Startups & Venture · August 2026
McKenzie and Alex Elliott spend the episode on the plumbing between banks and brokers: who extends credit to whom, and what happens when a counterparty vanishes overnight. He arrives at the retail version almost in passing, as an aside about how far credit reaches down. The turns on either side are about prime brokers and the 2008 collapses, which is the scale at which this point is usually made.
Transcript
I like the example of how much business do we do with Fidelity, because something that might not be in people's muddle here is regardless of how trusted an institution is, there is maybe one institution that is exempt here, which is the United States federal government, because they can print dollars at will. But for everybody else, there is some level of business that you're willing to do with them and no higher. Because if they have the worst day possible and their firm goes down, we can't go down with them. It's extremely complicated at the level of globally significant financial institutions. Just to pick two names, not to pick on two firms. But it would take an extensive science project involving thousands of people probably the better part of a few years to completely figure out how many ways that Bank of America and Chase are tied at the hip. But there has to be an answer in some places. And there has to be an answer for, okay, if you are a credit card processor, how much business do you do with Visa every day? And that's a weird one. But you can imagine vice versa, Visa. Okay, there are many people on the Visa network and each of them have some limit that we are comfortable being exposed to, even though I'm hand-waving away a lot of compliance. I can
use a real example. So I worked at a prime broker and that comes in. So one of the functions of a prime broker is you might have a lot of small customers or customers at different, they could be large customers, but they just don't do a lot of flow, particularly, let's say, like crypto. So what you do as a prime broker is you go to an exchange and you say, hey, exchange, I'm going to have a session that's tied to me as the prime broker. And then I will be acting as a middleman for a lot of other customers that will flow through me. So A, I get the volume discount of coming of all these customers. I can give them a discount on basically going directly to the exchange. And, you know, you might be dealing with very small, unsophisticated market participants that are just a couple guys in a conference room somewhere in Florida, let's say, and they're like a little day trading shop. Or you might be dealing with different parts of a giant bank or corporation, but there's a US entity and a European entity, et cetera. And so it can be tricky to sometimes figure out, A, how much volume, to your point, even who to call. Like, do we call the Euro guy? Do we call the U.S. guy? Like, these are all real questions that pop up, particularly if there's an outage and you're like things are breaking and you need to call somebody. That person might not be at the firm anymore. So yeah, it's, yeah, it's, it's, it, to your point, you just assume it's all accounting, but then you realize there's a lot of fuzziness and you have to get to the right person and get them on the phone and they have to know how to handle it, et cetera.
And one of the functions of prime brokers is extending credit to people. Lots of trades happen on credit for a variety of reasons. One magnifies returns. Another reason is that basically like credit functions in many places as sort of like lubricant in the economy, where if we were doing everything cash and curry, if there was no credit extended between firms, there just simply isn't enough money to be at the various places. And that would generally have the effect of like raising the cost of capital to various firms, slow things down generally, et cetera, et cetera. It is broadly underappreciated by people. But even if you look at your like retail checking account statement, the number that you believe is your balance is like not necessarily your balance. That is the rollup of a number of credit decisions that your bank has made on your behalf. And there are other people that are making credit decisions vis-a-vis your bank, et cetera, et cetera. And so your quote-unquote settled balance is like a probabilistic statement about what we believe about millions of transactions at this exact moment in time. Be that as it may. At some point, like somebody at a prime broker has to say, you know, a couple of years ago when we got into this relationship, we were happy to have them. And for every day since, we've been happy to have them. And I'm not sure I'm happy to have them tomorrow. Or like previously, you know, we had extended this particular client a credit line of up to make up a number of $3 billion. And maybe they're still good for $2 billion of that, but I don't really want to lose the last billion. Maybe we have to have a communication with them. I'm like, okay, well, if you own $3 billion of assets, maybe own less very quickly. Or there's often an ORL. Involved in those. Do you want to talk just very briefly on what is the or else?
Yeah, it's well, sometimes there's just giant events. So, for example, in 2008, like Lehman just disappeared one day, or Bear Stearns just disappeared one day. And you had all of these interactions, like you were mentioning before about being tied to the hip. You don't even know who to call. Like, you call the number and no one answers, right? They've shut the office down, and now you have these giant positions you have to deal with. I'm not as familiar with some of the like the lending, like the pure prime brokerage around, okay, this person is like now we don't think of them as a good customer, but there are definitely amounts of order flow that you'll take from certain people. Sometimes it's not a credit, it can be also this is very smart flow or very dumb flow. We're like, we don't want to take the smart flow. We'd rather take what's the dumb flow. Some people might say sharp and not sharp. So it is definitely a thing that relationships can get cut off quickly and they can get cut off for different reasons, et cetera. So yeah, definitely a thing there.
The classic example on flow is payment for order flow where retail orders, people transacting their accounts at Schwab or Robinhood, are almost definitionally not hedge funds. And so it is extremely unlikely that they have material market moving information. And so they're transacting because my daughter is going off to college or this is the day that my 401k gets the transfer from work and then I immediately buy or et cetera, et cetera. And so if you knew you were just dealing with noise traders, with people who didn't have a point of view on the true value of a security or who had no better point of view on it than the market does, you would be able to quote them very generous prices. And to the extent like your non-informed flow is mixed in with people who are quite informed flow, well, you have to be a little careful about what prices you quote them. And then if it is Goldman Sachs online too, you should be very careful about what prices you give to Goldman because as one great line of dialogue from the Big Short movie, this is Goldman Sachs. If you offer us money, we're going to take it. And it's to pull it against their interest there, but broadly, a good rule. Yeah, there are layers upon layers of this. I feel like we could discuss war stories for a very long time, but one thing I want to just emphasize for people is this is intellectually interesting and keeping the world running. And there are fun challenges every day. And I'm glad that you came on to share some of those fun challenges. So where can people follow me on the internet if they want to read about stories in the future?
Sure. So I'm very active on Twitter. My user account is AlexPotato. I have a whole bunch of threads about all kinds of different topics. There's a large portion of that is about finance or technology. If folks are interested in what it's like being technologists in finance, there's a couple there. My website is alexpotato.com. Also have some book recommendations and my own podcast is there as well. So yeah, this was great.