Category: Risk

Welcome back to our ongoing risk series … err, what’s the opposite of masterclass? Yeah that thing. Today, we’re tackling credit risk, which frankly goes both ways just like a poorly tuned metronome:

  • The risk an individual bank sees
  • The risk that you’re controlling

Spoiler: The bank’s risk is minimal compared to yours.

Bank’s Perspective: You Look Like a Baddie, and not a Good Baddie

Normal people use their credit card for a few hundred dollars worth of groceries, Netflix, the local coffee spot, a restaurant or two, with wild out of the ordinary purchases once or twice a year that exceed $1,500, like say a new couch.

A manufactured spender, on the other hand, might spend $5,599.99 one minute, $1,999.99 at a store repeatedly over the next 10 minutes, and then $2,047.60 five minutes later, all using the same card. Sure, you can train a bank’s algorithm to think that’s normal, but the second a fraud analyst looks at your transactions, the jig is up. When an analyst looks at a manufactured spender’s account, scary sounding terms like bust-out (it looks like it), money laundering (it’s not), identity theft (it’s not), fraud (it’s not), and spending problem (guilty) start appearing in their mind.

The bank is going to take that and go one of two ways:

  • Financial review: Pause your credit accounts, require your tax returns, and then ask you to justify how you can spend $90,000 daily on a W-2 job that definitely doesn’t pay that daily, or even monthly
  • Shutdown: They just close all your accounts, blacklist your social security number (unless they don’t), and accidentally mail you a check for -$0.33 to cover your confiscated points balance

So, how do you manage credit risk as seen from the bank’s perspective?

  • Train the automated algorithms so they don’t fraud alert while you’re buying $1,015.90 in bananas
  • Don’t do things that cause an analyst to look at your account
  • Have enough funds at the institution to give them confidence that you’ll be able to pay your credit card bill
  • Minimize cycling, where possible
  • Diversify your spend, don’t put it all on that Credit One Vegas Golden Knights card

It also helps to know which banks are more tolerant; like most things there’s a spectrum.

The Credit Risk You See

The way in which some manufactured spenders string together FinTechs, quasi-banking institutions, and rewards cards is magical at best and demonic at worst. It’s great when everything is working though! Let’s take a sample fictitious loop:

  • Credit card → Neobank → Futures market → Bill Payment → PayPal (heaven forbid) → FinTech → Hub bank account → Credit card

You probably earn something at most of those steps along the way. Cool, eh?

Now, what if you’re floating $450,000 spend spread across a dozen credit cards in-between statements while running through this loop, and PayPal decides it’s going to freeze your account and hold existing funds for 180 days? In the process, it rejects an incoming payment and causes the futures market provider to hold its funds too.

Now you’ve got some or all of that $450,000 tied up for six months, and probably credit card bills coming due to multiple lenders in less than a few weeks.

How do you manage that?

  • The age-old adage: Never float more than you can afford to lose (hopefully only lose temporarily in this case)
  • Why do one big loop when you can have multiple smaller, hopefully uncorrelated loops? Let one fail rather than all of them
  • Have a plan for stitching together the ends of the loop when the middle fails
  • Chargebacks? (Don’t do this)

Good luck out there, and have a nice weekend friends!

Next time: How to know when the jig is up, networking style.

Introduction

We have a series on risk that won’t write itself, so I guess that’s what I’m here for. Smart readers can guess today’s entrant (because it’s in the title): Shutdown risk. What’s that? Well, (a) duh, and (b) the risk that a bank, FinTech, credit card issuer, or other counterparty throws its virtual hands up in the air and says “that’s a nah from me son.”

Shutdowns as a Spectrum

Shutdowns come in many forms, much like your crazy ex’s promises. A few examples:

  • The Gentle Backoff: When you say jail to a churner, the first thing they’ll think of isn’t metal bars and locks, but rather AmEx Pop-Up Jail, which prevents you from getting future sign-up bonuses.
  • The Not-so-gentle Backoff: Small to medium sized credit unions are great at this, generally something like “if you don’t stop refunding those travel redemptions the week after you book them, we’re going to close your account”.
  • The Cold, Calculated Axe: Banks famously don’t care about feelings, and the good ones have a risk algorithm or two that, when alarms, leads to immediate shutdown. The really good ones will send you a polite letter telling you to pound sand and kick rocks while you’re at it too.
  • The Random Wildcards: Gift card sites, obscure portal aggregators, and fly-by-night buying groups don’t have compliance departments, instead they have automated ban-hammers. Breathe on them sideways when the wrong Toby analyst is looking and your account is locked instantly, often taking your pending payouts, rewards, and maybe your money with it.

Some shutdowns obviously sting more than others.

Managing Shutdown Risk

I know, I know, no one likes to be managed. So do the managing yourself:

  • Earn and Burn: Points sitting in an account aren’t assets, they’re unbacked IOUs
  • Learn about an Institution’s Triggers: Some issuers that rhyme with schminkrony hate cycling for example, while other FinTechs hate when you taek them as nothing but a hub, while others hate it when you chase their deposit accounts; know the pitfalls so you can dodge ’em
  • Isolate Your Real Accounts: Is your mortgage payment coming out of the same account that you’re depositing buyer’s group checks into? Well, cut it out. Would P2 be eternally mad if you lost your Kohl’s card? Maybe be careful with Capital One
  • Consider horizontal scaling: A dozen accounts for your friends and family each spending $50,000 a month is a lot less likely to ring alarms at a FinTech compared to spending $600,000 a month in a single account

As a corollary, perhaps develop a thick skin.

Coping

Remember: If you haven’t been shutdown by an institution, you haven’t gone hard enough yet.

Happy Thursday friends!

Next time: Managing digestive risk.

Introduction

A few weeks ago in a drunken rage (reportedly), we talked about a series on risk in manufactured spend, because apparently sending $173,000 worth of gift cards to a guy named “Rob” that you met on Telegram deserves slightly more analysis than “he seems cool and stuff”.

Enter counterparty risk: the possibility that the person, company, or robotic-AI-cow on the other side of your transaction doesn’t do what they’re supposed to do. In manufactured spend that can mean:

  • A buyer doesn’t pay in part, or in full
  • A merchandise reseller “never received” your inventory
  • A liquidation partner’s accounts are frozen
  • Someone who paid you with a credit card disputes a transaction after
  • A company freezes withdrawals
  • Rob moves to Argentina, which I hear is popular right now

Each of these actually happens in the real world, though fortunately are somewhat rare. Need to beat a dead horse though? See The Plastic Merchant.

Reputation

The manufactured spend community has a surprisingly effective decentralized credit-rating system and we gave it a super unique, fancy name: reputation.

When people you trust have successfully exchanged millions of dollars with someone else (let’s call them a counterparty), that’s what we call in the business “useful information”. It’s certainly better than dealing with DefinitelyLegitBuyer420 whose references consist of his Canadian girlfriend and another Telegram account that was created Tuesday.

Unfortunately though, reputation tells you about past behavior, not future solvency. A reseller that successfully paid you $100,000 last month may still be unable to pay you $100,000 next month. Businesses fail, bank accounts get frozen, employees steal, payment processors shut accounts, fraud happens, and occasionally otherwise honest people decide that your money would look better in their couch.

I guess tl;dr: Reputation reduces counterparty risk, but reputable parties still can go pear shaped.

Exposure

Setting aside reputation, let’s take a hard body stance and reframe counterparty risk directly as exposure: Suppose that you’ve got a scheme with a broker where you’re paid back two Fridays after the broker receives your goods. Every week, you send the broker $20,000 in merchandise, and every two Fridays later, you get that back.

After seeing this work well for months, you decide to triple your volume, and a couple of weeks later, the broker delays payment from Friday until Monday because reasons. Well, congratulations, your 2*$20,000 counterparty risk quietly became 3*$20,000, and if you keep going, maybe it becomes 4*$20,000.

At that point, you need to decide, “Am I comfortable with making a bigger unsecured six-figure loan to Steve from discord?” Because that’s exactly what’s actually happening. This also leads to the now common refrain from whales in manufactured spend.

“Never float more than you can afford to lose.”

Controlling Risk

Ok, so what do we do about it? Simple friends, we manage it:

  1. Commit to an exposure limit: Decide how much money you’re willing to have outstanding with a counterparty, and reevaluate that periodically, knowing that you could lose it all
  2. Watch settlement time: A buyer paying reliably every two days is a different risk from the same buyer paying every two weeks, Faster settlement means less exposure over time, and speed bumps appear more quickly
  3. Scale slowly: A successful $2,000 transaction proves that someone can successfully complete … a $2,000 transaction. It doesn’t prove that they can successfully complete a $200,000 transaction #themoreyouknow
  4. Diversify: The likelihood of multiple brokers failing at the same time is quite a bit smaller than a single broker failing (duh)
  5. Look for speed bumps and react: Tuesday payments become Wednesday payments, then Friday payments, then bank issues, then supposed hospital stays, then something about being part of the next mission around the moon. Signs usually exist, watch for them
  6. KYC (sorry): A real name, business entity, address, phone number, mutual contacts, and some idea of how the operation actually works are all more useful than a Telegram avatar of a Lamborghini with a beer can in the driver’s seat

Finally, note that good counterparties generally communicate when something goes sideways. “ACH got held, here’s what happened, here’s the documentation, and here’s when I expect it to clear” is very different from silence followed by “sorry bro been busy”.

tl;dr

Counterparty risk can be managed, but let’s repeat the most important point because it’s easy to forget when the money is flowing:

“Never float more than you can afford to lose.”

Happy Thursday!

On the other hand, maybe Rob had a totally valid reason to go to Argentina on short notice, looks legit.

One of the most surprising aspects of manufactured spend is the sheer number of people that send six-plus figures worth of goods, gift cards, precious metals, or other consideration to someone on the internet that they know only by a handle, and if they’re lucky, a first name. This works for two reasons:

  • Broker reputation
  • Effective communications in the community about reputation

In other words, you may only know a guy as “Michael“, but if a hundred other contacts that you trust have successfully done big business with Michael, then doing business with that guy is probably slightly less risky than a random Michael you met in downtown Portland.

Of course past performance doesn’t guarantee future gains and Michael may choose your shipment as his ticket to a new life in Argentina, a risk we’ll call counterparty risk. That’s not the only kind of risk though, in manufactured spend, we’re subject to:

  • counterparty risk
  • shutdown risk
  • credit risk
  • tax and audit risk
  • fraud risk
  • cybersecurity risk
  • clawback risk
  • operational risk
  • concentration risk
  • automation risk
  • MCC coding risk

… amongst other risks. A quick treatise on each will make you a better and safer manufactured spender, and we’ll have a semi-irregular post here about each in the upcoming (I have no idea how many) months. Stay tuned friends.

Oh, and so you don’t walk away feeling like you didn’t get anything out of today’s post:

Happy Tuesday!

Pictured: Michael