How Wall Street tricks us into giving it money
Wall Street's business model is different than what most people assume
This article is based on an idea I’ve heard Ben Hunt mention on multiple occasions (most recently in this video). Namely, Wall Street earns more from facilitating transactions than it does from betting on directional moves. While we may think of Wall Street as being hedge funds, mutual funds and prop traders furiously punching orders into their terminals, that’s not an entirely accurate depiction. The largest firms generate their revenues with the picks and shovels business of collecting fees for their services.
While I don’t have the tools necessary to analyze the plumbing of Wall Street firms in intimate detail, the transaction model makes intuitive sense once you examine how the institutions behave.
Big banks take companies public and make lots o’ loot from the IPO, but they may not actually hold any shares of that company
In the options market a Wall Street firm seeks to match a buyer and a seller, the market maker doesn’t want to take a directional bet on the trade. If the firm is forced to take a side, they’ll hedge their position. This explains the financial lunacy we’ve seen with delta hedging
Banks love to securitize everything under the sun, but their idea of a good time is selling that security to a
dupesophisticated investor like AIG. The most obvious example being Wall Street packing up the subprime mortgages and dumping them all over like financial nuclear waste
How it affects us
To understand how we’re affected we must consider the incentive structure. Wall Street has a vested interest in getting people to transact. To a greater or lesser degree, the big firms don’t care all that much whether asset prices go up or down. Wall Street’s mission is to inculcate fear and greed such that investors never stop trading. Whatever the direction, always stay involved!
Once you understand that Wall Street has a vested interest in getting people to transact, a lot of the mainstream media makes more sense. Jim Kramer and all his buddies on the Cartoon Networks aren’t subsidized by Wall Street to ensure that people make smart long term decisions (obviously). Kramer’s ordained role as a financial priest is to elicit emotion. Oh shit, this thing is going to zero sell now! Lord take mercy it’s already up 100% and if I don’t buy I’m going to miss out. Buy, buy, buy!
Just because I’m writing this article doesn’t mean I’m immune to the pressure. While I don’t bed down in the crack house that is CNBC, I am a frequent visitor to the refined crack mansion that is FinTwit.
On at least several occasions (this year) FinTwit has influenced me to transact when I should have sat tight. I find it too easy to get sucked into a certain narrative and make a bad decision, when the best move would be to shut off my computer and take my dog for a walk.
The Tl;Dr on all of this is that without sounding too much like a worshipper of the deep state, there exists a system whose sole purpose is getting people to transact. Buy or sell, Wall Street doesn’t give a damn so long as you stay in the casino. Hopefully in becoming aware of this influence we can learn to make better decisions with our investments.
