Mr. Goldman’s Hat
Ksusha McCormick
June 2nd, 2022
One of the reasons that Decameron Technologies came into existence is that my co-founders and I saw an opportunity to democratize access to some very powerful tools, applying them to challenges faced by new entrants into the lending and investing markets. Consumer lending, solar finance, and other parts of the financial universe are growing rapidly. Fintech lenders specializing in these sectors are increasingly harnessing new technologies for origination and distribution, but often regard themselves as technology companies first and financial companies second. As financial conditions change rapidly, the solutions we provide have shifted from “nice-to-have for a rainy day” to “necessary for survival.”
Many of the challenges and opportunities created by new tech are truly brand new. But when it comes to the “fin” part of fintech, it can be instructive to look back to the good old days to see how participants in financial markets evolved and adapted in order to succeed. I was reminded of this recently while reorganizing the overflowing bookshelves in my New York apartment.
Prior to launching Decameron, I spent about 16 years on Wall Street, first as a trader and portfolio manager and then in wealth and asset management. For six of those years, I worked at Goldman Sachs, where, presumably like all new employees, I received a copy of Charles Ellis’ The Partnership. I confess I never read the book from start to finish, but during a recent re-org I stopped for a minute to look over the story of the earliest beginnings of the firm that became Goldman, Sachs & Co.
Fleeing a violent revolution in his native Germany, the young and enterprising Marcus Goldman immigrated to America, eventually settling in New York and in 1870 opening a business brokering the promissory notes of small commercial borrowers in what is now the city’s Financial District. Ellis writes: “Collecting the paper he purchased during the morning inside the interior band of his high silk hat, Goldman would take a horse-drawn cab up Broadway to the crossing of Chambers and John streets to visit the commercial banks where he hoped to resell the paper at a small profit.”
This is of course an amusing contrast to how commercial paper and other assets are traded on a present-day trading floor. But for lending markets that are new and reliant on disruptive technology, the trajectory of development of the financial part of the business in many ways mirrors the story of how Goldman Sachs got from there to here. In particular, it can be instructive to think about WHY Mr. Goldman’s business had to evolve in order to scale at various points along the way.
When I imagine myself for a moment in Mr. Goldman’s hat, as it were, full of paper that I’m hoping to resell to some commercial bankers, a few questions immediately spring to mind. For one, is today really the best day to sell? What if it’s better to take the paper into inventory and wait? For another, how confident am I that when I get to the corner of Chambers and John, I’ll be talking to the right buyer? Perhaps one of my promissory notes is from an outstanding merchant who is too small / too new / too something to get past the banker’s rigid screening process and won’t get the bid that it deserves. And finally, what is a fair price for the intermediation services that I’m providing? If there are many willing brokers out there, perhaps I should decrease my haircut to stay competitive, but if there’s no one out there, I should charge more for my troubles.
These are questions that ought to be posed by any intermediary that is looking to uncover a new, previously underserved market. Just as Mr. Goldman sought out the wholesale jewelers and leather merchants of downtown Manhattan, so is the new generation of lenders and investors of today seeking to reach borrowers who were previously considered too small, too young, too difficult to analyze or simply too risky to be matched up with a conservative financial institution. And while only a crystal ball can provide the correct answer to these questions 100% of the time, a financial model, properly designed, can create a framework that allows the practitioner to combine art with science to analyze the present in the context of the past and make predictions about the future.
As my co-founder John Tsai writes in his white paper on the best practices for building good models, “a financial model is a quantitative representation of the way various forces influence market prices … A model typically reflects both what is happening and quantifying the extent to which this diverges from what should happen given the model’s assumptions … When presented with model information on both price and risk, it is then up to the market practitioner to decide whether the model’s assumptions accurately reflect the prevailing paradigm.”
In other words, a good model is NOT a black box, but rather something that makes it easier to evaluate and change assumptions, to apply intuition and judgment, and, crucially, to determine whether the paradigm that governs market forces has shifted. Instead of making you forget about the unquantifiable factors, a good model should make it easier to weigh them based on your experience. It’s by no means a guarantee of success, but it is a way to reduce unforced errors, which can ultimately make the difference between business death and survival.
Like Marcus Goldman in 1870, many of today’s new lenders are connecting new participants to the financial ecosystem. Back then, the ultimate buyers of the assets were large and powerful, but not particularly sophisticated. These days, the matchup between a disruptive upstart and a large financial institution is no longer a fair fight. Meanwhile, rates are rising, inflation is climbing, credit spreads are widening, and previously secure distribution channels are becoming wobbly. In order to survive and continue to grow, having a quantitative framework for answering the questions that popped into Mr. Goldman’s head on that buggy ride will help the new generation weather the coming storm and many more.
Ellis, Charles D. The Partnership. New York: Penguin Group, 2009.
Tsai, John C. “General Principles of Decameron Technologies’ Model Construction.” Decameron Technologies, August 2021, www.decamerontech.com
"New York - Lower Manhattan (Postcard c.1914)" by roger4336 is licensed under CC BY-SA 2.0.
