The Liquidity Illusion

There are times throughout history when the absolute worst of times was caused by something so innocent and inconsequential that it was hardly a blip on anyone’s radar. Initially the US sub prime crisis of 2007, morphed into the great financial crisis of 2008. What started as a small crack quickly snowballed into an event that almost collapsed the modern world’s financial system.

The things that we see coming are things that can easily be dealt with, corrected, and adjusted to ensure a path forward. The things we cannot see, or better yet – choose to ignore, are usually the things that lead to the greatest danger.

Over the past 2 weeks there have been a couple of cracks develop – that on their own seem downright mundane, but coupled together and added on to a weakening economy could spell trouble. The cracks I am referring to are CDK Global and Synapse. I am willing to bet that 99.9% of people do not even know who these companies are, what they do, or why they matter, so let’s jump in.

Technology has promised us many things over the years. Fintech promised to build upon technology in the financial arena and make our lives better, fees cheaper, and the process more fun. We, as a society have put our trust into technology and fintech like no generation before us. We trust technology to help make our lives better, and most of the time it delivers, but when it goes wrong, the same efficiencies that technology saved us, hurt us by the same amount – and then some.

CDK Global was a fintech-ish type of platform that was widely used by car dealerships in the US. It allowed dealerships to sell, finance, track, order, and do everything they needed to do in their dealership. Small car lots to multi million dollar mega super car showrooms used this platform to run their business. 2 weeks ago, CDK Global was the victim of a cyber attack, and for security reasons, they shut the platform down. Imagine your entire dealership running on one platform, and then one day it is just gone. No way to submit an appt to a bank for financing, no way to order parts for the service department, no way to know your inventory without manually counting it, and no ability to ring through a customer paying cash. So, what happens when 15,000 car dealerships can’t buy, sell, or trade? Now, of course this will put a hit onto the GDP, payroll numbers, inflation numbers etc. that get released for June. The reason that is important is that you will most likely see a lot of volatility around those releases to yields, currency and the like. So far the first 2 days of July have seen some restoral to systems, but the system is still not up and running completely, so you may see some impact in the July numbers that get released in about 6 weeks time as well. Of course the bears will use the big drop in numbers to justify why things really are that bad, and the bulls will tell us it was a one time blip. Maybe it is a bit of both?

The bigger issue we have right now is Synapse. Synapse is what, in industry jargon is described as a banking-as-a-service platform. Basically this fintech company allows banks to integrate credits and debits in a tech based world. As any Canadian knows, banks aren’t exactly on the cutting edge of technology. They tend to be slow, cumbersome, and so far behind the times, that you can’t even see them in the rear view mirror. The problem with being so far behind, is that younger people are demanding tech heavy banking – enter Synapse. Synapse is basically a platform that allows a bank to roll out tech features without investing in tech. Say I was a bank ( I would be called RBC….Ryan’s Bank of Canada ). Now, I don’t have millions or billions to invest in cutting edge tech, but I want to have cutting edge tech, so I contract a company like Synapse to do the tech for me. Using their platform they allow me to have a fully integrated, tech based platform, an app in for Android or ios, and they provide all the back office technology to keep the debits and credit flowing. I pay this company pennies to manage the platform, and they simply push through the debits and credits every day through the financial systems plumbing. Viola, I know have a way to have a tech based platform without all the heavy investment in technology, and life is good.

Well, the problem with this little arrangement is that Synapse is a 3rd party. My entire bank, at least the part done through online and an App on the phone is now beholden to receiving correct, timely information from the 3rd party. This shouldn’t be a problem though, because we have a contract. Cool. But, the real problem hits when said 3rd party goes bankrupt like Synapse did a month ago. Of course they were working through the bankruptcy proceedings in Delaware, so it was okay – for a while. But the real problem kicked into high gear when Synapse shut off the platform that records all of the 3rd party information. In a few seconds there were over 100,000 Americans who no longer had access to their funds, no ability to take cash from a bank, no way to pay bills, no way to access their paycheck, etc. Now we have a problem. Technically the funds are still insured by the FDIC and the money is still there, but you just cannot access it. Well, I think we can all agree that having money is great, but it is useless if you cannot spend it. Unfortunately you can’t buy groceries, pay your rent, or even buy a cup of coffee with an IOU.

So, you now have 100,000 people with no access to their funds. What happened if their down payment and closing costs were in one of those accounts? What if they needed to pay their bills? What if they wanted to go out for dinner? Well, quite frankly – too bad. 100,000 people is a small drop compared to a population of 340 million, but what effect is there on the economy when 100,000 people don’t have money to spend? A BIG effect. While the FDIC, banking regulators, and a whole host of other important government divisions sort out the pieces of this shit show, and assign blame and point fingers, we need to ask ourselves other questions.

Our entire monetary system is based on one thing, and one thing only – TRUST. We trust that the value of our money can be redeemed at any time for the face value. We trust that the financial system will always have our money available when we request it. Things like the 2 examples above start to slowly knock that trust. As we saw in 2007 and 2008, when you lose trust in the financial system – shit goes bad quickly. How much trust has been lost in the financial system because of these 2 events? Probably not much, but it is starting to chip away at our faith. It starts to lead people asking questions like ” is my money safe”, “do I trust my bank”, “is technology the solution, or is it the problem”? When people cannot access their money, or trade their money to buy a car, we really have to ask ourselves if the system is working correctly, don’t we? Are people going to go out and make big ticket purchases like a home or a car ( well, they can’t buy a car if they even wanted to right now ) when they don’t trust their money is safe?

But no matter how you answer the questions above, the end result will be the same, and we start to lose liquidity in the system. Our financial system requires liquidity. Money must move freely from buyer to seller, bank to bank, consumer to business all the time in order for the system to stay afloat. In 2007 and 2008 we saw what happened when trust was lost, and liquidity dried up. Hell, banks didn’t even trust other banks during that little fun financial experiment!!! Now, if bankruptcy can happen to one banking-as-a-service platform, can it happen to the rest of them? Maybe, maybe not. But, whatever you believe the answer to that question is, there is currently dozens of providers of banking-as-a-service ( baas ) that handle over 3 billion dollars a day in transactions around the world. Customers banked using baas are hard to nail down, but estimates range from half a million to over 4 million, but the sector is growing by almost 40% a year – especially in regions of the world with a lot of underserved clientele. We could be potentially putting our world financial liquidity in the hands of some technology platforms that could be here today, and gone tomorrow, taking with them all of your transactions. The reason I post the very relatively small numbers of people using baas is that it has some great parallels to the sub prime crisis of 2007, where we were constantly told that sub prime was only 2% of the mortgages written, so it wasn’t a big deal ,and certainly nothing to worry about.

Getting back to our trust component of the system, it makes me wonder if changes may be coming. It is no secret that the economy is slowing. Lenders of money tend to cut back loaning money when the economy is slowing. But now there is another potential wrench in the system. As a lender, would you loan money to someone that deals with a baas bank, knowing that you may never be able to debit the borrowers account for the loan payment if the tech platform folds? Would a bank be more likely to restrict credit offerings to certain people based on where they bank? It is quite possible. This would further erode liquidity in the financial system. Will it happen? Maybe, maybe not, but it certainly isn’t outside the realm of possibilities.

Technology was supposed to make things better, and make our lives easier. For millions of people in the last couple of weeks this same tech that was supposed to make things better has somehow not allowed them to spend a dime from their bank account, or buy a car. It seems to me like a very basic function of the financial system isn’t functioning – at least in small circles. However, when you are already entering a slowing general economy, any further removal of any liquidity starts to have outsized effects. I hope I am wrong, and this is a nothingburger, but always be sure to keep your eye out for things like this.