulations that came in post crisis. So Millennium Citadel hedge funds and so on and so forth. Exchanges too, Exchanges have grown. They do clearing activities now again as a result of new laws that were introduced post 2008, 2009. So what you've seen is an increase in the addressable market for exchanges, stock exchanges, multi manager hedge funds, trading companies and private credit companies. And for private credit, the regulatory arbitrage, if you like, was simply that they don't have to put up the same amount of capital to back a loan to a small mid market company as a bank would have done. In fact, banks were actually additionally limited. It's quite well known the constraints around capital and liquidity, but they were explicitly limited on lending. They could do above a certain ratio of ebitda. And so a lot of the more leveraged lending activities flowed out of the banking system into private, into private credit. And so private credit grew. It grew because of. It grew in addition, because at the same time as everything I've changed just mentioned, you also had as a result of low interest rates, a thirst for yield. And private credit was able to provide that. So you know, whenever I look at new asset classes, I always look at supply and demand and where the equilibrium is. And with private equity you had a surge of supply because private equity was able to intermediate assets that banks were no longer economically able to process, but also a demand from end investors looking for yield. And so private equity surged. These days people talk about it in its purest sense, maybe $1.6 trillion of assets, but more broadly defined over two, even $3 trillion of assets, a lot of which has grown since 2008.
- [15:31]
B
When we think about this split off parallel track with the traditional finance industry, is it right or wrong to think about the traditional banks and the private space, especially within private lending and private credit competitors, collaborators, how do we think about the tracks that these each run on?
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A
Yeah, I mean, look, you know what the word often is used is frenemies. They are both competitors and collaborators. So private, private credit, private equity too. But private credit couldn't really exist independently of the regulated bank banking sector. Private credit relies on additional leverage increasingly so provided by the banks. So the banks talk about, and many of the banks have actually now set up their own private credit vehicles on the basis that customers should be able to choose between cheaper bank loan or the certainty. The appeal to a company of private credit is it can be underwritten more quickly in size compared with the traditional process of bank syndication. So a company may choose to pay a slightly higher spread for the certainty of private credit. And so JP Morgan, for example, issues private credit directly of its own balance sheet, but they also lend to private credit companies. JP Morgan itself has spoken about $160 billion of lending to private credit type vehicles off its own balance sheet. And overall the banking sector loans to private credit more broadly, non depository financial institutions is what they would call them, has grown like fivefold since over the past 10 years, kind of 16% per annum over the past 10 years. So banks underpin some of the lending that goes on in private credit. And you mentioned right up front, you know, the Fed's not worried about the redemption risks. Other regulators are worried about this risk. So recently deputy governor of the bank of England talked about the risk of leverage. She calls it the layer cake that you've got private credit, which is that you've got companies. In some cases there are three layers here. There's a company that's making loans, there's private credit lending to that company, and then there's banks lending to the private credit vehicle. Now in most cases there's just two layers, but in some cases private credit lends to the, to the non bank financial intermediary system itself, in which case you get three layers of credit. So Sarah Breeden, who's the deputy governor of the bank of England, she is concerned about this risk of leverage. You Know one thing we learned from the financial Crisis back in 2008, 2009, is that the biggest source of risk emanates from the place where you're not looking. So it's important to look well, you're not monitoring. And often credit can be made more opaque, often intentionally through these kinds of layer cake structures.
- [19:27]
B
Apart from just the traditional finance industry, we also have insurance on the margin here too. And you've been putting pointing this out so like not just the banks, the insurance companies and what their relationship is back to private credit. Can you explain what that is, why this is of interest?
- [19:45]
A
And I should say before I come to that, I should say just on the prior point that there was a case really recently which has blown this kind of layer cake structure out into the open, which is hsbc, one of the largest banks in the world, announced with its earnings, with its first quarter earnings, it was taking a 400 million pound charge off because of exposure to a private credit company called Atlas, owned by Apollo, used to be owned by Credit Suisse, which in turn was making loans to a company called MFS which did mortgage loans, kind of non standardized mortgage loans largely in the uk. Now there was some fraud here and the proprietor of MFS is being investigated on allegations of double pledging his collateral. But that flowed all the way back through NFS into hsbc. HSBC thought that they were being protected by two things. They were being protected one by a high loan to value ratio. In their case they were lending at 80% loan to value which actually wasn't high enough in most cases of back, they call it back leverage bank lending to private credit vehicles. They're doing it at maybe 75% of its first lien, 60, 65% if it's more junior. And they also thought they were getting the benefit of diversification. And again a lot of finance comes back to some basic axioms. A lot of risk management comes back to some basic rules. Don't grow too quickly, don't fight the last battle, look for the risk where no one else is looking. That was something we just mentioned. But another one is diversification. And don't assume that there's no correlation. Often correlations will spike when you least expect them. HSBC thought it was getting lots of diversification benefits. But actually Atlas, unbeknown to hsbc, allegedly was overexposed to NFS and had a very large exposure to that one one credit and ultimately that one risk. So there's concentration risk there as well. So that's just. Sorry, going back to the Prior question.
- [22:40]
B
Well, this is, this is so important because, and I'm glad you brought this in there because I was going to bring this up later too. This is the interconnectedness of this, like this layer cake is really across the entire financial sector. And it's really important to understand what this is because as people are building portfolios or thinking about their own layers of diversification, if you're not already thinking about the interconnectedness here, it creates other problems later. So take, take me to insurance because this is another spot where people probably aren't thinking about what the connection is between insurance company financials and the rest of the financial sector with this common thread in private credit.
- [23:21]
A
Yeah, insurance is interesting. Now, there's nothing new about insurers taking credit risk. In fact, going back through, going back 100 years to the 1920s and 1930s, a lot of the commercial real estate lending activities that occurred in the United States were supported by knowledge insurance companies, life insurance companies specifically, which had long term liabilities that they were able to match into long term assets. And a commercial real estate project would exactly fit that bill. So there's nothing unusual about it. Again, another feature of post crisis 2008, 2009 is that there was, and Apollo was really the pioneer here. They went looking for long term assets and there was a kind of a fallout in the fixed annuity market. And so they started picking up exposure to fixed annuities through acquisition. They seeded their own company, company called Afene Athene, then grew through further acquisitions. They did it in Europe as well as in the US through another company, and they've continued to grow. Apollo is now one of the largest annuity providers in the US if not in the world outside of Japan. And the company argues that those liabilities are very well matched for its traditional business model of finding long term private assets. And there's a lot of merit in that. What has happened more recently though is the lines that you kind of alluded to, these lines have begun to blur. And a lot of the insurance companies, and traditionally insurance companies, well certainly they're not as centrally regulated as banks in the U.S. insurance companies are regulated on a state by state basis. And there's some competitiveness there. And in addition, a lot of insurance is conducted outside, out of Bermuda or the Cayman, where there are different regulatory structures still. And so kind of a number of latent risks have emerged, one of which is that. One of which is that. And some of these have been identified by regulators. So the bank of England has flagged this up. The IMF has flagged this up, the Financial Stability Board flag this up. But increasingly it's not clear. And you can't have a run on an insurance company, but increasingly, which is the defense that's often put up by the private credit providers. After Silicon Valley bank suffered a run in 2023, Apollo rushed out a presentation to investors identifying the fundamental differences between its business model and that of a traditional bank. That's all fine, but again, if something grows very, very quickly, questions will be raised. And these insurance assets have accumulated very quickly. And so questions are being raised in addition around overlap between, between the origination side of the business and the distribution side of the business that is conducted through the assurance book. So in many cases, insurance companies will end up owning assets that have been originated by their private credit owner. And that can raise questions around incentives because you've got multiple stakeholders here. You've got the insurance policyholder, you've got the insurance company, you've got the private equity, you've got the private credit originator. In some cases they're also doing private equity. So maybe credit is being issued out of companies that are private equity portfolio companies themselves owned by the same or brought to market by the same firm. In many cases you've got cross shareholdings between all of these entities. You've got. And again, I go back through history when looking at investment banks, potential conflicts. And so a lot of these potential conflicts are currently under scrutiny by regulators and it is a source of latent risk.
- [28:46]
B
Inside of this, how much do we think about how much it's grown in the last couple of years versus how much it grew post financial crisis? Because it seems like it's not just the three layer cake. This is a whole web and it's pretty dense. And it's not a lot of people understand it, hence the regulatory interest. But then there's also the explosion in the amount of assets that are in this space. How much do we think about how, how quickly it's evolved in the last even just few years versus what it was in say, 2015?
- [29:21]
A
That's exactly right. So we've seen an acceleration in the rate of growth, growth from 2009 to maybe 2020 was contained. A lot of that was due to low interest rates. We've had higher interest rates since 2022. We actually, I talked about Silicon Valley Bank. We haven't. I think had you known in 2020 that rates would still be where they are currently, I think, and increased at the speed that they did back in 2022, I think commentators might have thought more things would have broken than just Silicon Valley Bank. And we've seen a few cockroaches, mostly related to fraud like first brands like mfs, which I've just mentioned. But we haven't seen that much break yet, and that's a big question mark. And we've seen an acceleration in the rate of growth since maybe 2020. We saw a massive flood of liquidity hit the market in 2020, which has had a whole range of consequences, many of which were still working through. And. But we've had mitigating factors, economic growth. We've had mitigating factors. We haven't seen a credit cycle. We can come on and talk about some of the US Bank's first quarter results and what they reflect of the credit cycle. We haven't seen a credit cycle. We're going on now 15, 16 years since 2000. Credit losses actually peaked. There's always a lag between market discounting of a credit cycle and the peak in losses. Losses peaked in 2010. The market fully discounted that in 2009, but losses peaked in 2010. So we're going on now 16 years. This is a long credit cycle. I don't recall actually that kind of elongated period prior to that where we didn't have any kind of credit cycle. But it's being mitigated. It was mitigated first by low interest rates, then by liquidity that hit the market in 2020, and now by. There's a kind of an AI boom, various other factors as well. But yeah, it's building up. It's building up. Lloyd Blankfein, who navigated Goldman Sachs, the CEO through the crisis, exceptionally well. He was on the road recently marketing his memoir, which is a useful book to read. And he talks about, he quotes the Godfather. He talks about the mattresses and he says, he quotes, he says when Michael Corleone is being explained to him this concept of the mattresses that has to happen every five years just to draw out the bad blood. And we haven't seen that in credit markets. And that in and of itself presents a risk.
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B
Kind of fascinating that he goes with the going to the mattresses thing and completely avoids the forest fire, Nassim Taleb thing.
- [32:57]
A
Yes.
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B
The stuff they've learned not to say.
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A
Right, what's the next good point?
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B
You brought up banks and bank earnings. And I think this is part of where it's interesting to hear your brain on this, looking at specifically at bank stocks and their earnings. They have to address all this stuff because it's just enough in the headlines but they also are doing the normal earnings pony show and pointing at what's, what's good and what's working and what's the non event. What's your read? We're recording this May of 2026, so obviously nothing has broken yet officially. What's your read on bank earnings? What they're saying, how they're describing this, what people might want to look closer at with any banks they hold.
- [33:41]
A
So they all on their recent pony shows talked about this dichotomy between consumer confidence which is at an all time low. Michigan surveys are reflecting levels of consumer confidence below anything we've seen and who they've been surveying since the 75 years they've been doing it below global financial crisis, which we've spoken about, below all of the shocks of the 1980s, below even the COVID period. It's unclear why that is. You know, the UK we talk about a cost of living crisis that's been going on since 2021. There are inflationary pressures in the US and elsewhere. Even when inflation has come down, the rate of inflation has come down, prices inevitably have been sticky. And so maybe that just deflates consumer confidence, you would think. And historically there was a pretty good correlation here that would have an impact on consumer spending and on consumer delinquencies and it hasn't, you know. And all of the CEOs of the banks address this point on their calls. People talk about Jamie Dimon, he is a great one to quote. But Bill Demchak, who's the CEO of, of PNC is used to work for Jamie Dimon. He's, he's a great one to quote. He's, you know, if you're looking for, you're looking for people in the industry with their finger on their pulse kind of worthless, listening to everything they say. Mark Rowan at Apollo is one. Jamie Dimon is one because everyone else listens to him. But Bill Jebchuk is another and he said when he looks through the spending patterns, growth in savings activity levels, loan growth, everything he sees in his day to day business, it's almost at complete odds with the surveys he's seeing on confidence. So there is a dichotomy there. I can't explain it. They can't explain it. Bank of America is now so large that they really do have a window into the economy. Its customers spend $4.5 trillion a year through wire transfers, credit cards, debit cards, all of their other payments mechanisms. They see everything and they're seeing spending up 5% year on year, which is kind of the same it has been for the past few years. They're seeing delinquencies quite low, they're not seeing an uptick in delinquencies. Everything's kind of looking okay. And that's true on the corporate side as well. Outside of some of the fraud related events like mfs, which HSBC suffered from that we spoke about.
- [36:52]
B
Talk for just a minute more about Bill Demchak and just leaders and their ability to communicate these things. Because I think what's interesting about what you pointed out with him is acknowledging the dichotomy and I know we're seeing this from a number of people too, but when you see a leader both acknowledging and commenting on a dichotomy that they don't understand, what signal is that giving you? Maybe with the old portfolio manager hat on, but just in general, you've been looking at this space so long.
- [37:20]
A
That's a good question. You know, when they say I don't know, that's always worth listening to because they're trained not to say I don't know. Jamie Darwin's very good at that. They. And the flip side though is people, these people are not. You know, I remember when a bunch of them were hauled up in front of the banking committee on the Hill in D.C. in 2008, 2009, and they were addressed as being captains of the industry, masters of the universe. That ceased to be the case a long time ago. They don't have the credibility anymore that they used to. The tech CEOs do. The banking CEOs are being used by the tech CEOs and I think one of the problems is one of the things I like looking at as an analyst is the post mortem reports after a crisis you pull down when the newspapers are no longer. You're talking about Silicon Valley bank In December of 2023, it was old news. And then the Fed and the FDIC they pulled out a post mortem report. When Credit Suisse put out a post mortem report after it suffered huge losses on Archegos. These things are worth reading because they tell you and they're written objectively, often with through third party council, they tell you what's going on below the hood and they scared the shit out of me. Because what they, what they show you is that what you thought you knew at the time, you knew nothing. That when you. That what was going on under the hood at Silicon Valley bank at the end of 22 and going into January and February 23, when the stock was trading at a premium to its tangible book value when in every analyst on the street was recommending it as a buy. And it was held up as a poster child for how growth can look in the financial system and the financial systems play on the innovation economy. They were subject to a number of reviews by. There's a funny thing. So actually this is quite interesting because I don't know how well known this is. So the concept of insider information is very well understood in financial markets and the SEC polices it very strictly, but makes an exemption in the banking system uniquely for confidential supervisory information. Csi where the Federal Reserve or any of the supervisory bodies, any of the regulators might be inside a bank asking questions, probing. And that's known to the board, certainly known to the executives, but they cannot make that public. And so it supersedes the SEC requirement around kind of insider information and market abuse and revealing information that is pertinent to stock prices. And that was going on at Silicon Valley bank at the beginning of 2023. They were subject to a number of reviews. Nobody knew about it, not least the analysts who were rating a buy, not least the investors who were valuing it at a premium to tangible book value. And when you learn about this after the fact, as I say, it scares the shit out of you because you think, what else don't you know? What don't I know today about what's going on inside JP Morgan, what's going on inside even PNC? Now when you have CEOs that convey credibility and both of those do, you can, you can make peace with that, but in many cases that's not the case. And it's actually why the banking sector trades at a discount to the market on a price earnings basis.
- [41:46]
B
Let's switch lanes for a minute. I want to talk about this idea and what you wrote about Revolut. Did I say it right? Yeah, properly pronounce this. So this quest to build the world's first truly global bank, which I think is a both fascinating concept and fascinating for to hear somebody like you unpack and maybe start. Start us off here. Take me back to when the Visa executive told the angel investor not to back them.
- [42:13]
A
It's a good story. Right, so start.
- [42:15]
B
Start there.
- [42:15]
A
Yeah, there's great storage. So I was sitting in a room with a venture capitalist, actually more of an angel investor, didn't have institutional money behind him. He wrote checks for his personal account. And we were. I've got a background in financial services, I'm interested in financial technology. We were talking about some of the fintech plays that he was currently backing. And he introduced me to this company called Revolut, founded by Russian immigrant to London. He previously traded derivatives at Lehman Brothers and Credit Suisse. And he'd gone off in 2013 to found a new company which he launched in 2015 called Revenue, which promised to which provided travelers with a prepaid debit card that they could travel with in order to spend in local currency without getting slammed or foreign exchange fees, the way Amex and all the traditional credit card companies were at the time, but still to an extent, charging them. So he introduced me to this thing. He kind of opened up his laptop, he showed me the management view of the dashboard which was showing number of users, frequency of use, growth. Everything was going in the right direction. And. But he said it's quite an interesting story this because it kind of reflects the prevalence of gut over analytics in finance. He said as part of his due diligence, he called a contact of his very, very senior executive at Visa in Europe to ask him what he thought. And the Visa executive was highly dismissive. Well, it's kind of a small segment of the overall credit card landscape. Banks or credit card issuers, they could eradicate this business just by changing their pricing overnight. Don't invest, it won't work. And his gut prevailed and he invested anyway. He put in tens of thousands of dollars. That investment today, $2.5 billion now, I don't know, I mean, there are some angel investments which come close. Paul Graham of Y Combinator has made many in stripe, in OpenAI and various others. But this has to be up there. And I say the company is now worth. This is revenue. They've now got 70 million customers. They don't just do credit card spending for tourists. They've got ambitions to be a super app. They compete with banks in multiple markets. They are, they've received funding from SoftBank, Tiger, all of the large VC and crossover funds. They're looking for an IPO. I mean, I don't know if it's going to be 2007. They've talked about maybe 20, 28. The number out there is 200 billion. And that's largely because the CEO in a kind of Tesla type of practice, gets incentivized for hitting that valuation, $200 billion. But look, you know, if SpaceX can IPO at 1.75 trillion, then I don't know where valuations land anymore. So, yeah, that's it. It's a little bit disingenuous that they say, as per your Intro that they want to be the world's first global bank. Citi tried it and failed. HSBC tried it and failed. But Revolut's a lower cost model, so maybe they can succeed.
- [46:45]
B
It's just so interesting to me, the I'm calling it diversity. Not to put on the diversification hat on this, but it's interesting inside of the sector. It's a. You can have a business growing like this that I don't think is a household name. I don't think everybody knows what this is. Unless you have either friends who travel a lot or especially international travelers who have been exposed to this story.
- [47:06]
A
Everyone in Ireland knows it. You know, they have a 75% share of Irish adults. And that's largely. It was a very concentrated market. One of the features post financial crisis in Ireland is that five, six banks became to and Revolut moved into that to provide an alternative provider of financial services to Irish consumers. Absolutely right. The core point is absolutely right.
- [47:39]
B
Another place I want to take you to while we still have some time left.
- [47:42]
A
And actually I should say as well, this is also interesting. You know, we talked about growth. And one of my kind of axioms of financial analysis is that growth is bad in fabs. Either because on the asset side you are giving away credit too cheaply or and this was the case of Silicon Valley bank, because even if you're growing on the liability side, you still got to back that with assets. And any form of asset growth at scale will allow in some bad apples or some deterioration because underwriting takes time and can't often be done at scale. And Revolut was, Revolut fell victim to that as well. So Revolut wasn't classified as a bank, wasn't licensed as a bank, grew very quickly, ran into some problems around its audit and around its systems. And then when it wanted to become a bank, was so large that the bank of England, which would be its primary regulator, had never in its history been asked to license anything that large. And so it took years, took a long, long time. And Revolut had to rebalance between growth at all costs, kind of move fast and break things. The tech mindset, the more prudent banking mindset, which is shit, we need to invest less in marketing and more in compliance and operations. And so that's what they did. And it took time. Took time to adjust.
- [49:33]
B
So another place I want to take you to the golden age of arbitrage, this idea. And I know we brought up Jane street, you've written about them, Glencore You've talked about lots of these different businesses that operate in these interesting places. Explain what the golden age of arbitrage is, what this concept is to you.
- [49:50]
A
Yeah, so I picked it up off an FT op ed piece where the author was talking about commodities principally, and that in a environment of geopolitical fragmentation, in a world which is becoming more multipolar, the price of an asset locally is not necessarily consistent with where it might trade globally. And this was the case historically. You know, historically financial markets were created too and created a lot of profits for those that were able to exploit differences between price of gold in New York, say, and the price of gold in London. And a lot of information technology was to the benefit of financial services. You know, that Reuters originally distributed news through carrier pigeons. You know, historically the advantage of being able to convey information quickly through carrier pigeons, through the telegraph, through, through the telephone, through the Internet, through microwaves between Chicago and New York, which has fueled the race to lay down that infrastructure, was fueled by latency arbitrage in high frequency trading. So a lot of the progress we've made in information technology, we can be grateful for the financial system for funding initially or for finding the killer app for the first use cases. For historically, that's always been the case. And the Open was talking about oil very specifically being in the context of the closure of Australia, of Hormuz, very different rates for a barrel of oil globally at the moment. And it comes to me you're also seeing this in the dichotomy between private assets and public assets, that public assets allow arbitrage to be mitigated very quickly. Private assets don't. We spoke before, for example, about business development corporations. Now, you could argue, we didn't talk about this at the time, that one of the reasons for the increase in redemptions at Blue Owl is because on the screen it trades in the asset value. But on another screen, you can buy a publicly traded business development company for 20% discount in that asset value. So why wouldn't you redeem one, the private asset, and buy public asset to lock in, all else being equal, that 20% gap? And as private expands, you'll see, you'll see more of that. So I don't know if it's a golden age as such, but you're seeing more opportunities for arbitrage, and that's reflected too in the earnings of those that started off at least as arbitrageurs, like Jane Street. But increasingly, I think what you see, and this is true in history as well, is that, you know, one of the things about investment banks in 2008 is they kind of almost outgrew their footprint. They optimized for, they optimized for how much they could pay their employees. And as compensation expectations rose each year beyond that which the industry could contain, they had to increase leverage, find new product sources in order to meet that compensation requirement. And I haven't written this up yet, but I arguably you've seen some of that at Jane street, that Jane employees have outgrown the market that pure arbitrage can sustain. And in order to meet, because, you know, think about finances, people, they want. This was certainly true in investment banks. You know, your, your number every year, your bonus every year was a function of two things. What your expectation was a function of what everyone else in the industry was getting paid, but also what you paid last year. And was this expectation that there would be a escalator of earnings that would go up over time. And if arbitrage in its purest sense is no longer able to sustain that, then you got to move the envelope. And that means taking more risk. That means no more zero risk trades. Lloyd Blankfein, we spoke about him earlier, talked about in his book, he talked about Jay Aaron, which is the gold arbitrage company he used to work for that was bought by Goldman Sachs. And he talks about this, he talks about how the founder of Jay Aaron and his son didn't want to take any balance sheet risk whatsoever. But over time there was some leakage. And the company and the investment bank subsequently and Jane street today, more leakage, taking on more proprietary trading risk could be over seconds, could be over minutes, could be over days. Actually in their cases now, over years because they're actually making venture capital investments alongside the traditional arbitrage activities that they did.
- [56:18]
B
It's amazing to think about these things like as they scale up and how that scale and that growth, like you said before, growth can be a negative word that begets the fragility when we get away from these core businesses.
- [56:31]
A
Yep.
- [56:35]
B
Let's go out on what's one thing about the state of banking right now that you think is most misunderstood? So think about your peers, think about how they talk about this space. What do you think is the least understood or the most misunderstood part of the finance sector today?
- [56:54]
A
I think broadly it's fine. I think there's a playbook. I think people are still obsessed by the 0809 playbook. And every time there's a wobble in markets, people pull down that playbook. They sell the banks and it's frustrating to the likes of Bill Demchak, Jamie Dimon, who we've spoken about, probably you need a generation to. You need people. We're kind of getting there, right? You need nobody in finance to anymore remember 2008, 2009, not to reach for that playbook anymore. We're actually, we're actually getting there. It's a long time ago. And I mean I would hazard that majority, more than 50% of people, you know, I would be fairly confident more than 50% of people working in finance today were not around, were not beyond college in 08 and 09. So you need a generation, you need a turnover of a generation no longer to remember. And I think it's frustrating for them because I think they think maybe Covid was the proof. They think that Silicon Valley was the proof. But we haven't had a recession, we spoke about this before, we haven't had a credit cycle. So they need that as the proof. So that was kind of misunderstood. But there is risk in the system. I'd be worried about government bonds. I think there's a lot of, to a degree, yeah, I'd be worried about government bonds. Some of the risk that's building up there, marginal buyers of government bonds today or some of these non bank financial institutions, something regulators and policymakers are looking at. So there are risks out there, but they're not necessarily on banks balance sheets.
- [58:50]
B
One more with the dust off the old fund manager hat. I'd think this way if you were still in a long short position managing a fund or being part of a fund that ran like a long short strategy right now, how would you be looking at this market here partway through 2026? How would you be thinking about financials? And I'm thinking about this for if you're an allocator, if you're an advisor, if you're somebody else watching at home, you're doing the portfolio yourself. Like what would a long short manager think about the finance sector right now? Where they'd want exposure, where they'd be like, I'm betting on the other direction
- [59:29]
A
or not even involved the market overall is confusing, right? I mean people I speak to, I regularly speak to people still managing money and many of them say that they don't recall a time when they've been as confused as currently. Against a tide of bad news, this is all quite well rehearsed. But against the tide of bad news, the market just powers ahead and many explain it away through market structure. Role of passive. For example, more retail investors obviously AI has a huge influence on market internals right now and allocations. So it's just really confusing. Against that, financials become kind of quite simple. So against that financials, they're never a safe haven because that playbook is still there to be pulled down. But and Europe, Europe in particular, I would say, you know, Europe, we've seen this huge, huge divergence between US and Europe over many years. Like a lot of trends, so many trends have accelerated over the past few years. You know, we spoke about this in the context of private credit growth, but just, you know, the AI trade, US versus Europe, you know, anything that was tootling along in a linear fashion on a chart has just tipped up over the past couple of years. And US versus Europe is another example of that. And Europe's not as bad as people think. We've spoken about Revolut. Probably they'll list in the US doesn't really matter where they'll list. You know, DeepMind is a UK company listed in the US inside of Google Alphabet. You know, we talked about Jane street, one of its largest competitors lies under the radar company called xtx which is London based. Revolut is another on is another. Could be one of the biggest beneficiaries of a change again traded in the US could be a beneficiary of changing free float rules that NASDAQ is introducing for its indices recently. So a lot of innovation in Europe, it's not that bad. And so yeah, I would say long shul. Europe versus the US Financials versus the market.
- [62:09]
B
Mark, you're still one of my favorite minds in this space. This just confirms it further. Where should we send people to bug you on the Internet?
- [62:17]
A
I write a weekly substatial called Net Interest. Best place to find me and you can communicate directly with me is through that netinterest co. Make sure you check it out.
- [62:31]
B
Even if you're not directly investing in financial names or you feel removed from the space where you don't have to be as concerned with it. Mark is the source of information for how the plumbing in this works and then how to think about both public and private securities in the space. You'll always learn something, even if it's just tracking the evolution of Apple, which we didn't even get into today, and the payment system and whatnot. You'll learn more about the markets through this lens than you will in most other places. Thank you so much for coming on Access Returns Mark.
- [63:00]
A
Yeah, thank you Matt. I really appreciate it.
- [63:02]
B
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