Full Transcript: Marc Rubinstein on Private Credit, Banks, and Fintech
The Net Interest Newsletter Author on Risk in the Financial System
Matt: You’re watching Excess Returns, the channel that makes complex investing ideas simple enough to actually use, where 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 compliment. 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 as interesting as he does. Creator and author of the Net Interest newsletter on Substack, Marc Rubinstein. Welcome to Excess Returns.
Marc: Thanks, Matt. Great to join you.
Matt: 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 this for a while. What do you think the Fed’s seeing? Why are they saying it? What are they missing?
Marc: 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 are institutions, then who cares, right? They are big enough to read the small print. They are big enough to withstand redemption gates. 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, 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.
Matt: So you did go quite deep on Blue Owl. Let’s spend some time just talking about the firm. Let’s talk about the gates. Let’s talk about the request for forty percent liquidity, putting up the five, 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.
Marc: 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 the early nineteen nineties. Blue Owl’s a lot newer than that. It came to the market in the form of a SPAC merger back in twenty twenty-one. It was slammed together with a GP stakes company called Dyal, which -- I mean, we won’t go into it now, but it takes stakes in other alternative asset management companies. It’s kind of like a 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 via a SPAC transaction. So they’ve been publicly traded since twenty twenty-one.
Blue Owl runs a number of private credit vehicles. It runs some business development companies, BDCs, that are not traded, and it runs some that are publicly traded BDCs. The underlying fundamentals of those two types of structure aren’t that dissimilar, except for one important difference, which is that the 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 there, 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 at net asset value. And so Blue Owl’s got a kind of problem. It’s got some vehicles out there which trade at a discount, some which trade at net asset value. It saw a big surge in redemption requests for its privately traded business development company, a company called Blue Owl Capital Corp. Two. They don’t have the most interesting names, these BDCs. Blue Owl Capital Corp. Two saw a huge surge in redemptions beyond its promise to meet five percent of those redemptions. And so what it did back in February of this year was it agreed to fund a thirty percent 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.
Opportunistically, another fund run by Boaz Weinstein, Saba, 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 with Blue Owl, and it’s become almost a poster child for the problems faced by private credit today.
Matt: Take us back because I’m interested -- you’ve been covering financials since we established this in our Intentional Investor conversation, the nineties? Yeah. Is that when? So you’ve been following and tracking financials, broad brushstroke, 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.
Marc: 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, a 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 regulated banking sector.
And private credit is one of those. But it 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’s businesses for any of the major Wall Street firms. In fact, if you slapped 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 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 two thousand and eight, two thousand and nine. 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 credit. And so private credit grew. It grew because of -- it grew in addition because at the same time as everything I’ve 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 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 credit 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 credit surged. These days, people talk about it in its purest sense, maybe one point six trillion dollars of assets, but more broadly defined over two, even three trillion dollars of assets, a lot of which has grown since two thousand and eight.
Matt: 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, as competitors, collaborators? How do we think about the tracks that these each run on?
Marc: Yeah. I mean, look, the word often used is frenemies. They are both competitors and collaborators. Private credit, private equity too, but private credit couldn’t really exist independently of the regulated banking sector. Private credit relies on additional leverage, increasingly so, provided by the banks. 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 a 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 J.P. Morgan, for example, issues private credit directly off its own balance sheet, but they also lend to private credit companies. J.P. Morgan itself has spoken about a hundred and sixty billion dollars 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 over the past ten years, kind of sixteen percent per annum over the past ten 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, the 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 -- 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 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. 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 everywhere you’re not monitoring. And often credit can be made more opaque, often intentionally, through these kinds of layer cake structures.
Matt: Apart from just the traditional finance industry, we also have insurance on the margin here too. And you’ve been pointing this out. So 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?
Marc: 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 four hundred 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 MFS 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 eighty percent loan-to-value, which actually wasn’t high enough. In most cases of back leverage -- bank lending to private credit vehicles -- they’re doing it at maybe seventy-five percent of its first lien, sixty, sixty-five percent 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 MFS and had a very large exposure to that one credit and ultimately that one risk. So there was concentration risk there as well. So that’s just -- sorry, going back to the prior question.
Matt: Well, this is so important because -- and I’m glad you brought this in there, ‘cause I was gonna 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 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.
Marc: 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 large insurance companies. Life insurance companies specifically, which had long-term liabilities that are 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 -- 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, a company called Athene. 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 -- and you kind of alluded to this -- 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 US, 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 a number of latent risks have emerged, 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 has flagged this up. But increasingly it’s not clear -- and you can’t have a run on an insurance company, which is the defense that’s often put up by the private credit providers.
After Silicon Valley Bank suffered a run in twenty twenty-three, 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 the origination side of the business and the distribution side of the business that is conducted through the insurance vehicle. 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 policy holder, 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. 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.
Matt: 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 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 quickly it’s evolved in the last even just few years versus what it was in, say, two thousand and fifteen?
Marc: No, that’s exactly right. So we’ve seen an acceleration in the rate of growth. Growth from two thousand and nine to maybe twenty twenty was contained. A lot of that was due to low interest rates. We’ve had higher interest rates since twenty twenty-two. We actually -- I talked about Silicon Valley Bank. I think had you known in twenty twenty that rates would still be where they are currently, and increased at the speed that they did back in twenty twenty-two, 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 we’re still working through.
But we’ve had mitigating factors -- economic growth. We haven’t seen a credit cycle. We can come on and talk about some of the US banks’ first quarter results and what they reflect of the credit cycle, but we haven’t seen a credit cycle. We’re going on now fifteen, sixteen years since -- the 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 sixteen 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.
And it’s being mitigated. It was mitigated first by low interest rates, then by liquidity that hit the market in 2020. And now by a kind of an AI boom, various other factors as well. But yeah, it’s building up. Lloyd Blankfein, who navigated Goldman Sachs 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, when Michael Corleone -- it’s 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.
Matt: Kind of fascinating that he goes with the going to the mattresses thing and completely -- yeah -- avoids the forest fire Nassim Taleb thing. Yes. The stuff they’ve learned not to say. Right. Yes. Good point.
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 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 good and what’s working and what’s the non-event. What’s your read? We’re recording this May of twenty twenty-six, 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?
Marc: 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, below anything they’ve been surveying since the seventy-five years they’ve been doing it. Below global financial crisis, which we’ve spoken about, below all of the shocks of the nineteen eighties, below even the Covid period.
It’s unclear why that is. In the UK we talk about a cost of living crisis that’s been going on since twenty twenty-one. 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. 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 PNC -- used to work for Jamie Dimon -- he’s a great one to quote. He’s, you know, if you’re looking for people in the industry with their finger on the pulse, kind of worth just listening to everything they say. Marc Rowan at Apollo is one. Jamie Dimon is one because everyone else listens to him. But Bill Demchak 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 you’re 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 four point five trillion dollars a year through wire transfers, credit cards, debit cards, all of their other payments mechanisms. They see everything. And they’re seeing spending up five percent 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. So 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.
Matt: 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.
Marc: That’s a good question. When they say, “I don’t know,” that’s always worth listening to because they’re trained not to say, “I don’t know.” And Jamie Dimon’s very good at that. The flip side, though, is -- you know, I remember when a bunch of them were hauled up in front of the banking committee on the Hill in DC in two thousand and eight, two thousand and nine, and they were addressed as being, you know, 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 have been usurped 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 know, you pull down -- when the newspapers are no longer talking about Silicon Valley Bank. In kind of the summer of twenty twenty-three, it was old news, and then the Fed and the FDIC, they put 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 counsel. They tell you what’s going on below the hood, and they scare the shit out of me because what they show you is that what you thought you knew at the time, you knew nothing.
What was going on under the hood at Silicon Valley Bank at the end of ‘22 and going into January and February of ‘23, when the stock was trading at a premium to its tangible book value, when 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 system’s play on the innovation economy -- they were subject to a number of reviews. There’s a funny thing, and actually this is quite interesting because I don’t know how well-known this is. The concept of insider information is very well understood in financial markets, and the SEC polices it very strictly. But it 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, it’s 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 twenty twenty-three. They were subject to a number of reviews. Nobody knew about it -- not least the analysts who were rating it 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 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.
Matt: Let’s switch lanes for a minute. I wanna talk about this idea and what you wrote about Revolut. Did I say it right? Yeah. Is that the way you’d properly pronounce this? So this quest to build the world’s first truly global bank, which I think is both a fascinating concept and fascinating to hear somebody like you unpack, and maybe start us off here. Take me back to when the Visa executive told the angel investor not to back them.
Marc: Yeah, it’s a good story, right?
Matt: Start there.
Marc: Yeah. No, it’s a great story. 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 a 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 Revolut, 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 on foreign exchange fees the way Amex and all the traditional credit card companies were at the time, and 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. But he said -- and it’s quite an interesting story, this, ‘cause it kind of reflects the prevalence of gut over analytics in finance. He said that as part of his due diligence, he called a contact of his, a very, very senior executive at Visa in Europe, to ask him what he thought, and the Visa executive was highly dismissive. “It won’t work. It’s kind of a small segment of the overall credit card landscape. Banks or credit card issuers, they can 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. There are some angel investments which come close. Paul Graham of Y Combinator has made many -- Stripe, and OpenAI and various others -- but this has to be up there. And so -- and I say the company is now worth... This is Revolut. 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’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 gonna be 2027. They’ve talked about maybe 2028. 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, 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 wanna 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.
Matt: It’s just so interesting to me -- 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.
Marc: Everyone in Ireland knows it. 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 two, and Revolut moved into that to provide an alternative provider of financial services to Irish consumers. Okay. But you’re right. Absolutely right. Your core point is absolutely right.
Matt: Another place I want to take you to while we still have some time left -- and actually, I should say as well, this is also
Marc: interesting. You know, we talked about growth and one of my kind of axioms of financial analysis is that growth is bad in finance. Either because on the asset side you are giving away credit too cheaply, or -- and this was the case with Silicon Valley Bank -- because even if you’re growing on the liability side, you’ve 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 fell victim to that as well. 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, it 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. It took a long, long time. And Revolut had to rebalance between growth at all costs -- you know, kind of move fast and break things, the tech mindset -- to 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. It took time to adjust.
Matt: So another place I want to take you to -- the golden age of arbitrage. This idea -- and I know we’ve 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.
Marc: Yeah. So I picked it up off an FT op-ed piece where the author was talking about commodities principally, and that in an 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. Historically, financial markets were created to -- and created a lot of profit for those that were able to exploit differences between the 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. Reuters originally distributed news through carrier pigeons. Historically, the advantage of being able to convey information quickly through carrier pigeons, through the telegraph, 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 historically. That’s always been the case. And the old panel was talking about oil very specifically being, in the context of the closure of the Strait of Hormuz, very different rates for a barrel of oil globally at the moment.
And it occurred 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 at net asset value, but on another screen you can buy a publicly traded business development company for a twenty percent discount to net asset value. So why wouldn’t you redeem the private asset and buy the public asset to lock in, all else being equal, that twenty percent gap? And as private expands, 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 over history as well -- is that one of the things about investment banks in 2008 is they kind of almost outgrew their footprint. 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 arguably you’ve seen some of that at Jane Street, that Jane Street employees have outgrown the market that pure arbitrage can sustain, in order to meet -- ‘cause the thing about finance is, people -- this was certainly true in investment banks. Your number every year, your bonus every year was a function of two things. Your expectation was a function of what everyone else in the industry was getting paid, but also what you were paid last year. And there was this expectation that there would be an 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’ve 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 -- talks about in his book, he talks about J. Aron, which is the gold arbitrage company he used to work for that was bought by Goldman Sachs. And he talks about how the founder of J. Aron 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 case, it’s now over years because they’re actually making venture capital investments alongside the traditional arbitrage activities that they did.
Matt: 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.
Marc: Yep.
Matt: 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 most misunderstood part of the finance sector today?
Marc: So I think broadly it’s fine. I think there’s a playbook. I think people are still obsessed by the ‘08, ‘09 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 getting there. It was a long time ago. And I would hazard that the majority, more than fifty percent of people -- I would be fairly confident more than fifty percent 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’s 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 -- the marginal buyers of government bonds today are 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.
Matt: One more. Dust off the old fund manager hat and think this way. If you were still 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 two thousand and twenty-six? 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. What would a long-short manager think about the finance sector right now, where they’d want exposure, where they’d be like, “I am betting on the other direction or not even involved”?
Marc: Look, the market overall is confusing, right? 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, you know, a tide of bad news. This is all quite well-rehearsed, but against a tide of bad news, the market just powers ahead, and many explain it away through market structure, the role of passive, for example, more retail investors. Obviously AI has a huge influence on market internals right now, and on allocations, so it’s just really confusing.
Against that, financials become kind of quite simple. So against that backdrop, financials -- they’re never a safe haven because that playbook is still there to be pulled down. But -- and Europe in particular, I would say -- you know, Europe, we’ve seen this huge divergence between US and Europe over many years. Like a lot of trends, so many trends have accelerated over the past few years. We spoke about this in the context of private credit growth, but just, the AI trade, US versus Europe -- 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. DeepMind is a UK company listed in the US, inside of Google Alphabet. We talked about Jane Street -- one of its largest competitors flies under the radar, a company called XTX, which is London-based. Revolut is another. Arm is another -- could be one of the biggest beneficiaries of a change. It’s 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-short Europe versus the US and financials versus the market.
Matt: Marc, 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?
Marc: I write a weekly Substack called Net Interest. Best place to find me -- and you can communicate directly with me -- is through that. netinterest.co
Matt: Make sure you check it out even if you’re not directly investing in financial names or you feel removed from the space, where you’re like you don’t have to be as concerned with it. Marc is the source of information for how the plumbing in this works and how to think about both public and private securities in this 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 Excess Returns, Marc.
Marc: No, thanks Matt, really appreciate it.
Matt: Like, comment, subscribe, all the things below, and we are out.