The Shadow Courts Edition

Summary

Slate Money: "The Shadow Courts Edition"

Episode Date: October 8, 2016
Host: Felix Salmon
Guests: Cathy O’Neill and Hayley Sweetland Edwards

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Episode Overview

This episode of Slate Money centers on Hayley Sweetland Edwards' book "Shadow Courts: The Tribunals That Rule Global Trade" and dives deep into the controversial world of Investor-State Dispute Settlement (ISDS) mechanisms. The hosts explore what ISDS is, the origins and evolution of these secretive arbitration courts, and their implications for democracy, corporate power, and international investment. After unpacking "Shadow Courts," the conversation pivots to trends in active vs. passive investment management and concludes with a spirited discussion on congestion pricing in cities, capped off by the signature "numbers round."

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Key Discussion Points

1. The Secret World of Investor-State Dispute Settlement (ISDS)

[02:43–21:40]

• Introduction to ISDS:
  Hayley Sweetland Edwards explains that ISDS is “a mechanism buried in almost every trade agreement and bilateral investment treaty,” allowing corporations to sue governments in supranational tribunals outside of local courts.

  “I decided to write this book because I found out about ISDS ... I thought, that can’t possibly exist.” — Hayley (03:09)

• Notorious Cases:

  • Philip Morris vs. Australia: Tobacco giant used ISDS to challenge Australia's anti-smoking regulations, arguing their intellectual property was expropriated.

    “If you try to protect your people from us, you have to pay us the money that we would have made from hurting those people.” — Cathy (05:40)
    The panel notes Philip Morris ultimately lost but highlight its chilling effect on public health policy.

  • ExxonMobil vs. Chad: Chad fined ExxonMobil $74 billion; ISDS mechanisms provide corporations avenues to challenge such government actions in international tribunals.

• Origins and Intent of ISDS:

  • Created in the 1950-60s to protect foreign investors against unreliable legal systems, especially in countries with histories of expropriation.

    “It was also, it had this kind of world peace side to it ... an avenue in which the corporation and the sovereign nation could go up against each other in a peaceful venue … No more gunboat diplomacy.” — Hayley (07:27, 07:56)

• From Good Idea to 'Very Shitty':

  • Cathy points out design flaws: Only companies can initiate cases; no appellate system; ad hoc tribunals with corporate lawyers as arbitrators; inconsistent rulings.

    “It’s like you have this inconsistent and arbitrary system which is trying to prevent internal countries’ laws from being inconsistent and arbitrary.” — Cathy (08:13)

  • Felix clarifies that all courts have inconsistencies, but Hayley emphasizes the unique lack of transparency, judicial standards, and appellate review in ISDS.

• Evolution & Proliferation in Trade Agreements:

  • ISDS migrated from obscure bilateral investment treaties to multilateral trade deals (NAFTA, CAFTA, TPP). Use exploded in the 1990s and 2000s.

    “There were 40 cases in 40 years ... It wasn’t until NAFTA ... that you saw this incredible mechanism that allows us to challenge sovereign nations outside of their court system.” — Hayley (12:47–13:33)

• 'Legitimate Expectations' and Expanding Corporate Rights:

  • Tribunals have ruled in favor of corporations based on violated “legitimate expectations” of regulatory and investment environments, such as in Argentina's crisis.

    “If you invest ... then you get a new administration in that changes those things ... Those violate my expectations of what I thought life would be like while investing in your country.” — Hayley (15:00)

• Political Backlash Across the Spectrum:

  • Both liberals (concerned about regulatory "chilling") and conservatives/Tea Party types (concerned about U.S. sovereignty) oppose ISDS in modern mega-trade agreements.

    “It’s now embedded in the Democratic platform ... we should be concerned about ISDS ... to challenge sovereign nations’ regulations outside of that sovereign nation’s court system.” — Hayley (21:11)

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2. Active vs. Passive Investment Management

[21:40–32:08]

• Janus-Henderson Merger & Active Management’s Woes:

  • The panel discusses the merger as emblematic of active fund managers’ struggles in a world where investors are moving en masse to low-cost passive investing.

    “[In 2016,] $200 billion investors yanked out of active management and put into passive management.” — Hayley (23:59)

• Passive vs. Active Investment Explained ([24:29–25:31]):

  • Felix and Cathy break down what constitutes passive management (just buy and hold the index) and active management (trying to beat the market).
  • Cathy raises social and market concerns: Does favoring indexes (like S&P 500) steer too much capital to established companies, starving innovation and smaller firms?

• Counterarguments:

  • Felix rebuts: Buying indexed stock on the secondary market doesn’t funnel new capital to firms but can affect cost of capital through price signals; no evidence of privileged access or valuation distortion so far.

• System Stability:

  • Felix: “You would need passive investment to be somewhere north of 95% of the stock market before the capital allocation started getting screwed up. … We’re a very, very long way away from this.” (29:18)

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3. Congestion Pricing in Global Cities

[32:08–43:04]

• Congestion in London Despite Pricing:

  • Firsthand cab ride anecdote leads to explanation of how London's congestion pricing (fees for driving in central zones) succeeded at first but hasn’t solved gridlock.

    “On the face of it, [congestion pricing] has utterly, utterly failed ... There is more congestion than ever.” — Felix (35:54–36:38)

• Why?

  • Felix: Drastic reduction in private cars, but congestion persists due to commercial vehicles, taxis, and delivery trucks.
  • NIMBYism (residents closing streets to through-traffic) results in fewer routes for vehicles, pushing more traffic onto main roads.

• Policy Ideas and Global Comparisons:

  • European cities often ban trucks during peak hours—unlike New York—and enforce traffic investments that serve public rather than private mobility.
  • Cathy: “I think we should charge 20 bucks for congestion and also close half the streets because it’s actually a better city.” (39:43)

• Economic Impacts of Congestion:

  • U.S. drivers lose 38 hours a year to gridlock, with major economic and environmental costs ([42:24–42:49]).

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4. Numbers Round

[43:12–48:00]

• Cathy’s Number: 6%

  • The British pound fell 6% in a flash crash overnight—a historic drop attributed to possible algorithmic trading.

    “Did you know that the pound dropped 6% in overnight trading… some kind of mini flash crash?” — Cathy (43:12)

  • Felix explains the mechanics and incentives behind such rapid FX moves, including derivatives like knock-in options.

• Hayley's Number: 8.7 Billion

  • The number of internet-connected devices globally—projected to almost triple to 21 billion in four years.

    “A little glitch in code… can lead to 6% drop in the pound sterling, or it can lead to everyone’s coffee machine … beginning percolating at 2 AM.” — Hayley (46:18–46:31)

• Felix’s Number: 25 Billion

  • The anticipated value (in dollars) for Snapchat upon its IPO, despite little revenue and no profits—a provocative example of modern tech valuations.

    “They have revenue right now of a few hundred million dollars a year … but this is still a crazy multiple of their revenue, let alone their profits.” — Felix (47:41)

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Notable Quotes & Memorable Moments

• On ISDS’s Evolution:

  “This is the great narrative that I’ve been trying to harp on … there were 40 cases in 40 years. … It wasn’t until [ISDS] was inserted into NAFTA and then began being inserted into these multinational trade agreements that you saw ... ‘holy shit! We have this incredible mechanism that allows us to challenge sovereign nations outside of their court system.’”
  — Hayley (12:47–13:33)

• On Regulatory Chilling Effects:

  “If you try to protect your people from us, you have to pay us the money that we would have made from hurting those people.”
  — Cathy (05:40)

• On Passive Investment’s Systemic Impact:

  “If everybody did it, then we would be in some bad place. ... What degree of investment would you need in order to get to that bad place? ... You would need passive investment to be somewhere north of 95% of the stock market.”
  — Felix (29:18)

• On Urban Congestion:

  “The answer is never building more roads. No, but this has been proven empirically time and time again, which is that traffic expands to fill the number of lanes available. … It never, ever works.”
  — Felix (42:05)

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Timestamps for Major Segments

• [02:43–21:40] — Shadow Courts and the ISDS system
• [21:40–32:08] — Active vs. Passive investment management
• [32:08–43:04] — Congestion pricing and city transport policy
• [43:12–48:00] — Numbers round: Pound flash crash, internet of things explosion, Snapchat’s IPO value

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Tone & Style

Conversational, sharp-witted, and occasionally irreverent, the panel combines deep financial and policy insight with a humorous, skeptical edge.

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In Summary

This Slate Money episode unpacks the shadowy mechanisms of ISDS, explores the tension between active and passive investing, and muses on how cities do—and don’t—solve congestion, offering fresh insights and laughs throughout. Hayley Sweetland Edwards' "Shadow Courts" emerges as a must-read for anyone curious about the hidden rules governing global trade and the expanding power of international arbitration tribunals.

Transcript

[A]

The following podcast contains explicit language. Hello, and welcome to the Shadow Quartz edition of Slate Money, your guide to the business and finance news of the week. I'm Felix Hamminer. Fusion. I'm joined, as always, by Kathy o', Neill, the author of Weapons of Math Destruction.

[B]

I'm here. I'm so happy to be here.

[A]

Find it. Oh, and you were recently shortlisted for something fabulous.

[B]

Long listed. Long listed, not shortlisted. But yes, I was extremely happy.

[A]

You get a silver medal.

[B]

Yeah, whatever. I'll take it. The National Book Award for Nonfiction.

[A]

National Book Award for Nonfiction. Which means it's a good book.

[B]

That's how I know.

[A]

Yeah. Yeah, that's great. We weren't in touch. We all enjoyed reading it, but we don't trust our own.

[B]

No, no. Why would we?

[A]

We wait for the National Book Award.

[B]

We need external measures of success.

[A]

Exactly. And talking of books, we are also joined by Hayley Edwards, who has written a book. It's one of those wonderful short books. If you remember, a while back, we had Bethany Maclean on talking about Fanny and Freddie, and we were gushing about how awesome it was that her book was short and readable. And this is another short.

[B]

Oh, my God. I got this last night and I'm done.

[A]

I read it. It's amazing. And it's one of those books you can just. In the sitting.

[B]

I mean, I felt like underlining every word of every page, so that's a good sign.

[C]

Oh, thank you.

[A]

So, Hayley. Yeah. You are something. Something with Time magazine.

[C]

Yeah, I'm a policy correspondent with Time magazine.

[A]

And you are also the author of Shadow Courts, the tribunals that rule global trade.

[C]

Bum, bum, bum.

[A]

Because all nonfiction books need subtitles always. Even if they're short.

[B]

The good ones do. The good ones do.

[A]

And the bad ones, they all have one day. We're gonna have a author on this show who doesn't have a subtitle, and we're going to be like, where's your subtitle?

[B]

How do we know what the book is really about?

[A]

Exactly. So, anyway, we are going to talk about Hayley's book. We are going to talk about congestion pricing, which is one of my favorite subjects. And we are going to talk about active management as well, because.

[B]

Also one of your favorite subjects.

[A]

Also one of my favorite subjects. But, yeah, we may as well, since Hayley is here. Oh, and by the way, we should probably mention that there's a void in the room.

[B]

Yeah, it's very sad.

[A]

He's in the eye of a hurricane. So, Jordan, if you're listening to this. Keep hunkered down in Florida and try and stay alive. So you're coming back next week on Sleep Money. Hayley, tell me about this book and why you wrote it.

[C]

Well, Shadow Courts is about a mechanism buried in almost every trade agreement and bilateral investment treaty and called Investor State Dispute settlement. And you'll almost always hear that just shorthand, isds. And I decided to write this book because I found out about isds. I was just reading the Internet and I read about it and I thought, that can't possibly exist.

[B]

Can we. Can we just get right to the sexy, nasty cartoon villains of the situation? Can we talk about the cigarette companies, the oil companies, the polluting companies?

[A]

Okay, so there is a vague news hook here, which I'm going to.

[B]

Oh, really?

[A]

Yeah. I don't know if you guys saw, but Chad recently, like this week, fined ExxonMobil $74 billion, plus $819 million in royalties for breaking Chadian law or something. Or not breaking, because it's not exactly a robust state. Anyway. Chad decided that they were going to find ExxonMobil $74 billion, which, by the way, is five times their GDP.

[B]

Wow.

[A]

And the obvious reaction to that is what? You know. And so there are ways in which companies can sort of appeal these things in supernational tribunals. So we like these Investor State dispute tribunals and the International center for the Settlement of Investment Disputes in all of these places because they help put these poor benighted companies on an equal footing with them evil countries. And that's more or less your book. Right?

[C]

That's a really interesting case, the Chadian one. I mean, Kathy referred to the tobacco companies earlier, which is another way of looking at this, and also was mentioned on the John Oliver Show. So it's the one that, if anyone has heard of isds, this is the one that they've heard of. It's Philip Morris used Investor State Dispute settlement, these supranational tribunals, to challenge Australia's decision to pass anti smoking laws that would require basically putting, you know, brown paper around cigarette cartons and limiting the amount of advertising you can do in the country. They passed this law. The tobacco companies challenged it. It went all the way up to the Australian Supreme Court. They decided that it was constitutional. And then Philip Morris went outside of the Australian courts to challenge it through the supranational tribunal to say that, in fact, by passing that law, Australia had more or less expropriated Philip Morris's intellectual property.

[A]

Wow.

[C]

And they were demanding, you know, x hundreds of Millions of dollars in.

[B]

So basically, if you try to protect your people from us, you have to pay us the money that we would have made from hurting those people.

[A]

I mean, we should jump in here and say they lost.

[C]

They did lose.

[B]

Oh, good.

[C]

Yes. And that was this big case, and that gets into a lot of the politics of these. You know, that case actually got attention from the Western media. Another case that's getting attention from the Western media is after Barack Obama canceled the Keystone XL pipeline last November. The Canadian company that was going to build that pipeline then used isds under NAFTA to challenge the US Outside of US Courts on the grounds that that cancellation in some way violated its.

[A]

Okay, so here's the question. Is this a good thing or a bad thing?

[C]

That is actually a great question because the way that I frame it in the book is it basically started out as a good thing. It started out doing what? Protecting investors operating in countries where there was rickety rule of law and unreliable court systems. And they wanted to go invest in places like Pakistan or Chad or Venezuela. And they weren't going to do that unless there were external protections. That was the idea in the 1950s and 60s when this came around. And that was also a period of, you know, rapid nationalization and expropriations and communist regimes were gaining power all over the place and just expropriating Western investors. Factories and oil fields and things like that.

[B]

So basically it was created in the, like kind of to try to tell other companies, like foreign companies, come invest in our country. And we won't, we won't get away with just taking over your company once you've set it up.

[C]

Exactly. And it was also, it had this kind of world peace side to it where, you know, Jimmy Carter was actually very in favor of this in the late 70s because he would see American corporations getting into tussles basically, with Latin American countries. And he wanted there to be a. An avenue in which the corporation and the sovereign nation could go up against each other in a peaceful venue and not. And the US Wouldn't be dragged in.

[A]

There wouldn't be the. No more gunboats Diplomacy.

[C]

Exactly. The proverbial gunboats in the, in the.

[A]

In the harbor which happened in Venezuela and in various places.

[C]

Absolutely.

[B]

So one of the fascinating things that you lay out in the book is just how these things actually work and how they are basically very, very shitty. So, I mean, I'll name a few.

[A]

How do we get from good thing to very, very shitty? Like, this is the thing which I.

[B]

Don'T understand It's a very bad design. I mean, I'm going to just mention a few characteristics of these isds courts. There's three people, there's an asymmetry of who can start one of these cases. Like basically the companies can start them against the countries, but the countries can't do the opposite. It's low cost for those companies. They could do like basically copies of the same case and they sometimes win and they sometimes lose. And there's no way of sort of understanding how you take those two decisions and make them consistent. And in fact the decisions are very, very inconsistent. So I mean to sum it up, it's like you have this inconsistent and arbitrary system which is trying to like prevent internal countries laws from being inconsistent and arbitrary.

[A]

But okay, so again, I'm just going to be like the devil's advocate here and I'm going to say all judicial systems are inconsistent and arbitrary. There is no court in the world which can't be accused of being inconsistent and arbitrary. And yes, there is a certain asymmetry in that. If the company is suing the country, it happens in this court. But if the country is suing the company, obviously they're going to do it in their own courts.

[C]

So I think this is a really important point because you're absolutely right that every judicial system in the world is inconsistent. The US Judicial system is wildly inconsistent a lot of the time, but it's an institution and there's an appellate mechanism and judges are full time judges for life. And there's rules governing conflict of interest. And if two courts disagree with one another, there's a mechanism through which they reconcile those decisions. This, what we're talking about here is supranational binding arbitration before a private tribunal. So the three people who determine whether or not Australia's tobacco regulations in fact violate investor treaties are corporate lawyers. They're private individuals.

[A]

I think the real problem here is not so much the courts and the tribunals who have a very, very tough job to do and sometimes do it well and sometimes do it badly so much as it's the way in which free trade agreements are negotiated under the sort of auspices of thousands and thousands of corporate lobbyists who are just inserting all manner of clauses into these various bilateral investment treaties and multilateral investment treaties and no one else really. And it's very hard for the individual countries to say no, that's stupid. Especially when the United States, which gets to drive a lot of these free trade agreements, is really pushing a bunch of IP protections and things like that. Which no one else really wants in there, but the US Won't sign it unless they're in there.

[C]

Well, and this is something that wrote this book last fall, before we really thought Trump was gonna be a candidate, before we. Before the Brexit vote, before there was this kind of. We're seeing this massive right wing populist backlash.

[A]

Before Hillary Clinton came out against tpp.

[C]

Before Hillary Clinton, Exactly. So there's. I wrote it at a time when it was kind of a different context. And now I feel like the lady doth protest too much. Where it's like, this isn't actually about trade. What we're taught, investor state dispute settlement is not actually about trade in any way. The first time that it was included in a free trade agreement wasn't until the 1990s. It wasn't until NAFTA and like this. So we started off talking about like this start. This was a good idea. In the 1950s and 60s. There were basically no claims.

[A]

Where was it put if not in a trade agreement in the 50s and 60s?

[C]

In bilateral investment treaties.

[A]

Aren't those trade treaties?

[C]

No, they're investment. Yeah. They're entirely designed to protect investors and to. And to basically establish the rules for how investors will be treated in two countries. So they're bilateral and those are just much smaller bore agreements. And it wasn't until the 1990s that someone gets this great idea, hey, let's just take that entire bit and let's just wedge it into a chapter of NAFTA and CAFTA and TPP and TTIP and every other massive trade agreement coming down the pike.

[B]

You do a great example in the middle of the book about right as NAFTA starts being enforced that you see that it goes directly from the idea that you should be treating foreign companies fairly to you should be compensating foreign companies for possible future profit loss.

[C]

Exactly.

[B]

That's a real shift.

[C]

And this is what this is, this is the great narrative that I've been trying to harp on is that you have this idea like let's protect foreign investors property abroad. Fine, great. But there were no cases for 30 or 40 years. There were 40 cases in 40 years. You know, they didn't really happen from about 1960 to 2000, this mechanism was basically never used. It wasn't until it was inserted into NAFTA and then began being inserted into these multinational trade agreements that you saw. It's kind of like, I imagine it like the cartoon light bulb going off above the legal community's head all of a sudden. It was like, holy shit. We have this incredible mechanism that allows us to challenge sovereign nations outside of their court system.

[A]

So here's the question. I mean, obviously companies are very wary of suing sovereign nations inside that sovereign nations court system because they will always lose. So they're like, okay, so, you know, we'll sue them outside. That makes sense. And my general feeling about trade agreements is that multilateral is better than bilateral, and that bilateral is like a kind of crappy way of excluding countries, and multilateral is a kind of good way of including countries. And if you structure the multilateral treaties in such a way that they basically, they're like bilateral treaties, but including lots of countries rather than just two, that's a good thing. The question I have for you is, is has any company actually won a case at one of these tribunals where they got awarded profits that they would have made had the law not been passed?

[C]

Yes. Yes, they have. And this gets in about the late 90s or early 2000s, this idea of legitimate expectations was first introduced by tribunals. And this is, again, there's no jurisprudence. This is just three individuals looking at treaties and interpreting extremely vague language. Because what was written into these treaties in the 60s and 70s, no one really thought it would ever be litigated. There wasn't even an infrastructure on the international stage through which a corporation would challenge a sovereign nation. It didn't exist. The ICSID that you referred to before didn't exist. So it was the idea that these were actually legal documents, didn't occur to anybody. So the way that they're written now is basically like, you know, felix, Felix, sustain. You agree to treat Haley Corporation with, you know, fair and equitable treatment. You agree to give me fair and full protection. That sounds great, but what the hell does that actually mean once you have three people looking at this? And so beginning in the late 90s, you saw people, these arbitrators, saying, anytime you violate my expectations of what it would be like to invest in your country, that's a violation of these investment treaties or these investment provisions. And anytime I, you know, you passif I invest in your country in a certain umbrella of regulations, under a certain tax code, and then you get a new administration in that changes those things. Those violate my expectations of what I thought life would be like while investing in your country.

[B]

And the example is from Argentina, Right?

[C]

So Argentina is a really interesting example and I think gets to a lot of these questions of what do we mean when? Or what's the meaning of local rule and federalism in this international world. Another case that I write about in the book, I mean, I write about Argentina, I write about Ecuador, I write about Czech Republic. There are a lot of different cases. But you have. In Argentina, you have this massive financial crisis. No one's going to say that the Argentinians behaved that well. Right.

[A]

You know, I believe the word is contumacious. We've used that before. Argentina is, as regular listeners to Slate Money will know, is my favorite subject in the world. We've talked about Argentina a lot. And actually, Argentina is a fascinating case because it's one of the few cases where Argentina was actually taken to court, not to one of these tribunals, but to the second Circuit in New York and lost.

[C]

So this actually gets to one of your questions you asked before. What are corporations supposed to do when they go invest in a country like Argentina or Venezuela or Ecuador or, you name it, where they don't want to rely on the local court systems, because.

[A]

Relying on the local court system in Ecuador, not smart.

[C]

Right. But you have. So another alternative to that is that you do as that, as, you know, the hedge funds did when they wrote, when they signed contracts with Argentina, they said, if there's any dispute, we're hearing it in New York courts. And another thing is if you have these, you basically don't necessarily need these supranational tribunals that are only designed for. For corporations in order to have extra judicial protections for those corporations.

[B]

That brings me to the most important question for me, which is that these TPP and ttip, they all have this ISDS stuff, and they're all basically secretly negotiated by corporations. And we hate them as good liberals. Anyway, I do. I'm raising my hand. The question becomes, then is there a better way to have international treaties? And maybe this is similar to what Felix was saying, but can we have labor represented there? I feel like. Or the general public. Good. Because I feel like one of the issues here and all these examples is like, these corporations are like, what about my rights? And there's like, very little pushback because there's no space for the rights of the public. Yeah. So in other words, is it, like, badly designed and, like, badly populated, or is it just. This is a terrible idea.

[C]

It's. I mean, you're kind of. You're walking up to one of the really interesting intellectual debates going on in the sort of ivory tower of how we talk about trade right now, which is that these deals are not about trade in any traditional sense of the word. And, you know, you have. And that really is new too. That's in the last 25 years. So it used to be that trade agreements were to be about tariffs and quotas. Right. They were about the movement of goods and services across more borders, more quickly. That was the entire idea of free trade. Beginning in about the 1990s, free trade agreements became about intellectual property on biologics, they became about trafficking of exotic animals, they became about child labor laws, they became about, they turned into these massive tomes that were all about global rulemaking. And I think that that's why we're seeing a lot of this backlash right now that you're not, or a lot of this kind of shifting political relationship to trade agreements, because you can quibble over whether or not there should be a 7 year exclusivity or a 12 year exclusivity on certain pharmaceuticals in ways that you wouldn't argue over whether there should be a tariff on bananas. A tariff on bananas, exactly. And so we're just, we're talking about different things. And ISDS is such a great example of that, because it's not about trade. It's about a supranational judicial system that is designed to protect corporate property rights abroad.

[B]

It's about risk. Like, who isn't, who's, who's on the hook for this risk.

[C]

Yes. And that actually gets to this point that I think is so important that, you know, you mentioned like good liberals opposing these trade agreements. Well, you actually, this is not. You have backlash from it on the conservative side as well. And conservative. And specifically around ISDs, you have the traditional conservatives, the Tea Party folks, who really are suspicious of ISDS on the grounds that it's an imposition on U.S. sovereignty. Why are we allowing TransCanada, a foreign company, to challenge a U.S. executive action outside of the U.S. court systems? What's wrong with our court systems? So that's one problem. The libertarians are opposed to it, deeply opposed to it, on the grounds that it acts as a international subsidy for outsourcing. Because it's about risk. If you're going to be Apple, you're Apple and you're going to go invest in China. You know that there's a lot of risk that goes along with that. But Apple doesn't have any ISDS protections. There's no treaties between the US and China that includes ISDS protections. And they're going in there anyway because they're willing to assume that risk, the market, is big enough. And then you have the liberals who are opposed to it, the Elizabeth Warrens, the Bernie Sanders you know, Tim Kaine came out against it. It's now embedded in the Democratic platform that, you know, we should be concerned about ISDs on the grounds that it is a way to challenge sovereign nations regulations outside of that sovereign nations court system. So we're not talking about trade agreements in the way that our grandparents would or even our parents.

[A]

Okay, so that's the book. It's called Shadow Courts, the tribunals that rule the world. Hayley Sweetland Edwards, find it in all good bookstores, and maybe you'll understand why Britain voted to leave the eu. Yeah. Yeah. So let's move on to something completely different, which is. Is an international trade merger where you get two big financial services companies. In Europe, you have this thing called Henderson, and in the US you have this thing called Janus. And they've decided they're going to merge. And there's a bunch of different things going on here. We can talk a little bit in a minute about the whole concept of active management, that these are active management, and they're being sort of squeezed by the passive management revolution, which we all love, and so our hearts are bleeding for them. Not much. But also, I need to just start off with this. The reason why the financial press loves this merger so much, or one of the reasons is because Janus is famous as the place where Bill Gross went after he got fired by Pimco, and he was running hundreds of billions of dollars, trillions of dollars at Pimco, and now he has, like 1 billion of his own dollars at Janus. And he's just. And he's still, like a crazy person.

[B]

He's still in trouble with. With those guys.

[A]

Well, he keeps on trying to sue them, and they're like, this is ridiculous. He's trying to sue them for, like, wrongful dismissal and stuff. And it's crazy.

[B]

Gosh.

[A]

And he. It turns out in the litigation, like, this is why you should never sue anyone. Because in the litigation, you get discovery. And then the discovery was revealed that from Barry Ritholtz at Bloomberg View, that Bill Gross was being paid $300 million a year, that the person who leaked that to Barry Ritholtz was Bill Gross.

[B]

Oh, my God. Wow.

[C]

Full circle.

[B]

The egos.

[A]

So crazy. So crazy. You know, octogenarian, like Bond madman, Bill Gross has now been bought by a relatively sane company in England called Henderson. Haley.

[C]

Yeah.

[A]

What do you make of this? Is this. Is this a sign that all of these companies are doomed because they're doing something which no one wants, which is charging lots of money for Active management, which always winds up underperforming.

[C]

Yeah, I think that the number I saw most recently was from bank of America Merrill lynch, that $200 billion investors yanked out of active management and put into passive management. That's a record breaking number. And I think that you're going to see the Bill Grosses of the world are.

[B]

Can we just define our terms here? Just just briefly, because I actually think I'm going to defend active management, says.

[A]

The former hedge fund employee.

[B]

But I have to make sure I understand what my terms are. How would you define passive management?

[A]

Passive is where you just buy the index and sit on it.

[B]

So which index?

[A]

So that's a very good question.

[B]

It's important.

[A]

This is very easy. In equities, you can more or less pick your benchmark. Often it's the S&P 500. But there are a million different passive. You can buy any index. You can buy an index of all stocks which begin with the letter A if you want. It doesn't need to represent the market.

[B]

But what do people actually do?

[A]

But what they do is they just. The point about passive management is it's a sort of set and forget it strategy. You decide what you're going to buy on day zero, you then buy that. And if you want to invest more money, you buy more of that. And then you never trade, you never think, oh, that's expensive, I'm going to sell that and that's cheap, I'm going to buy that. You just retain that exact asset allocation in perpetuity.

[B]

The argument for passive management, which we've made and I agree with, is that as individuals, we're not going to beat the market. And if we hand our money over to someone who's trying to beat the market, they're going to charge us a lot and they're also not going to beat the market. And so it's bad in both of those. The alternatives are bad. So we do this. The argument, my anti passive management argument is completely different. Right. I want to look at the world of investments like what needs money? And should we give money to companies to give them money so that they can grow? And the answer is, yeah, probably we should give money to companies in general. It's a good thing for the economy at large. But then the question becomes which companies deserve our money? And my problem is this idea that we have, have this set index S&P 500, which means that so many people are sending all their retirement money, say not all of it, but a large portion of it to these 500 companies which privileges those 500 companies over all the other companies. And when and when we have so many people putting their money into passive management, as we're seeing more and more, then we have more and more of this privilege going to these specific 500 companies and not to the sort of world of all companies.

[A]

And I understand that in theory, but in practice I don't buy it for this reason, which is that when you buy the S&P 500, you are not sending your money to the S&P 500 companies. If you spend $1,000 on an S&P 500 index fund, exactly zero of that thousand dollars makes its way to the companies in question. It's not like they all get $2 each. 100% of your money goes to the people you bought the stocks from. This is a secondary market. It's not a primary market. The people that you're buying it from are the people who were invested in the S&P 500 before you. And then eventually, at some point in the future, you will sell that fund.

[B]

And I don't really want to go.

[A]

Buy that someone else. But let me finish. Which is the way that there's a second order effect which is that if a, if a bunch of people are buying the S&P 500, then that means those stocks are going to be more expensive relative to Non S&P 500 stocks and that the cost of equity capital for those stocks is going to be lower and that those companies are going to have an advantage. And so the way we can judge whether this is happening is by looking at the PE ratios for the S&P 500 or the cost of equity capital for the S&P 500 and compare it to the cost of equity capital for companies which are not in the S&P 500. And say, do the S&P 500 companies have an obvious advantage here? And when you do that, the answer is no, not really. There's no particular evidence to suggest that just by being entered into this select group of companies, you suddenly get a competitive advantage.

[B]

Let me ask you this, and you make a good point about how when I buy S&P 500 stock, it's not going to the company, but at some point companies enter the stock market, right?

[A]

And then they ipo.

[B]

When they ipo, do they never issue.

[A]

New stock and then sometimes they issue new equity? Yeah.

[B]

So the, so it's still true that, you know, people who are passively investing and not never ever looking at their investments are not the ones who are like looking at these new IPOs and judging them and deciding to put money on them. So in other words, it is. It's funneling money away from new, new other companies that are not already in.

[C]

That position and not only other companies. I mean, I think you would make the argument that it's. That you can be more ethical in your investments.

[B]

Yeah, you can actually have an opinion. Right. I mean, look, again, I don't think for an individual, I'm arguing against it. I'm just saying, like, if everyone does the same thing, like, then, then we're not actually the. The market as a whole is supposed.

[A]

To actually serve a function, capital allocation function, and passive. Passive investment does not serve the capital allocation function function. But this is one of the most common and also one of the most frustrating arguments against passive investment is this slippery slope argument which says, well, if everybody did it, then we would be in some bad place. I do it, by the way, and the question is, what degree of investment would you need in order to get to that bad place? How much of the stock market would need to be passive investment before the capital allocation started getting screwed up? Before, like the, you know, the price arbitrage has started going away because so much money was just dumb and there wasn't enough. There weren't enough arbitrage shares my view. You would need passive investment to be somewhere north of 95% of the stock market right now. It's not even close to being half of the stock market. We're a very, very long way away from this.

[B]

I'm not, I'm not saying we're about to hit that point either.

[C]

I think it's also just part of human nature. I don't. I mean, people are always going to be like, oh, I have this. There's this company that I heard about that it's going to be great and it's going to be the next fill in the blank. There's always going to be the people rolling the dice out there wanting to play that game. I don't think that that's a major risk. I think from an individual standpoint, you have an 85% chance of keeping up with the index if you do passive investment. And if you spend all this money on fees and stuff, I think you have a 14% chance of actually beating it. I mean, it's tiny. It doesn't make sense from, from grandma who's like, you know, investing her portfolio.

[B]

I'll just make one last stupid comment, which is that, you know, as people enter the passive investment thing, the market will go the S. And P500 index will go up because more and more people are buying.

[A]

Doesn't know. I just don't think that's true.

[B]

How is that?

[A]

Not because it will get away? Because you only need a tiny percentage of the market to do the active arbitrage of the S&P 500 against the rest of the market. And that will. The dumb money is very, very slow. The amount of money that goes into passive management is large on an absolute level. But in terms of actual trades in the stock market, it's very low because it's one trade. I go in there, I buy the stock, I sit on the stock, I never buy it again, I never sell it again. So the overwhelming majority of the trades in the market, remember, it's the trades on the market every day which is setting the price. The overwhelming majority of those trades are active managers. Even though, even if you have a majority of investors are passive, a majority of the traders are always going to be active and it's the traders who are setting the price, not the investors.

[B]

I'm going to think about that, but I don't think I agree with you. We'll come back.

[A]

We will come back. We will revisit active management at some later edition of Slate Money.

[B]

Now, I want to jump in.

[A]

Before you even say anything, Kathy, talk to me.

[B]

You know where I was last week?

[A]

Where were you last week?

[B]

I was sitting in a cab in London.

[A]

That's a bad move.

[B]

I had a hotel at Charing Cross on the Strand in London, which is literally the busiest street I've ever seen.

[A]

It's a parking lot.

[B]

It's a parking lot.

[A]

It is actually used as a parking lot. Weirdly, the traffic management system in London is incredibly sophisticated. And at the bottom of the Strand is the world's biggest, most complex roundabout called Trafalgar Square. That's where it was. And the people who are in charge of traffic in London have very, very fine control over how much traffic enters Trafalgar Square to make sure that the traffic in Trafalgar Square always keeps on moving. You don't want gridlock in Trafalgar Square. And the way they control that is by basically backing up traffic on the Strand and letting it into Trafalgar Square very, very slowly. Because they're much happier with the Strand being a parking lot than with Trafalgar Square being a parking lot.

[B]

So it's like a remote control, like traffic hell, they have situated.

[A]

And Kathy, not realizing this, got the bright idea into her head that the best way to go down the Strand would be to sit in the cab.

[B]

No, I totally realized it. Here's what. And this is like, this harkens back to our discussion of auto driving cars and what will happen in the future. What happened was I knew how long it was gonna take me to get to the Guardian right from my hotel where I was doing a podcast. So I actually not only got coffee for the ride, but I organized a, like, interview on the phone at the same time. Like, it was basically my temporary office.

[A]

And how long did it take?

[B]

It took 45 minutes.

[A]

And you could walk it in less than that.

[B]

I could have walked faster, but I was like, then where would I have put my coffee? Like, it. Like, it is a lifestyle and it's. It's incredible. And, you know, obviously it shouldn't happen. I should have taken the tube, obviously. But I mean, my point being, like, why aren't they just, like, charging me so much for this that it's just not worth it?

[A]

How much was your cab ride?

[B]

I have no idea. It was paid for by my publisher.

[A]

But were you in a black cab? Yeah. So if you were in a black cab, that cab ride, I'm going to guess, would have been well over 50 bucks.

[B]

Wow.

[A]

And that's crazy. And they are charging you for this. And this is part of what we call congestion pricing. The taxis have always had congestion pricing. The longer it takes you to get from point A to point B, the more you pay in cab fare, and so the more traffic there is, the higher the cab fare goes up. The higher the cab fare goes up, the less demand for cabs there is. And so the more traffic, the more traffic there is, the more demand goes down. And that's exactly the pricing mechanism that is meant to work. And then what London did was it extended that pricing mechanism not just to cabs, which have always had it, but also to private cars in general. That if you wanted to drive, if you want to drive a private car in Central London on weekdays during business hours, you have to pay this congestion charge. And they implemented this a few years ago, and the amount of traffic congestion in London fell. And it also raised a bunch of cash, which was useful, which they could reinvest in buses. And so everyone was like, yeah, this is the great solution to all of our problems, congestion pricing. And then Mike Bloomberg tried to introduce it in New York City and failed because of Albany politics, but that's a whole other thing. And everyone sort of looked at Stockholm, which has it, and Singapore.

[B]

You're missing the fact that it's terrible traffic in London.

[A]

Okay, so then, so that was this. So rewind maybe three or four years ago and I wrote a big piece for Wired about congestion pricing and why it was such a great thing. And there's this guy in New York called Charlie Kovanoff who's wonderful, who will literally put massive, the biggest spreadsheet you've ever seen together, like proving how wonderful congestion pricing is. And then you go to London and you realize that on the face of it, it has utterly, utterly failed. And there are actually because part of congestion pricing involves doing something which people never used to do before, which would take very, very accurate measures of how much congestion there is in various bits of the city at various times. And you've done that in London and now right now there is more congestion than ever in London.

[C]

Wait, but why is that?

[A]

I'm so glad you asked. The answer is not okay. The answer which people thought before they actually looked at what was going on was that drivers became inured to the congestion church that what would happen is that congestion would go down because everyone would be like, I'm not paying six pounds to go into London. And then eventually, after paying six pounds a couple of times, people would realize that the sun rose the following morning and they would rather pay six pounds than not be able to drive. And so they'd start paying £6 and then congestion would go back up. And then the way to solve this problem would be to raise the charge to £10. I'm not paying £10 to go to London.

[B]

I can't get over how good a.

[C]

London person could do is an incredible impression.

[A]

But that's not actually what happened. In fact, if you look at the number of private cars in London, to a first approximation, it's zero. And all of the traffic is people getting deliveries to their office. It's buses, it's taxis, it's all of the commercial traffic which cities need. And then so that's half of it. And then the other half is NIMBYism.

[B]

Yeah, I saw that.

[A]

Which is fascinating because there are actually lots of streets in London. But what happens is there are streets which people live on and the people who live on those streets go, I don't want a lot of traffic on this street. And so they cut off one end of the street and so no cars drive down that street. It just becomes a sort of residential mews.

[B]

It is really nice to walk in London.

[A]

It's lovely to walk around. But most of the streets in London don't have any traffic on them at all because they don't go anywhere. And so because of all of this NIMBYism and people closing off their streets that they live on, there are very few streets that you can actually drive on to get you from A to B. And those streets also are the streets where the people are riding the bus lanes and the bike lanes. So the number of lanes for cars has gone down and there's just massive congestion.

[C]

So maybe, I mean, this is slightly off topic, but I think this every time I'm in New York where you have these, these giant delivery trucks blocking an Entire street for 30 minutes in the middle of the day or during the middle of rush hour or something like that. Is there any city that actually implements laws forbidding that?

[A]

Most European cities forbid that. This is a very simple law which is incredibly easy to implement where you just say that any truck over a certain weight cannot drive on city streets between the hours of 8am and 5pm so easy to do that. But.

[C]

So why don't we have that here?

[A]

But the, you know, that violates, you know, your inalienable American right to get your Amazon delivery same day.

[C]

Right? Okay. Yeah.

[B]

And it's not really the big things. I mean, like I was on a three lane road where like there was two FedEx trucks parked next to each other. Like, could one of you move to the front? You know, like that happens all the time in New York.

[C]

Right.

[B]

I think, you know what I think we should do in New York? I think we should charge 20 bucks for congestion and also close half the streets because it's actually a better city. London is great as long as you're willing to walk or bike.

[A]

So, and this is, and this is actually, I think the exact correct conclusion is that yes, congestion is bad in London. And if you want, if you're foolish enough to want to try and take a private car or a taxi from Trafalgar Square to Kings Cross, then God help you.

[B]

Yeah.

[A]

But the city actually works very well if you don't do that. And the vast majority of people in London don't do that. And it works fine for those people. And in New York, Andrew Cuomo, the governor has, has now announced that he wants to set up this new system which is basically the precursor to congestion pricing in New York City. And it will make things better, it will make things work worse for car drivers and it will make things better for everyone else. And I think that's okay.

[C]

I mean, I got really interested in the idea of what the economic impact of congestion was in the wake of Bridgegate, of course. And I don't know what it is in London or the UK in general, but here in the US it's that people lose about 38 hours a year sitting in traffic.

[A]

The average, it's higher than that for anyone who dares to drive in New York. The one thing which I. Which we have to mention here is this only works if there is an alternative to driving. You couldn't do this in most of the cities in the US because most of the cities, you can't do it in Miami because there's no public transport in Miami. So if you implement congestion pricing in Miami, all that happens is that the people who need to drive somewhere now can't afford to do that anymore.

[B]

There's an amazing essay, I think in the Atlantic I'll get a link about the traffic in Bangladesh.

[A]

Oh, in Dhaka, Yeah.

[B]

Oh, my God, it was epic.

[A]

Yeah. Bangladesh is just one big traffic jam.

[C]

There's also. I mean, that's also a big political discussion. I lived down in Seattle for a long time, and the traffic is terrible. And it's terrible crossing the big lake there, like Washington. And there's always this push and pull of like, you know, do we build five more lanes so that you can get traffic across? And then people say no, because then we'll have five more lanes worth of cars in the city. What we need is.

[A]

Yeah, the answer is never building more roads. No, but this has been proven empirically time and time again, which is that traffic expands to fill the number of lanes available. It's called induced demand. And if you build more roads, you do not reduce the amount of traffic. This has been tried over and over again, and it never, ever works.

[C]

Right, Exactly. And that's like, you know, the 38 hours a year sitting in traffic. That includes everybody all over. That includes, you know, folks in Kansas City and Alaska. So, yeah, I'm sure that in New York and other places. But if you actually look at the monetary cost of that through not only pollution, but fuel and loss of productivity and things like that, I mean, we're talking about, like, billions of dollars a year.

[A]

And it also helps explain why urban centers are becoming priced out of reach for most people. Because people will pay astonishing premiums to be able to live somewhere where they don't need to sit in traffic for an hour to get to work.

[C]

I'd do that. I'd pay any amount not to sit in traffic.

[A]

Okay, let's move on to the numbers round, because this is the best bit of the show I've got A number, what's your number?

[B]

6%. I had to jump in because I was like, someone else is gonna take my number.

[A]

My number was not 6%.

[B]

Okay, so did you know that the pound dropped 6% in overnight trading? Some kind of mini flash crash. Did you hear about this?

[A]

So this is a fascinating story. The pound is astonishingly weak. It's at a 31 year low. It's floating around 123, 124 right now, which is crazy. I remember when there were $2 to the pound, or normally that's around 160, 170. Now it's in the 120.

[B]

It went down to 118, it crashed.

[A]

Down to 118 for just what, like 30 seconds. It wasn't there for very long. It went down, it went back up. And there's this weird feeling in the markets that this is a bad thing and that like it's bad for the pound to be at 118 for 30 seconds and that if it just stayed at 123, 124 the whole time, that would be better. Can you explain why it's a bad thing for having these little mini.

[B]

I don't think it's. I actually am less worried about flash crushers than many people. What it means is my guess anyway and people's, people seem to be guessing that it's an algorithmic trade that was, it was an overnight Asian markets, which is thinly traded.

[A]

But yes, so it's just, it was not that thinly traded. There was actually quite a lot of.

[B]

Volume relative to other times.

[A]

And, and you know, algorithmic is basically the new way of saying, you know, a price change and we don't know why.

[B]

Well, it also, it probably is a bug in a, in somebody's code.

[A]

It might be a bug or it might be a feature. My is that the FX market is by far the biggest and most liquid market in the world. And there's a lot of derivatives. In fact most of the FX market is not done in what's known as spot fx, which is the number which you're quoting here. It's done in derivatives and futures. And some of these derivatives are extremely complex. And one of the more common types of derivatives, complex derivatives, are these things called knock in and knockouts where you, you know, where basically you make a lot of money or you lose a lot of money if a certain price goes below 120 ever. And so what happens is in the middle of the night, someone who'd written a knock in, you know, sees an opportunity to sell a bunch of pounds, get it below 120 for 30 seconds and then suddenly they're in the money on their knock.

[B]

And it was worth it. It cost them some money to do, but it was worth it for how much money they made.

[A]

Exactly.

[B]

Totally possible.

[C]

So on that note, actually, you know, the coding. My number is 8.7 billion and that is the number of Internet connected devices that are currently in operation right now.

[B]

And they're all in my house.

[C]

Exactly. And you know, I feel I have.

[A]

You know, a couple dozen. I can't believe that the ratio of Internet connected devices to people in the world is barely one to one.

[B]

My 14 year old has half a million and it won't be.

[C]

And in about four years it's supposed to be 21 billion.

[B]

Oh my God. Three times bigger, almost.

[C]

Yeah, exactly. And like a little glitch in code, you know, can lead to 6% drop in the pound sterling or it can lead to, you know, everyone's coffee machine, you know, beginning percolating at 2:00am I mean, who knows? It's this. We're in this.

[B]

That wouldn't be such a bad thing. That's like taco trucks in every corner.

[A]

Exactly. More coffee and more tacos. This is, this is an Internet connection.

[C]

The future future.

[A]

So my, my utopian vision of the Internet connected future is 25 billion, which is the anticipated value in dollars of Snapchat when it goes public, as it is going to do, which is something like 50 times its current.

[B]

Are you Snapchat?

[C]

I love Snapchat. So really, I love it. It's so much fun. It's like I was a late adopter because I'm not, not quite young enough to be snapping my friends. But the filters are like the best thing in the world. I've been watching the presidential debates with the filter on. So they can see the candidates with like, you know, as dogs, as mice.

[B]

Yeah.

[C]

Or as bunnies. And when they open their mouth, it like sprays carrots. It just makes the entire thing endurable.

[B]

That's actually a really good advertisement for.

[A]

As a Snapchat user. Hayley, you can tell us, how often do you see ads on that platform?

[C]

I don't think I've ever seen an ad yet.

[B]

So there's basically no revenue.

[A]

Well, they have revenue right now of a few hundred million dollars a year. And they are going, they claim that next year they're going to have a billion dollars of revenue, but this is still a crazy multiple of their revenue, let alone their profits. They don't have any profits.

[B]

Right? Right. Right. Wow.

[C]

Well, maybe I'm not like the target Snapchat user.

[A]

No, you're exactly the target Snapchat user because you're hard to reach and you're wealthy and you're wonderful, enthusiastic, and everyone wants to reach you.

[B]

And you wrote a great book.

[A]

And you wrote a great book. So listen, thank you to Hayley, thank you to Viralyn Williams, the producer, and to Steve Lichti and Andy Bowers, the executive producers. Find all of the Panoply podcasts on iTunes.com Panoply subscribe to us, Send us emails. Our email address is sleepmoneyleep.com and we will talk to you next week on sleepd Money.