Weekly Briefing No. 86 | Banks vs. NYC Subways, Tech-Fueled Disinflation, Neural Networks Gone Rogue

As this week was National Pollinator Week, we urge you to be kind to any bees that cross your path, and please take note of the latest financial innovation buzz:

  • Banks vs. New York’s subway system
  • A Fed governor awakens to the new tech reality; Facebook’s AI went rogue
  • Ethereum’s flash crash; Local currencies sprout
  • Strategic investments in insurtech and biometrics are booming
  • Comings and Goings: Mercari, ITG and CleanCapital add talent
  • Company of Note: Extraordinary Re

IN DEPTH

“F” is also for fiasco.

A ride on New York’s F subway line can take you from Jamaica Estates in Queens through Manhattan to Coney Island. But how long that ride will take is anyone’s guess, as monthly subway delays have risen from 28,000 to 70,000 in five years. The reasons for the breakdown: NYC’s subway relies on signals installed in the 1920s; budgeting is highly politicized; committees run strategy; and the MTA maintains a 24/7 operating schedule, which promotes a major path dependency challenge. A new subway system is desperately needed, but sadly, major change seems like a pipedream (What do tourists from Copenhagen think when they visit New York?).

Bank tech innovation seems similarly challenged, as Chris Skinner points out in a recent post summing up comments by Capco’s Jeff Tijssen (See link below). But in actuality, there are banks, large and small, that are making steady progress in shedding their old rails. Goldman, unsurprisingly, leads the pack with its Marcus division now growing robustly and its CEO harnessing Twitter’s power like no other banking chief. But it’s not just the big firms. WSFS, a 185 year-old Delaware bank, found itself as the subject of fintech gazers thanks to its partnership with SoFi (post its acquisition of Zenbanx) and Boston’s Radius Bank seems well on its way to reinventing itself as a digital bank with all the bells and whistles you’d expect. So if you find yourself in New York this summer, it’s OK to roll your eyes when trying to get around town underground. But when it comes to the banks, don’t lose all hope for rapid movement. Real change is really hard, but it is possible.

The Fed should cut a deal with WeWork.

We continue to be puzzled by the puzzlement of central bankers over the absence of inflationary pressures in the economy. It’s as though none of them have heard about companies creating solutions that replace humans and/or reduce their leverage to demand a raise. We’re not experts on the Phillips Curve, but a central banker just has to walk around a co-working space to see how the economy’s headline numbers don’t tell the full story about the evolving nature of work. Fortunately, on the back of Amazon’s purchase of Whole Foods, the Chicago Fed’s Charles Evans is beginning to question economic principles that look increasingly antiquated. Our advice to Evans: stick a handful of economists in one of the five WeWorks close to the Chicago Fed’s office on S LaSalle Street. And while they chat with an increasingly diverse set of professionals of all ages, they also should observe that money continues to pour into dividend-paying stocks because investors see little threat of inflation coming.

Neural networks gone rogue.

Imagine the trading activities of the nation’s largest banks one day being driven by AI programs. That scenario could lead to healthier institutions. Or it could produce outcomes scarier than those of the financial crisis’ darkest days. Back then, at least, regulators were able to act to stabilize the financial system once it became apparent that several bank CEOs had little understanding of their exposures. But in the case of trading operations governed by artificial neural networks ten years from now, it’s possible nobody would understand what the bots were doing. For those who think we’re being paranoid, consider what just happened at Facebook’s AI lab, FAIR. As described by the FAIR team, chatbots began deviating from their script and developed their own language ─ without human input. That’s certainly cause for concern, because if we don’t really understand AI approaches, how could anyone be confident that during a meltdown, humans could stem a crisis?

IN BRIEF

The Ethereum flash crash is worse than a fat finger. 

Last month, we discussed the potential for a bad actor to benefit by manufacturing a cryptocurrency crash that could force position liquidations and enable absurdly low buy orders to get filled. So when Ether dropped by over 99% on Wednesday afternoon, we immediately wondered who stood to benefit. Soon after, GDAX (formerly known as Coinbase Exchange) solved the mystery by explaining in a blog post that a big sell order triggered the chaos. Nevertheless, the bad guys were given a great look into Ether’s fragility. And with Ethereum’s importance in the ICO/blockchain universe on the rise, it’s troubling to see that an exchange couldn’t do more (i.e., halt trading) to ensure orderly market behavior.

Wörgl revisited.

The year was 1933, and despite the success of a local currency in the hamlet of Wörgl, Austria’s central bank freaked out and kiboshed any more attempts by other villages to follow suit. In doing so, it squelched the fascinating ideas developed by economist Silvio Gesell, as well as the “Miracle of Wörgl.” 84 years later, digitized versions of the Wörgl miracle are regaining momentum. In the US, Cinch is promoting community solidarity through an app that enables neighborhood merchants to offer discounts to locals. In the UK, meanwhile, blockchain company Colu recently announced that it has established an East London currency named the “Local Pound, East London” (catchy) to enable its residents to support community businesses. Hopefully, Gesell is looking down and smiling.

Strategic investments in insurtechs keep coming. 

Recently, UK life insurance start-up Gryphon raised a whopping £180m from investors including Leadenhall Capital, an insurance asset manager. In the subsequent week, news hit that Reinsurance Group of America (RGA) has participated in a recent funding round for life insurtech start-up Getsurance. Also, American Express disclosed that its venture arm had participated in a recent financing for Next Insurance, which is offering policies for small businesses such as contractors and personal trainers. So while overall start-up insurtech investment may have moderated a little, strategic investors are remaining aggressive.

Biometrics are booming.

This week, Accenture and Microsoft announced a partnership to develop a biometric ID prototype that could help the 1+ billion people who don’t have documented proof of their existence. On the same day, BBVA and Das-Nano announced the formation of Veridas, a company that will pursue biometric solutions for client identification and authentication systems. The next day, AimBrain announced it has closed on a Series A financing for its “three-dimensional identification approach” to fighting fraud. Could the biometric heat map of this sector be any redder?

COMINGS AND GOINGS: Mercari, ITG and CleanCapital.

Japan’s Mercari stepped up its bid to take on eBay in the US by hiring John Lagerling of Facebook to serve as its chief business officer. Also this week, Mitul Raul left his post as head of JP Morgan’s cross-asset global analytics platform for ITG, a provider of trading algorithms. Finally, Bradley Pattelli, Lending Club’s former CIO, has joined the board of CleanCapital in conjunction with its recent capital raise.  

COMPANY OF NOTE: Extraordinary Re.

As anyone who has ever tried to develop an asset class from scratch will tell you, it’s tough to build a new two-sided market. But with investors of all stripes on the hunt for fresh investments with attractive risk/reward characteristics, we’re always intrigued by such attempts. That’s why The FR’s Gregg Schoenberg connected with Will Dove, chairman and CEO of Extraordinary Re. The “reinsurtech” start-up is building a trading platform to connect buyers and sellers in the arcane market for insurance-linked securities (ILS). Dove and his highly experienced team are specifically targeting emerging reinsurance liabilities such as cyber-risk exposure as there is insufficient actuarial and historical data to enable risks to be packaged into securities (like catastrophe bonds). With several of the world’s largest insurers and reinsurers currently testing the company’s patented technology in trading simulations, Extraordinary Re intends to go live next year. “We are attacking a market with in excess of $20 trillion worth of notional value,” said Dove. “Given that size and the huge demand for uncorrelated assets, we are confident that buyers and sellers will look to engage on our platform.”

Quote of the Week

"Kid, haven't you heard of Friendster? Move on. It's over!"

~ Bessemer’s Jeremy Levine (LinkedIn, Shopify and Yelp) to Facebook co-founder Eduardo Saverin in 2004