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Money Goes Downmarket

In an era of information abundance, the road to financial ruin has become a superhighway.
September 1, 1999

Once upon a time, rich people often bought even small things on credit, lest they sully themselves handling filthy lucre. They employed professional investment advisers to manage their money, which might be deployed in stocks, bonds or real estate. Should the need for a loan arise, one’s personal banker arranged it. (Discreetly, of course.)

Nowadays that description might apply to the great bulk of middle-class Americans-except it’s inadequate. When I go shopping, I pay with plastic, obtaining instant credit from merchants anywhere in the world, even though they’ve never heard of me. As to investing, no robber baron or trust-fund scion ever had more choices. With a toll-free telephone call or a few mouse clicks, I can put my money in an infinite variety of stocks, bonds, mortgage-backed securities, real estate investment trusts, money market accounts, options and futures, to say nothing of professionally managed mutual funds. The assets held by these investment pools are scattered from New York to Nepal.

If I need a loan, I can write myself a check. If I want to buy a house, I can shop for a mortgage electronically. Rather than limiting myself to a single local bank (the one that knew my father and his father), I can scour the country for the lowest possible rates. Mortgages come in more flavors than gelato. Variable-rate loans, which require frequent recalculation, were made possible by the spread of cheap computing power. The same is true for money market funds. As to credit cards, modern telecommunications and information technology paved the way.

In a single generation, technology has remade the financial landscape. The net effect: a remarkable democratization of consumer finance and investing. As in other walks of life, technology is the leveler, giving the average person the ability to do what once required wealth, specialized flunkies and the greatest luxury of all-time.

“As much as anything, computer technology made the money revolution possible,” argues Joseph Nocera in his lively history of postwar consumer finance, A Piece of the Action: How the Middle Class Joined the Money Class. “Computers are the hidden spine of every modern financial device.”

But the marriage of technology and finance has proved to be, like most marriages, an affiliation with an uncomfortable side. The technology that has made it easy for me to buy anything, anywhere, anytime has created its own difficulties. For one thing, it’s made it easy for people to get into trouble, running faster and faster on the treadmill of getting and spending until they reach the point of financial exhaustion. The corollary is that bankruptcies have soared, and going bust has lost the stigma it had a couple of generations ago.

Then there’s the woman who stole my wife’s identity. She started by stealing her wallet. Despite my wife’s prompt notifications, the thief used the credit cards, passed a number of checks and adopted her victim’s name as an alias. For a long time thereafter,merchants required elaborate proof to accept my wife’s checks, and several years after the initial theft, she was rejected for phone service by a new provider because, the company said, she had a large outstanding balance. Generated, of course, by the crook.

This annoyance is more or less personal to us. But some dangers created by the technological revolution affect us all. Massive, cheap computing power has made possible a volume of securities trading heretofore unimaginable, while fostering a profusion of financial instruments so abstruse only savants understand
them. These “derivatives,” whose value derives from some underlying asset, often were created to control risk, but in the aggregate they add a huge, unknowable level of uncertainty to the financial markets. Edward Chancellor, in The technology buy anything, anywhere, created his recent Devil Take the Hindmost: A History
of Financial Speculation, notes that “by the end of 1996, the size of outstanding derivatives contracts was estimated at around $50 trillion, although since most of the derivatives trade was conducted away from the exchanges in the over-the-counter market, no one was sure of the figure.”

Equally troubling, the spread of Internet stock trading has made it possible for every Tom, Dick and Mary to become a day-trader. Using the Internet, investors can buy and sell shares for commissions in some cases 99 percent less than those charged in ye olde days of full-service brokers (in, say, 1992). At little effort or
expense, they can draw on company announcements, Securities and Exchange Commission filings, press reports, analyst recommendations and, of course, the opinions of other online aficionados.

What these wired do-it-yourselfers generally cannot do is beat the market. Researchers at the University of California, Davis, report that individual investors “pay a tremendous performance penalty for active trading.” In a study of 66,465 households with accounts at a large discount brokerage firm from 1991 to 1996, management professor Terrance Odean and finance professor Brad M. Barber found that the most frequent traders underperformed the market by a stunning 6.5 percentage points. “Our central message,” the professors wrote, “is that trading is hazardous to your wealth.”

One reason may be the propensity of investors to sell the wrong stock. In a study of 10,000 brokerage accounts, Odean writes, “I find the surprising result that, on average, the stocks they purchase actually underperform those they sell. This is the case even when trading is not apparently motivated by liquidity demands, taxloss selling, portfolio rebalancing, or a move to lower-risk securities.” This Wrong-Way Corrigan approach to trading persists despite-or perhaps because of-the growing volume of that makes it easy to anywhere, anytime has created its own difficulties. information available to private investors. Novices report being paralyzed by the vast array of mutual funds from which to choose, equaled only, it seems, by the vast array of publishers and others who provide information about mutual funds. Consider the change this represents. Not long ago, the trick was simply getting information in the first place, but the age of information scarcity is long gone. Gaining information is already easier than figuring out which information to pay attention to, and the future promises such unprecedented informational abundance that we’ll practically have to work just in order to avoid it. What will matter, in other words, is the quality of your filters.

Which brings us back to two dimensions of life in the previous era: expertise and personal service. Wealthy investors, for example, may hire personal data-editors or researchers, instead of bankers and brokers. Or they may hire well-educated assistants, the way people do in Hollywood, to administer their finances (if not their lives) using information technology. If knowledge is power, why not pay somebody to harness that power for you? (Of course, “agents,” the perennially heralded smart software that will go out on the Internet and find us just the right pair of shoes based on our lifestyle and color preferences, may usurp this function, or provide it to those who can’t afford an actual human being.)

The final scary aspect of the financial brave new world is the disappearance of money itself-at least in tangible form. Digital cash is right around the corner, potentially replacing the coin of the realm with “money” that exists only on “smart” cards, hard drives and other electronic media. Many of the implementations
of digital cash now being discussed lack one of cash’s primary characteristics-anonymity.Greenbacks let you buy anything without anyone knowing who you are, but most forms of digital cash would carry an indication of provenance, in some cases acting more like checks than dollar bills. Coupled with the extraordinary amount direct marketers seem to know about us, this potentially revolutionary change gives some of us the digital willies.

Only time will tell whether the main leveling effect of technology on money will be to make us all equally its slaves.

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