WEBVTT 00:00:00.000 --> 00:00:02.259 Welcome back to the Deep Dive. It is great to 00:00:02.259 --> 00:00:04.820 have you with us. Good to be here. Today, we 00:00:04.820 --> 00:00:08.480 are opening up a file that it sits right in the 00:00:08.480 --> 00:00:10.099 middle of the stack. It's something that feels 00:00:10.099 --> 00:00:13.279 incredibly mundane on the surface, but is actually 00:00:13.279 --> 00:00:15.439 doing a lot of heavy lifting for civilization. 00:00:16.019 --> 00:00:17.800 It's one of those topics, isn't it? It's part 00:00:17.800 --> 00:00:19.820 of the plumbing. Yeah. You don't think about 00:00:19.820 --> 00:00:22.440 the plumbing until it leaks or until you're buying 00:00:22.440 --> 00:00:24.379 a house and someone hands you a massive bill 00:00:24.379 --> 00:00:27.660 for it. Exactly. We are talking about the invisible 00:00:27.660 --> 00:00:30.899 safety net of the modern world. It's a word most 00:00:30.899 --> 00:00:33.899 people associate with, like high stress, confusing 00:00:33.899 --> 00:00:36.259 bank statements, and just stacks and stacks of 00:00:36.259 --> 00:00:39.539 legal paper. We are talking about escrow. There 00:00:39.539 --> 00:00:41.979 it is. And before you reach for the skip button 00:00:41.979 --> 00:00:44.179 thinking this is going to be dry financial advice, 00:00:44.420 --> 00:00:46.850 I want to promise you something. Okay. By the 00:00:46.850 --> 00:00:48.789 end of this hour, you are going to look at a 00:00:48.789 --> 00:00:51.429 vending machine completely differently. That 00:00:51.429 --> 00:00:55.070 is a bold promise. I like it. But the research 00:00:55.070 --> 00:00:57.250 definitely backs it up. Because it turns out 00:00:57.250 --> 00:01:01.689 this concept, escrow, is the glue holding together 00:01:01.689 --> 00:01:04.909 everything from billion dollar corporate mergers 00:01:04.909 --> 00:01:08.969 to, well, buying a bag of chips. It really is. 00:01:09.069 --> 00:01:11.950 It is the solution to a fundamental human problem. 00:01:12.109 --> 00:01:14.269 The problem of trust. The trust problem. Right. 00:01:14.590 --> 00:01:17.349 So let's start there. The mission of this deep 00:01:17.349 --> 00:01:20.790 dive today is to decode the different flavors 00:01:20.790 --> 00:01:23.750 of escrow and figure out why the system even 00:01:23.750 --> 00:01:26.650 exists in the first place. But to do that, we 00:01:26.650 --> 00:01:29.030 have to go back to the basics of human interaction. 00:01:29.329 --> 00:01:31.129 Yeah, let's strip away the modern economy for 00:01:31.129 --> 00:01:34.709 just a second. Okay. Imagine two strangers. They 00:01:34.709 --> 00:01:37.810 have absolutely no relationship, no reason at 00:01:37.810 --> 00:01:40.189 all to trust one another. Right. One has a high 00:01:40.189 --> 00:01:43.150 value item, let's say a deed to a castle. The 00:01:43.150 --> 00:01:45.730 other has a chest full of gold. The classic standoff, 00:01:45.829 --> 00:01:47.790 the old medieval standoff. It is a standoff, 00:01:47.849 --> 00:01:50.409 a huge one. If I hand you the deed first, how 00:01:50.409 --> 00:01:52.069 do I know you won't just jump on your horse and 00:01:52.069 --> 00:01:53.629 ride off with the deed and the gold? And from 00:01:53.629 --> 00:01:55.730 my side, if I give you the gold first, I'm terrified 00:01:55.730 --> 00:01:57.390 you'll just lock the castle gates and leave me 00:01:57.390 --> 00:01:59.689 standing out there in the mud. This friction, 00:01:59.790 --> 00:02:03.189 historically, was a massive barrier to trade. 00:02:03.640 --> 00:02:06.180 I mean, it's why things so often ended in violence 00:02:06.180 --> 00:02:08.819 or you just ended up only trading with your cousins. 00:02:09.039 --> 00:02:11.919 Right. You needed some pre -existing trust. You 00:02:11.919 --> 00:02:16.099 did. Civilization needed a patch for this bug 00:02:16.099 --> 00:02:20.099 in human nature. We needed a neutral zone, a 00:02:20.099 --> 00:02:23.180 demilitarized zone for assets, if you will. And 00:02:23.180 --> 00:02:25.199 that is the definition of escrow. That's what 00:02:25.199 --> 00:02:27.360 it is. Correct. Based on the sources we have 00:02:27.360 --> 00:02:30.000 today, the strict definition is a contractual 00:02:30.000 --> 00:02:32.740 arrangement where a third party. known as the 00:02:32.740 --> 00:02:35.699 stakeholder or the escrow agent, receives and 00:02:35.699 --> 00:02:39.360 disperses money or property for the primary transacting 00:02:39.360 --> 00:02:41.620 parties. The third wheel. The most important 00:02:41.620 --> 00:02:43.539 third wheel in history, maybe. So they just, 00:02:43.620 --> 00:02:45.740 they hold the goods. They hold the goods until 00:02:45.740 --> 00:02:47.620 everyone agrees the conditions have been met. 00:02:47.860 --> 00:02:49.800 But, and I know this was your favorite part of 00:02:49.800 --> 00:02:52.020 the research packet. Oh, absolutely. The word 00:02:52.020 --> 00:02:53.919 itself tells the story better than any legal 00:02:53.919 --> 00:02:57.020 dictionary ever could. This was my big aha. moment 00:02:57.020 --> 00:02:58.900 right out of the gate. I think most of us assume 00:02:58.900 --> 00:03:01.699 escrow is some, you know, some Latin banking 00:03:01.699 --> 00:03:04.340 term. Something very serious. Yeah, like fiduciary 00:03:04.340 --> 00:03:06.680 or something that sounds very serious and expensive. 00:03:07.099 --> 00:03:10.039 But it's not. No, it comes from the old French 00:03:10.039 --> 00:03:12.639 word escrow. And do you know what that translates 00:03:12.639 --> 00:03:15.900 to? A scrap of paper. A scrap of paper or more 00:03:15.900 --> 00:03:18.919 specifically, a scroll of parchment. Which just 00:03:18.919 --> 00:03:21.240 paints such a vivid picture, doesn't it? In that 00:03:21.240 --> 00:03:24.620 medieval context, the escrow wasn't the money. 00:03:25.020 --> 00:03:27.979 No. It was the deed itself. It was the scroll, 00:03:28.240 --> 00:03:30.539 the physical thing. So the escrow agent was literally 00:03:30.539 --> 00:03:33.099 the guy holding the scroll. Exactly. The instruction 00:03:33.099 --> 00:03:35.759 was, I am going to hold this scroll, this escrow 00:03:35.759 --> 00:03:38.319 in my hand. I will not hand it to the buyer until 00:03:38.319 --> 00:03:40.879 I see the coins on the table. Okay. And I will 00:03:40.879 --> 00:03:43.180 not give the scroll back to the seller unless 00:03:43.180 --> 00:03:46.460 the buyer fails to pay. It's the physical manifestation 00:03:46.460 --> 00:03:49.879 of the deal just hanging in a suspended state. 00:03:49.960 --> 00:03:52.879 That's the key phrase. A suspended state, it's 00:03:52.879 --> 00:03:55.219 a limbo. And that brings us directly to your 00:03:55.219 --> 00:03:57.560 promise about the vending machine. Yes, let's 00:03:57.560 --> 00:04:00.240 do it. Section one of our outline, the everyday 00:04:00.240 --> 00:04:03.379 escrow, because we tend to think of escrow as 00:04:03.379 --> 00:04:05.439 this thing you only do when you buy a house or 00:04:05.439 --> 00:04:07.840 maybe a business. Some huge life -altering event. 00:04:08.120 --> 00:04:10.719 But the research points out that we are engaging 00:04:10.719 --> 00:04:14.139 in a form of mechanical escrow all the time. 00:04:14.300 --> 00:04:16.600 It's fascinating engineering when you break it 00:04:16.600 --> 00:04:19.600 down. Think about the user interface of a standard 00:04:19.600 --> 00:04:21.779 vending machine. Okay, I'm picturing it. You 00:04:21.779 --> 00:04:24.860 want a soda. It costs a dollar. You put a quarter 00:04:24.860 --> 00:04:27.379 in. I hear the clunk. You hear the clunk. But 00:04:27.379 --> 00:04:30.199 where is that quarter physically? Well, I assume 00:04:30.199 --> 00:04:31.939 it's in the bank of the machine, right? It's 00:04:31.939 --> 00:04:33.819 in the pile with all the other quarters that 00:04:33.819 --> 00:04:35.540 people have put in. See, that's where you'd be 00:04:35.540 --> 00:04:38.779 wrong. And that's the magic. If it went directly 00:04:38.779 --> 00:04:42.899 into the vault or the profit bin, the machine 00:04:42.899 --> 00:04:45.120 would have already accepted the transaction as 00:04:45.120 --> 00:04:47.490 revenue. But I haven't bought anything yet. You 00:04:47.490 --> 00:04:48.930 haven't bought anything. You've just proven you 00:04:48.930 --> 00:04:51.149 have money. So the coin is sitting in a waiting 00:04:51.149 --> 00:04:54.009 room. It is sitting in a physical escrow area 00:04:54.009 --> 00:04:57.350 inside the coin mechanism. It is mechanically 00:04:57.350 --> 00:04:59.589 separated from the rest of the money. It is being 00:04:59.589 --> 00:05:02.149 held in trust by the machine. It's waiting for 00:05:02.149 --> 00:05:04.389 a condition to be met. Exactly. The condition 00:05:04.389 --> 00:05:08.370 is user presses button B4. So the machine is 00:05:08.370 --> 00:05:11.009 the neutral third party. The machine is the agent. 00:05:11.329 --> 00:05:13.750 The machine is the agent. Now look at the decision 00:05:13.750 --> 00:05:17.300 tree. If you press B4 and the machine verifies 00:05:17.300 --> 00:05:20.019 it has the chips, the little coil turns, the 00:05:20.019 --> 00:05:23.100 chips fall. Success? That is the closing of the 00:05:23.100 --> 00:05:26.620 deal. Yeah. At that exact moment, a little lever 00:05:26.620 --> 00:05:31.019 or a gate opens in the escrow area and your quarters 00:05:31.019 --> 00:05:34.019 finally drop into the secure coin vault, revenue 00:05:34.019 --> 00:05:36.899 recognized. But the real magic of escrow and 00:05:36.899 --> 00:05:39.339 the reason it exists is what happens if the deal 00:05:39.339 --> 00:05:42.000 fails? Right. Let's say you stare at the machine 00:05:42.000 --> 00:05:44.490 and you realize you don't want chips. You want 00:05:44.490 --> 00:05:46.870 your money back. So I press the coin return button. 00:05:47.009 --> 00:05:49.370 You press the coin return. It gives you your 00:05:49.370 --> 00:05:51.529 money back. Yeah. But notice how it gives it 00:05:51.529 --> 00:05:54.910 back. It doesn't dispense change from a tube 00:05:54.910 --> 00:05:58.149 of random quarters. It usually drops your specific 00:05:58.149 --> 00:06:00.430 coins back to you, the ones you just put in. 00:06:00.529 --> 00:06:02.230 Because they were sitting in the escrow bucket? 00:06:02.490 --> 00:06:04.990 They were in limbo. The machine releases the 00:06:04.990 --> 00:06:07.149 escrow back to the depositor because the transaction 00:06:07.149 --> 00:06:09.529 was canceled. It's just returning my property. 00:06:09.689 --> 00:06:11.790 It's a perfect physical analogy for what happens 00:06:11.790 --> 00:06:13.769 with millions of dollars in a corporate merger 00:06:13.769 --> 00:06:16.610 just happening with 25 cents. It prevents the 00:06:16.610 --> 00:06:19.370 machine from having to refund you, which is an 00:06:19.370 --> 00:06:22.629 accounting headache. Precisely. And ATMs do this, 00:06:22.670 --> 00:06:24.310 too, which is another great example from the 00:06:24.310 --> 00:06:26.680 source material we looked at. Oh, right. When 00:06:26.680 --> 00:06:28.879 you deposit a stack of cash. Yeah, if you've 00:06:28.879 --> 00:06:31.420 ever fed a stack of bills into a modern ATM, 00:06:31.800 --> 00:06:34.279 you know it takes a minute. It whirs, it clicks, 00:06:34.420 --> 00:06:36.160 it counts everything up. Right, it's thinking. 00:06:36.399 --> 00:06:39.339 And then a screen pops up that says, you inserted 00:06:39.339 --> 00:06:42.300 $200. Is this correct? It's the verification 00:06:42.300 --> 00:06:45.699 stage. And while that screen is up, your cash 00:06:45.699 --> 00:06:49.389 is in escrow inside the machine. It hasn't been 00:06:49.389 --> 00:06:51.670 mixed with the other deposits yet. It's sitting 00:06:51.670 --> 00:06:55.009 in a temporary cassette. So if you click no, 00:06:55.250 --> 00:06:57.850 cancel, the machine can spit those exact bills 00:06:57.850 --> 00:07:00.269 back out at you. Because once they are mixed, 00:07:00.410 --> 00:07:03.689 once they are commingled, you can't prove whose 00:07:03.689 --> 00:07:06.649 bill is whose. And that is the cardinal sin of 00:07:06.649 --> 00:07:08.230 escrow, which we will definitely get to later. 00:07:09.050 --> 00:07:10.970 Commingling funds. You have to keep the assets 00:07:10.970 --> 00:07:13.350 separate. Always. Yeah. Until the deal is done. 00:07:13.490 --> 00:07:15.589 It's amazing how much trust engineering goes 00:07:15.589 --> 00:07:18.250 into just giving a machine 20 bucks. But okay. 00:07:18.589 --> 00:07:20.769 Let's graduate from the snack bar to the biggest 00:07:20.769 --> 00:07:23.170 purchase of most people's lives. The big one. 00:07:23.329 --> 00:07:25.850 We have to talk about real estate. Of course. 00:07:25.910 --> 00:07:28.829 This is where the term escrow usually enters 00:07:28.829 --> 00:07:32.689 a person's vocabulary. And usually it enters 00:07:32.689 --> 00:07:34.889 it alongside a lot of anxiety and confusion. 00:07:35.389 --> 00:07:38.129 It's high stakes. In the U .S. specifically, 00:07:38.430 --> 00:07:40.930 the entire residential real estate market relies 00:07:40.930 --> 00:07:44.259 completely on this system. But. And this is a 00:07:44.259 --> 00:07:46.740 crucial distinction that the outline makes. There 00:07:46.740 --> 00:07:48.779 are actually two completely different types of 00:07:48.779 --> 00:07:50.839 escrow happening when you buy a house. And they 00:07:50.839 --> 00:07:53.560 get confused all the time. Constantly. You have 00:07:53.560 --> 00:07:55.579 the closing escrow, which is short term, and 00:07:55.579 --> 00:07:57.360 then you have the mortgage escrow, which is very, 00:07:57.420 --> 00:07:59.639 very long term. Okay. Let's break down type A, 00:07:59.699 --> 00:08:01.839 the closing escrow. This is the standoff solution 00:08:01.839 --> 00:08:03.699 we were talking about at the start. Yes. This 00:08:03.699 --> 00:08:05.420 is the modern version of holding the scroll. 00:08:05.660 --> 00:08:09.519 Yeah. So you find a house. You love it. You sign 00:08:09.519 --> 00:08:11.459 a purchase contract with the seller. Yep. The 00:08:11.459 --> 00:08:15.610 contract says you will pay. Say $500 ,000. And 00:08:15.610 --> 00:08:18.370 you write a check for earnest money, let's call 00:08:18.370 --> 00:08:20.790 it $10 ,000, to prove you aren't just wasting 00:08:20.790 --> 00:08:22.990 their time. But I don't give that check to the 00:08:22.990 --> 00:08:25.730 seller. Never. Absolutely not. Why not? Because 00:08:25.730 --> 00:08:28.290 what if the house fails inspection? What if you 00:08:28.290 --> 00:08:30.110 find out the foundation is cracked and you want 00:08:30.110 --> 00:08:32.769 to walk away from the deal? Right. If the seller 00:08:32.769 --> 00:08:35.690 already cashed your check and spent it, good 00:08:35.690 --> 00:08:37.909 luck getting it back. You'd have to sue them. 00:08:38.279 --> 00:08:40.419 And that's a nightmare. And conversely, the seller 00:08:40.419 --> 00:08:42.440 isn't going to sign the deed over to me until 00:08:42.440 --> 00:08:44.759 they know for sure that I have the other $490 00:08:44.759 --> 00:08:48.179 ,000. Of course not. So enter the escrow company 00:08:48.179 --> 00:08:51.460 or a title company or a real estate lawyer, depending 00:08:51.460 --> 00:08:54.860 on the state. They open a file. They are the 00:08:54.860 --> 00:08:57.340 neutral zone. So I send my deposit to them. You 00:08:57.340 --> 00:08:59.600 send your deposit to them. The bank sends the 00:08:59.600 --> 00:09:04.370 mortgage money to them. They're holding all the 00:09:04.370 --> 00:09:06.330 puzzle pieces. They are the gatekeepers. Their 00:09:06.330 --> 00:09:08.470 entire job is to look at the contract and just 00:09:08.470 --> 00:09:11.169 check off the boxes. Is the title clear of any 00:09:11.169 --> 00:09:14.190 leads? Check. Did the inspection contingency 00:09:14.190 --> 00:09:17.129 get resolved? Check. Is the fire insurance policy 00:09:17.129 --> 00:09:21.110 active and paid for? Check. And only when every 00:09:21.110 --> 00:09:24.350 single one of those boxes is checked. They close 00:09:24.350 --> 00:09:27.759 the escrow. In one single synchronized moment, 00:09:27.980 --> 00:09:30.340 they wire the money to the seller's bank account, 00:09:30.519 --> 00:09:32.860 they send the deed to the county recorder to 00:09:32.860 --> 00:09:35.399 officially put the house in your name, and they 00:09:35.399 --> 00:09:38.019 pay themselves their fee out of the funds. And 00:09:38.019 --> 00:09:40.539 that's it. That particular escrow is closed. 00:09:40.740 --> 00:09:43.779 The scroll has been handed over. The transaction 00:09:43.779 --> 00:09:47.090 is complete. But for most Americans with a mortgage, 00:09:47.350 --> 00:09:50.049 that is just the beginning of their relationship 00:09:50.049 --> 00:09:52.509 with the word escrow. Right. Because now we enter 00:09:52.509 --> 00:09:55.669 type B, the mortgage escrow. This is the one 00:09:55.669 --> 00:09:57.590 that confuses people on a monthly basis. This 00:09:57.590 --> 00:09:59.950 is the impound account. Right. And to understand 00:09:59.950 --> 00:10:01.850 this, we have to understand the acronym P -I 00:10:01.850 --> 00:10:06.269 -T -I. P -I -T -I. Principal, interest, taxes, 00:10:06.309 --> 00:10:08.610 and insurance. Principal and interest. That's 00:10:08.610 --> 00:10:10.289 your loan. That's the part that goes to the bank 00:10:10.289 --> 00:10:11.909 to pay off what you borrowed. That's straightforward. 00:10:12.190 --> 00:10:14.470 Sure. But the taxes and insurance. The T and 00:10:14.470 --> 00:10:16.549 the I. That's where the escrow account comes 00:10:16.549 --> 00:10:18.710 in. The question I always had, and I think a 00:10:18.710 --> 00:10:21.269 lot of people have, is why does the bank even 00:10:21.269 --> 00:10:23.950 care? I mean, I owe the bank money for the loan, 00:10:24.029 --> 00:10:27.169 sure. Why do they want to be involved in paying 00:10:27.169 --> 00:10:30.269 my property taxes to the county? Why not just 00:10:30.269 --> 00:10:32.889 let me write a check to the county myself? Seems 00:10:32.889 --> 00:10:35.330 like extra work for them. It's a great question, 00:10:35.450 --> 00:10:38.669 and the answer is brutal but simple. They don't 00:10:38.669 --> 00:10:41.149 trust you to protect their investment. It always 00:10:41.149 --> 00:10:45.429 comes back to trust. Or lack of it. Always. Think 00:10:45.429 --> 00:10:47.529 about it. If you start paying your credit card 00:10:47.529 --> 00:10:50.309 bill, what happens? You get a bad credit score, 00:10:50.509 --> 00:10:52.730 maybe a collection agency calls you. Annoying, 00:10:52.730 --> 00:10:55.289 but that's about it. Right? But if you stop paying 00:10:55.289 --> 00:10:57.889 your property taxes, what happens? The government 00:10:57.889 --> 00:11:00.809 gets angry. Very angry. The government places 00:11:00.809 --> 00:11:03.549 a tax lien on your home. And in most jurisdictions, 00:11:03.889 --> 00:11:06.980 a government tax lien has super priority. Super 00:11:06.980 --> 00:11:09.639 priority. What's that? It means it cuts in line. 00:11:09.720 --> 00:11:12.100 It jumps to the very front of the line of everyone 00:11:12.100 --> 00:11:14.440 you owe money to right in front of the mortgage. 00:11:14.720 --> 00:11:16.519 Wait, so the government gets paid before the 00:11:16.519 --> 00:11:18.200 bank? Yeah. Even though the bank gave me the 00:11:18.200 --> 00:11:21.899 money for the house? Yes. If the government forecloses 00:11:21.899 --> 00:11:24.639 on your house for unpaid taxes, they get their 00:11:24.639 --> 00:11:27.700 money first. The bank gets whatever scraps are 00:11:27.700 --> 00:11:30.440 left over. The bank could lose their entire collateral. 00:11:30.799 --> 00:11:33.100 So they are terrified of this. They are terrified 00:11:33.100 --> 00:11:36.120 of task meals. Right. So the bank says, We are 00:11:36.120 --> 00:11:38.360 going to give you the option to forget to pay. 00:11:38.700 --> 00:11:41.019 They take away the choice. Exactly. They say, 00:11:41.039 --> 00:11:43.759 we are going to estimate your annual tax bill. 00:11:43.799 --> 00:11:46.039 We're going to divide it by 12, and we are going 00:11:46.039 --> 00:11:48.860 to force you to pay that portion to us every 00:11:48.860 --> 00:11:50.860 single month. And they put it in a bucket. They 00:11:50.860 --> 00:11:53.419 put that money into an escrow bucket, a separate 00:11:53.419 --> 00:11:55.259 savings account that's attached to your loan. 00:11:55.539 --> 00:11:57.539 And when the tax bill arrives from the county, 00:11:57.759 --> 00:12:00.440 they pay it for you. From your money. They're 00:12:00.440 --> 00:12:02.559 protecting their position in the line. And it's 00:12:02.559 --> 00:12:04.759 the same exact thing with hazard insurance. If 00:12:04.759 --> 00:12:06.720 the house burns down and you forgot to pay the 00:12:06.720 --> 00:12:09.620 insurance premium. The asset is gone. The asset 00:12:09.620 --> 00:12:12.019 is gone. The bank is left holding a loan for 00:12:12.019 --> 00:12:15.080 a pile of ash. So they escrow the insurance payments 00:12:15.080 --> 00:12:17.860 too. Okay. Now this leads directly to the phenomenon 00:12:17.860 --> 00:12:21.500 that drives homeowners crazy. The escrow analysis. 00:12:21.980 --> 00:12:25.179 The annual letter of doom. I've gotten a few 00:12:25.179 --> 00:12:27.419 of those. You get a fixed rate mortgage. You 00:12:27.419 --> 00:12:30.000 sign the papers. You think, OK, great. My payment 00:12:30.000 --> 00:12:32.679 is $2 ,000 a month for 30 years. Predictable. 00:12:32.779 --> 00:12:35.179 Right. And then two years later, the bank sends 00:12:35.179 --> 00:12:38.259 a letter saying, just kidding. It's now $2 ,150 00:12:38.259 --> 00:12:40.759 a month. And people feel like they've been lied 00:12:40.759 --> 00:12:42.740 to. They feel like the bank just changed the 00:12:42.740 --> 00:12:45.419 rules. But the loan is fixed. The P &I part, 00:12:45.679 --> 00:12:47.639 the principal and interest, that didn't change. 00:12:47.899 --> 00:12:50.870 The T &I changed. The taxes and insurance changed. 00:12:51.110 --> 00:12:53.330 Because taxes and insurance, they never, ever 00:12:53.330 --> 00:12:56.309 seem to go down. Well, there's inflation. Property 00:12:56.309 --> 00:12:59.169 values go up, which means taxes go up. These 00:12:59.169 --> 00:13:01.570 costs are variable. And the source material gives 00:13:01.570 --> 00:13:03.789 a really clear example of how this math works. 00:13:04.190 --> 00:13:06.450 And it explains why the payment increase always 00:13:06.450 --> 00:13:08.289 feels bigger than it should be. Okay. Yeah. Let's 00:13:08.289 --> 00:13:10.230 walk through the shortage concept. This is important. 00:13:10.509 --> 00:13:12.590 Okay. Let's say your homeowner's insurance premium 00:13:12.590 --> 00:13:15.570 goes up by $120 for the year. All right. So that's 00:13:15.570 --> 00:13:19.190 $10 a month. $10 a month. Logic would say your 00:13:19.190 --> 00:13:21.490 total monthly payment should just go up by $10. 00:13:21.590 --> 00:13:24.690 Sure. Seems simple enough. But here's what actually 00:13:24.690 --> 00:13:28.570 happens. The bank usually has to pay that annual 00:13:28.570 --> 00:13:30.830 insurance bill before they get around to adjusting 00:13:30.830 --> 00:13:33.190 your monthly payment. Ah. So they pay the insurance 00:13:33.190 --> 00:13:36.370 company the new higher rate in, say, January. 00:13:37.029 --> 00:13:40.289 But you've been paying the old lower rate into 00:13:40.289 --> 00:13:43.029 the escrow bucket all of last year. So the bucket 00:13:43.029 --> 00:13:44.909 doesn't have enough money in it? The bucket is 00:13:44.909 --> 00:13:48.419 worse than empty. It's overdrawn. from the bank's 00:13:48.419 --> 00:13:50.940 perspective, or at least it's below the minimum 00:13:50.940 --> 00:13:52.799 balance they're required to keep. There's a shortage. 00:13:53.000 --> 00:13:56.620 Okay. So now the bank's analysis says, okay, 00:13:56.659 --> 00:13:59.039 for the next year, we need to raise your payment 00:13:59.039 --> 00:14:02.059 by $10 a month to cover the new higher price 00:14:02.059 --> 00:14:04.799 going forward. But T, we also need you to pay 00:14:04.799 --> 00:14:07.419 us back for the $120 shortage we had to cover 00:14:07.419 --> 00:14:09.399 for you this year. So they spread that shortage 00:14:09.399 --> 00:14:11.480 out over the next year too. They'll add another 00:14:11.480 --> 00:14:14.039 $10 a month just to pay back the shortage. So 00:14:14.039 --> 00:14:17.299 now your payment is up by $20, not $10. So they 00:14:17.299 --> 00:14:19.700 double dip in a way. And on top of that, federal 00:14:19.700 --> 00:14:21.960 regulations for ESPA, the Real Estate Settlement 00:14:21.960 --> 00:14:24.860 Procedures Act, allow them to keep a cushion 00:14:24.860 --> 00:14:27.379 in the account, usually equal to about two months 00:14:27.379 --> 00:14:30.220 of escrow payments. A buffer. A buffer. And if 00:14:30.220 --> 00:14:32.580 the payments go up, the required cushion has 00:14:32.580 --> 00:14:35.240 to get bigger, too. So they might add even more 00:14:35.240 --> 00:14:37.080 to your payment to build that cushion back up. 00:14:37.200 --> 00:14:39.940 So a simple $10 a month increase in your actual 00:14:39.940 --> 00:14:44.039 costs can easily turn into a $25 or $30 increase 00:14:44.039 --> 00:14:46.720 in your monthly payment for a year. Exactly. 00:14:46.879 --> 00:14:49.740 Until the shortage is paid back and the cushion 00:14:49.740 --> 00:14:53.139 is full again. It's an automated reality check. 00:14:53.500 --> 00:14:56.679 It's the adulting tax applied automatically by 00:14:56.679 --> 00:14:59.419 a bank's algorithm. And for certain types of 00:14:59.419 --> 00:15:02.659 loans, like FHA loans, you have no choice in 00:15:02.659 --> 00:15:04.639 this matter. That's correct. The source notes 00:15:04.639 --> 00:15:06.659 that federal housing administration loans require 00:15:06.659 --> 00:15:08.779 this escrow account for the entire life of the 00:15:08.779 --> 00:15:10.860 loan. No exceptions. And with a conventional 00:15:10.860 --> 00:15:13.320 loan? With a conventional loan, if you have enough 00:15:13.320 --> 00:15:16.240 equity, usually 20 percent or more, you can sometimes 00:15:16.240 --> 00:15:18.320 petition the bank to cancel the escrow account 00:15:18.320 --> 00:15:20.320 and let you pay your own taxes and insurance. 00:15:20.700 --> 00:15:22.379 But then you have to be disciplined enough to 00:15:22.379 --> 00:15:24.679 save up that huge chunk of money yourself for 00:15:24.679 --> 00:15:26.940 when those big bills come due. Which brings us 00:15:26.940 --> 00:15:29.179 right back to why the system exists in the first 00:15:29.179 --> 00:15:31.889 place. It mitigates risk. For the lender. Okay, 00:15:31.950 --> 00:15:34.669 that's a very deep dive into the U .S. model, 00:15:34.870 --> 00:15:37.889 but our mission is global. So let's look at section 00:15:37.889 --> 00:15:41.309 three, global perspectives. How does this work 00:15:41.309 --> 00:15:44.549 in, say, the U .K.? It's interesting. In the 00:15:44.549 --> 00:15:47.970 U .S., escrow is an industry. You have escrow 00:15:47.970 --> 00:15:49.870 officers and title companies that specialize 00:15:49.870 --> 00:15:53.529 in this. In the U .K., you don't really have... 00:15:53.950 --> 00:15:57.509 distinct industry. The function absolutely exists, 00:15:57.750 --> 00:16:00.029 but it's handled by the lawyers involved in the 00:16:00.029 --> 00:16:02.090 transaction. Just solicitors. Solicitors, or 00:16:02.090 --> 00:16:04.190 a professional called a licensed conveyancer. 00:16:04.350 --> 00:16:07.210 I love that term, conveyancer. It sounds like 00:16:07.210 --> 00:16:09.850 someone who moves luggage at a fancy hotel. It's 00:16:09.850 --> 00:16:11.950 the person who conveys the title of the property 00:16:11.950 --> 00:16:14.009 from one person to another. But effectively, 00:16:14.029 --> 00:16:16.029 they do the same thing. They hold the buyer's 00:16:16.029 --> 00:16:18.450 deposit in a special client account until the 00:16:18.450 --> 00:16:21.679 deal is done. So it's integrated into... The 00:16:21.679 --> 00:16:24.000 legal process. Exactly. But the source material 00:16:24.000 --> 00:16:25.940 highlights some other uses in the U .K. that 00:16:25.940 --> 00:16:28.299 I think are really clever and are becoming more 00:16:28.299 --> 00:16:30.559 common elsewhere, specifically for things like 00:16:30.559 --> 00:16:33.419 secondhand cars. This stood out to me. Buying 00:16:33.419 --> 00:16:36.179 a used car is the Wild West. You meet a stranger 00:16:36.179 --> 00:16:38.759 in a parking lot. You kick the tires. You hand 00:16:38.759 --> 00:16:42.200 over an envelope of cash. It feels incredibly 00:16:42.200 --> 00:16:45.080 dangerous. It is dangerous. It's a classic lemon 00:16:45.080 --> 00:16:47.440 market, as the economists call it. You don't 00:16:47.440 --> 00:16:49.080 know if you're getting a good car or a lemon. 00:16:50.460 --> 00:16:53.519 In the UK, and increasingly elsewhere, they're 00:16:53.519 --> 00:16:55.960 using escrow services for this. How does that 00:16:55.960 --> 00:16:58.799 work for a car? It's the same principle. The 00:16:58.799 --> 00:17:01.360 buyer deposits the money into a secure online 00:17:01.360 --> 00:17:04.900 account held by a third party. Okay. The seller 00:17:04.900 --> 00:17:06.500 gets a notification that the money is there. 00:17:06.579 --> 00:17:08.960 It's verified. So the seller delivers the car. 00:17:09.140 --> 00:17:11.470 And then what? The buyer gets an inspection period, 00:17:11.609 --> 00:17:13.970 a day, two days. They can take it to their mechanic. 00:17:14.089 --> 00:17:16.809 Does it start? Is the engine block cracked? If 00:17:16.809 --> 00:17:18.529 it's good, they go online and click a button 00:17:18.529 --> 00:17:20.410 to release the funds. And if it's a piece of 00:17:20.410 --> 00:17:22.750 junk? They reject the transaction and the money 00:17:22.750 --> 00:17:24.349 stays locked until they've returned the car. 00:17:24.470 --> 00:17:26.369 It eliminates the scam where the seller just 00:17:26.369 --> 00:17:28.410 takes the cash and runs. That seems like it would 00:17:28.410 --> 00:17:30.769 solve so many problems on places like Craigslist 00:17:30.769 --> 00:17:33.589 or Facebook Marketplace. It creates a trust bridge. 00:17:34.069 --> 00:17:36.240 And they use it for construction, too. This is 00:17:36.240 --> 00:17:38.700 a big one. Oh, home renovation horror stories. 00:17:39.180 --> 00:17:42.299 I paid the contractor $5 ,000 for materials and 00:17:42.299 --> 00:17:44.240 he just never came back. We've all heard that 00:17:44.240 --> 00:17:47.180 story. It's a classic. In the UK, it's becoming 00:17:47.180 --> 00:17:49.660 common to put that money in escrow. The builder 00:17:49.660 --> 00:17:51.920 knows the money is there, so they aren't worried 00:17:51.920 --> 00:17:53.359 you're going to stiff them at the end. Okay, 00:17:53.420 --> 00:17:55.339 so it protects them. But they can't touch it 00:17:55.339 --> 00:17:58.779 until the work meets a pre -agreed defined standard. 00:17:59.339 --> 00:18:01.859 Like phase one is complete when the foundation 00:18:01.859 --> 00:18:05.130 is poured and inspected. Exactly. It aligns the 00:18:05.130 --> 00:18:07.730 incentives perfectly. It forces honest behavior 00:18:07.730 --> 00:18:09.789 because the money is trapped in that neutral 00:18:09.789 --> 00:18:13.250 zone until the promise is kept. Speaking of scams 00:18:13.250 --> 00:18:15.710 and the Wild West, we have to talk about the 00:18:15.710 --> 00:18:18.009 Internet. Section four, the digital frontier. 00:18:18.509 --> 00:18:21.069 This is where escrow went from being a kind of 00:18:21.069 --> 00:18:23.769 boring legal term to a critical piece of tech 00:18:23.769 --> 00:18:25.829 infrastructure for the entire global economy. 00:18:26.069 --> 00:18:28.410 Think back to the early days of eBay. We're talking 00:18:28.410 --> 00:18:32.039 late 90s. The Beanie Baby era. The Beanie Baby 00:18:32.039 --> 00:18:34.359 era. You were buying a rare collectible from 00:18:34.359 --> 00:18:37.720 User 123 in Nebraska. You're in New York. You 00:18:37.720 --> 00:18:39.599 have to send them a money order. A physical piece 00:18:39.599 --> 00:18:41.720 of paper representing cash. You had to go to 00:18:41.720 --> 00:18:43.359 the post office. Yeah, put it in the mail. And 00:18:43.359 --> 00:18:45.980 then you wait. And you just pray that User 123 00:18:45.980 --> 00:18:49.279 is a decent human being and will actually ship 00:18:49.279 --> 00:18:52.180 you the thing you paid for. That friction, that 00:18:52.180 --> 00:18:55.579 terror of being ripped off, was a massive limit 00:18:55.579 --> 00:18:58.380 on the growth of e -commerce. You couldn't build 00:18:58.380 --> 00:19:00.380 a real marketplace on blind faith. You might 00:19:00.380 --> 00:19:02.359 buy a $10 book, but you're not going to buy a 00:19:02.359 --> 00:19:05.259 $2 ,000 vintage guitar that way. No chance. So 00:19:05.259 --> 00:19:07.759 internet escrow was born to solve this exact 00:19:07.759 --> 00:19:10.720 problem. Right. Companies like escrow .com, which 00:19:10.720 --> 00:19:13.039 the source says was founded by Fidelity National 00:19:13.039 --> 00:19:16.579 Financial way back in 1999, they basically digitized 00:19:16.579 --> 00:19:18.900 the scroll. They did. Walk us through the mechanics 00:19:18.900 --> 00:19:21.839 of a typical online escrow deal. Because it has 00:19:21.839 --> 00:19:24.119 that specific feature, the inspection period, 00:19:24.319 --> 00:19:26.480 that I think is the crucial innovation. Right. 00:19:27.079 --> 00:19:29.680 Step one, the buyer and seller agree on the price 00:19:29.680 --> 00:19:32.920 online. Step two, the buyer pays the escrow service. 00:19:33.859 --> 00:19:37.460 Very important. You do not pay the seller. And 00:19:37.460 --> 00:19:39.779 the service verifies the funds. They verify the 00:19:39.779 --> 00:19:41.900 funds are good. It's not a bounced check. It's 00:19:41.900 --> 00:19:44.440 not a stolen credit card. Then they notify the 00:19:44.440 --> 00:19:47.660 seller. We have the cash. It is safe. You are 00:19:47.660 --> 00:19:49.859 cleared to ship the item. So the seller is protected. 00:19:50.059 --> 00:19:51.980 They know they aren't shipping their valuable 00:19:51.980 --> 00:19:54.819 goods to a deadbeat. Exactly. So the seller ships 00:19:54.819 --> 00:19:57.880 the guitar. The buyer receives it. Now the clock 00:19:57.880 --> 00:20:00.420 starts on the inspection period. You agree to 00:20:00.420 --> 00:20:03.279 that ahead of time? Yes. Usually it's set to 00:20:03.279 --> 00:20:06.000 a specific number of days. Let's say 48 hours. 00:20:06.160 --> 00:20:08.839 So I have two days to open the box, play the 00:20:08.839 --> 00:20:11.099 guitar, make sure it's the real deal and not 00:20:11.099 --> 00:20:13.259 a counterfeit. And if you do nothing or if you 00:20:13.259 --> 00:20:16.059 log in and click accept, the money is automatically 00:20:16.059 --> 00:20:19.039 released to the seller. The deal is done. And 00:20:19.039 --> 00:20:21.180 if I open the box and it's just a brick with 00:20:21.180 --> 00:20:24.019 strings drawn on it? You log in and click reject. 00:20:24.730 --> 00:20:27.710 The money remains frozen in escrow. The process 00:20:27.710 --> 00:20:30.250 then guides you to ship the brick back to the 00:20:30.250 --> 00:20:32.329 seller. And once the seller gets it back. Once 00:20:32.329 --> 00:20:34.710 tracking shows it's been returned, the money 00:20:34.710 --> 00:20:37.170 is refunded to you. It neutralizes the risk for 00:20:37.170 --> 00:20:40.230 both sides. It effectively removes the risk of 00:20:40.230 --> 00:20:44.529 the classic take the money and run scam. But, 00:20:44.529 --> 00:20:47.450 and this is a huge but, the scammers are smart. 00:20:47.789 --> 00:20:50.880 They adapted. This is the bogus escrow section 00:20:50.880 --> 00:20:53.420 of the outline. This is truly insidious stuff. 00:20:53.599 --> 00:20:56.099 It is. Scammers realized that people were learning 00:20:56.099 --> 00:20:58.619 to trust the word escrow. So they thought, well, 00:20:58.640 --> 00:21:00.319 let's just create our own. They started setting 00:21:00.319 --> 00:21:03.680 up fake escrow websites. How do you even spot 00:21:03.680 --> 00:21:06.559 a fake? It's incredibly hard. They copy the logos 00:21:06.559 --> 00:21:09.339 and the design of legitimate companies. They 00:21:09.339 --> 00:21:12.910 use all the right words. bonded, insured, secure. 00:21:13.250 --> 00:21:15.670 They create a beautiful, professional -looking 00:21:15.670 --> 00:21:18.130 website. So the scenario is, I'm trying to buy 00:21:18.130 --> 00:21:20.670 a car on Craigslist. The seller says, hey, I'm 00:21:20.670 --> 00:21:22.269 in the military and I'm stationed out of the 00:21:22.269 --> 00:21:24.750 country, but let's use this great escrow service 00:21:24.750 --> 00:21:27.230 to make sure we're both safe. Here is the link. 00:21:27.390 --> 00:21:30.029 And that is the number one red flag. Here is 00:21:30.029 --> 00:21:31.970 the link. If you click the link provided by the 00:21:31.970 --> 00:21:34.099 seller. You go to the fake site they control. 00:21:34.299 --> 00:21:36.500 And it looks real. It looks perfect. You register. 00:21:36.619 --> 00:21:39.380 You see instructions to wire money to their secure 00:21:39.380 --> 00:21:42.140 account. You wire the money. But you aren't wiring 00:21:42.140 --> 00:21:45.859 it to a neutral third party. You are wiring it 00:21:45.859 --> 00:21:48.819 directly to the scammer's bank account in another 00:21:48.819 --> 00:21:52.319 country. And once that wire transfer clears, 00:21:52.599 --> 00:21:55.920 the money is gone forever. The website disappears. 00:21:56.400 --> 00:21:59.500 The seller disappears. That is terrifying. So 00:21:59.500 --> 00:22:03.889 the advice from the source is... To verify. Always, 00:22:03.889 --> 00:22:07.130 never, ever trust the link provided by the other 00:22:07.130 --> 00:22:09.289 party in the transaction. Do your own homework. 00:22:09.390 --> 00:22:11.190 Do your own homework. If they say, let's use 00:22:11.190 --> 00:22:14.390 escrow .com, don't click their link. Open a new 00:22:14.390 --> 00:22:16.569 browser window, go to Google, search for the 00:22:16.569 --> 00:22:18.549 official site yourself. And check the government 00:22:18.549 --> 00:22:20.930 registry. That's the most important step. These 00:22:20.930 --> 00:22:23.190 companies have to be licensed. In the U .S., 00:22:23.190 --> 00:22:25.849 it's a state -by -state thing. California, Arizona, 00:22:26.230 --> 00:22:29.029 Idaho, they have specific licenses for internet 00:22:29.029 --> 00:22:31.650 escrow. In California, it's the Department of 00:22:31.650 --> 00:22:33.470 Business Oversight. You can look them up online. 00:22:33.670 --> 00:22:35.369 You can go to the government website and search 00:22:35.369 --> 00:22:37.630 for the company by name. If they're not on that 00:22:37.630 --> 00:22:39.710 official list, do not send them a penny. It's 00:22:39.710 --> 00:22:41.650 a regulatory patchwork in the U .S., isn't it? 00:22:41.809 --> 00:22:44.569 Very fragmented. It really is. The federal government 00:22:44.569 --> 00:22:47.589 doesn't have a single unified license for this. 00:22:47.710 --> 00:22:50.549 It's incredibly fragmented, which can be confusing. 00:22:50.950 --> 00:22:53.549 Now compare that to Europe. The EU seems to have 00:22:53.549 --> 00:22:56.619 streamlined this quite a bit. They did. In 2009, 00:22:56.880 --> 00:22:59.000 the EU passed something called the Payment Services 00:22:59.000 --> 00:23:02.079 Directive. It basically harmonized the rules 00:23:02.079 --> 00:23:04.160 for these kinds of services across the entire 00:23:04.160 --> 00:23:06.779 continent. And what was the impact of that? It 00:23:06.779 --> 00:23:10.000 allowed for very low -cost escrow services to 00:23:10.000 --> 00:23:12.700 operate across the entire EU. The source mentions 00:23:12.700 --> 00:23:15.440 the cost difference. In the old days, for a big 00:23:15.440 --> 00:23:17.660 international transaction, you'd need a bank 00:23:17.660 --> 00:23:20.339 letter of credit. Which is very expensive. Thousands 00:23:20.339 --> 00:23:22.779 of euros sometimes. The directive made it possible 00:23:22.779 --> 00:23:24.440 for services to do the same thing for cents. 00:23:24.910 --> 00:23:27.509 It democratized trust. It made it possible to 00:23:27.509 --> 00:23:29.670 use escrow for smaller everyday transactions, 00:23:29.849 --> 00:23:32.490 not just huge corporate mergers. Which brings 00:23:32.490 --> 00:23:34.970 us to a different kind of asset. We've talked 00:23:34.970 --> 00:23:37.490 about physical things, houses, cars, guitars, 00:23:37.750 --> 00:23:40.829 but we live in an information economy. Section 00:23:40.829 --> 00:23:43.809 five, intellectual property and source code. 00:23:43.990 --> 00:23:46.569 This is a huge area that most consumers never 00:23:46.569 --> 00:23:50.150 see. But it is absolutely critical for keeping 00:23:50.150 --> 00:23:52.789 the business world running. The black box problem. 00:23:53.130 --> 00:23:57.430 Exactly. Imagine you are a massive bank. You 00:23:57.430 --> 00:24:00.930 rely on a specific software platform to run all 00:24:00.930 --> 00:24:03.410 of your checking accounts. It's the core of your 00:24:03.410 --> 00:24:06.049 business. And you buy a license for that software 00:24:06.049 --> 00:24:09.509 from a small, brilliant startup in Silicon Valley. 00:24:09.710 --> 00:24:13.799 So software as a service. Right. You don't own 00:24:13.799 --> 00:24:16.180 the software. You just rent it. You get the object 00:24:16.180 --> 00:24:18.259 code, the compiled program that runs. You do 00:24:18.259 --> 00:24:21.160 not get the source code, the human readable instructions, 00:24:21.519 --> 00:24:23.519 the secret recipe. Because that's the startup's 00:24:23.519 --> 00:24:25.400 most valuable asset. They're never going to give 00:24:25.400 --> 00:24:28.720 that to me. Exactly. But now. As the bank, you 00:24:28.720 --> 00:24:31.240 have a massive risk. What if that startup goes 00:24:31.240 --> 00:24:33.519 bust? What if they run out of cash and just shut 00:24:33.519 --> 00:24:35.640 down their servers next Tuesday? My bank's checking 00:24:35.640 --> 00:24:38.299 account stopped working. My customers would panic. 00:24:38.380 --> 00:24:40.420 It would be a catastrophe. And you can't fix 00:24:40.420 --> 00:24:42.119 it because you don't have the recipe. You are 00:24:42.119 --> 00:24:44.839 locked out of the black box. So source code escrow. 00:24:44.940 --> 00:24:47.559 It's an insurance policy, a very specific one. 00:24:47.819 --> 00:24:50.650 The startup agrees. as part of their contract 00:24:50.650 --> 00:24:53.329 with the bank, to deposit a copy of their source 00:24:53.329 --> 00:24:56.670 code with a neutral third -party escrow agent. 00:24:56.910 --> 00:24:59.009 And they keep it updated. Every time they release 00:24:59.009 --> 00:25:01.029 a new version of the software, they have to update 00:25:01.029 --> 00:25:03.150 the deposit in the vault. And it just sits there. 00:25:03.309 --> 00:25:05.789 It sits there, encrypted and untouched. Yeah. 00:25:05.849 --> 00:25:08.109 Unless a trigger event happens. A trigger event. 00:25:08.250 --> 00:25:10.950 What's that? The contract defines these triggers 00:25:10.950 --> 00:25:14.069 very carefully. Things like if the startup declares 00:25:14.069 --> 00:25:17.430 Chapter 7 bankruptcy. Or if the startup fails 00:25:17.430 --> 00:25:19.990 to provide technical support for more than 72 00:25:19.990 --> 00:25:23.750 consecutive hours. Or even if the key personnel, 00:25:24.049 --> 00:25:26.829 the main developers, die or leave the company. 00:25:27.069 --> 00:25:29.170 If one of those triggers is pulled, the escrow 00:25:29.170 --> 00:25:31.869 agent breaks the glass. They're authorized to 00:25:31.869 --> 00:25:33.769 release the source code to the bank. So the bank 00:25:33.769 --> 00:25:36.529 can then hire its own engineers to read the code, 00:25:36.630 --> 00:25:39.650 fix bugs, and keep the system running. It's a 00:25:39.650 --> 00:25:42.289 business continuity plan. It prevents the customer 00:25:42.289 --> 00:25:44.829 from being held hostage by the vendor's failure. 00:25:45.339 --> 00:25:47.460 And the sources point out this applies to a lot 00:25:47.460 --> 00:25:49.920 more than just software code. Oh, yeah. It's 00:25:49.920 --> 00:25:52.900 called information escrow, more broadly. So what 00:25:52.900 --> 00:25:54.900 else can you put in there? Industrial designs, 00:25:55.359 --> 00:25:58.180 chemical formulas, manufacturing blueprints, 00:25:58.319 --> 00:26:02.400 lab notebooks, even creative work. The outline 00:26:02.400 --> 00:26:04.660 mentions TD scripts and musical compositions. 00:26:04.740 --> 00:26:06.700 Right. There's something called the International 00:26:06.700 --> 00:26:09.859 Creative Registry. Think about if you're a screenwriter. 00:26:10.180 --> 00:26:12.970 You write a brilliant script for a movie. You 00:26:12.970 --> 00:26:15.269 go pitch it to a big Hollywood studio. And they 00:26:15.269 --> 00:26:17.930 say, no thanks, we'll pass. They pass. Five years 00:26:17.930 --> 00:26:20.589 later, they release a blockbuster movie that 00:26:20.589 --> 00:26:23.049 looks suspiciously like your script. And you 00:26:23.049 --> 00:26:25.349 want to sue them, but they just say, nope, we 00:26:25.349 --> 00:26:27.049 developed this internally, we never saw your 00:26:27.049 --> 00:26:29.289 script. It's your word against their army of 00:26:29.289 --> 00:26:33.450 lawyers. Unless you used escrow. If you deposited 00:26:33.450 --> 00:26:35.589 your script with a registry before you ever pitched 00:26:35.589 --> 00:26:38.900 it, you have third -party timestamp proof. Here's 00:26:38.900 --> 00:26:41.359 the script dated and sealed by an independent 00:26:41.359 --> 00:26:44.079 agent from five years ago. It's a time capsule, 00:26:44.200 --> 00:26:47.099 a notarized time capsule that establishes your 00:26:47.099 --> 00:26:50.000 rights and the date of creation. Okay, we are 00:26:50.000 --> 00:26:52.119 moving up the food chain now to the absolute 00:26:52.119 --> 00:26:55.480 peak of high finance. Section six, corporate 00:26:55.480 --> 00:26:58.720 mergers and acquisitions, M &A. This is where 00:26:58.720 --> 00:27:01.809 the numbers just get silly. We're talking hundreds 00:27:01.809 --> 00:27:04.490 of millions, even billions of dollars. When company 00:27:04.490 --> 00:27:07.250 A buys company B, it's not like buying a used 00:27:07.250 --> 00:27:10.210 car. The due diligence process is insane. It 00:27:10.210 --> 00:27:12.890 takes months, sometimes years. Yeah. But even 00:27:12.890 --> 00:27:15.430 with all that checking, there is always a risk. 00:27:15.589 --> 00:27:18.309 The seller makes certain promises. They say, 00:27:18.309 --> 00:27:21.309 we have no lawsuits pending against us. That 00:27:21.309 --> 00:27:24.250 is called a warranty. But promises can be broken, 00:27:24.390 --> 00:27:27.069 or people can just be wrong without knowing it. 00:27:27.190 --> 00:27:29.650 Exactly. So the buyer asks for an indemnity. 00:27:30.009 --> 00:27:32.430 which basically means if it turns out you were 00:27:32.430 --> 00:27:34.569 wrong about that promise, you have to pay me 00:27:34.569 --> 00:27:36.630 back for any damage it causes. But if I've already 00:27:36.630 --> 00:27:38.789 paid you a billion dollars for your company and 00:27:38.789 --> 00:27:40.630 you've distributed all that money to your shareholders, 00:27:40.930 --> 00:27:42.869 how am I possibly going to get it back from you? 00:27:43.029 --> 00:27:44.549 You can't. It's like trying to put toothpaste 00:27:44.549 --> 00:27:47.809 back in the tube. It's gone. So big M &A deals 00:27:47.809 --> 00:27:50.630 almost always use a holdback. A holdback. They 00:27:50.630 --> 00:27:53.569 put a chunk of the purchase price, maybe 10 or 00:27:53.569 --> 00:27:56.349 15 percent, so it could be $100 million, into 00:27:56.349 --> 00:27:58.289 an escrow account instead of paying it to the 00:27:58.289 --> 00:28:00.480 seller at closing. For how long does it sit there? 00:28:00.720 --> 00:28:03.220 Usually for an extended period, like 12 to 24 00:28:03.220 --> 00:28:05.759 months after the deal closes. It just sits there. 00:28:06.420 --> 00:28:09.779 If a surprise lawsuit pops up or a tax audit 00:28:09.779 --> 00:28:12.259 from three years ago goes bad. The buyer can 00:28:12.259 --> 00:28:14.940 make a claim. The buyer can take the money to 00:28:14.940 --> 00:28:17.079 cover the damages straight from that escrow account. 00:28:17.559 --> 00:28:19.619 They don't have to chase a seller and try to 00:28:19.619 --> 00:28:22.700 sue them. It's leverage and security. It is. 00:28:23.140 --> 00:28:25.359 But when you have $100 million just sitting in 00:28:25.359 --> 00:28:27.880 a bank account for two years, new problems arise. 00:28:28.589 --> 00:28:30.990 Interest. Oh, right. $100 million earns a decent 00:28:30.990 --> 00:28:32.970 amount of interest. Millions of dollars in interest. 00:28:33.049 --> 00:28:35.609 So the lawyers have to fight and negotiate over 00:28:35.609 --> 00:28:37.769 who gets the interest. Does it go to the buyer, 00:28:37.890 --> 00:28:41.029 the seller? Do they split it? It's a huge point 00:28:41.029 --> 00:28:43.910 of contention. And the credit worthiness of the 00:28:43.910 --> 00:28:46.490 bank holding the money? That's a huge point in 00:28:46.490 --> 00:28:48.950 the research. You don't want to escrow your $100 00:28:48.950 --> 00:28:50.990 million holdback in a bank that might collapse 00:28:50.990 --> 00:28:53.029 next year. No. So they fight over which financial 00:28:53.029 --> 00:28:55.299 institution. gets to be the agent. They have 00:28:55.299 --> 00:28:58.140 to be rock solid. There is one more legal use 00:28:58.140 --> 00:28:59.980 case here that I think affects a lot of normal 00:28:59.980 --> 00:29:05.160 people. Class action lawsuits. Yes. We've all 00:29:05.160 --> 00:29:07.140 gotten those emails or postcards in the mail. 00:29:07.559 --> 00:29:10.700 If you bought this specific brand of milk in 00:29:10.700 --> 00:29:14.240 2014, you may be entitled to a settlement of 00:29:14.240 --> 00:29:18.140 $1 .50. And usually I just ignore them, but someone 00:29:18.140 --> 00:29:20.480 has to manage that whole process. Imagine you're 00:29:20.480 --> 00:29:23.210 the company that got sued. You agree to settle 00:29:23.210 --> 00:29:26.529 the case for, say, $50 million. Okay. You do 00:29:26.529 --> 00:29:28.150 not want to be in the business of mailing out 00:29:28.150 --> 00:29:30.410 10 million checks for $1 .50. You want to watch 00:29:30.410 --> 00:29:32.809 your hands of it and move on. You want finality. 00:29:33.009 --> 00:29:36.150 So you wire the entire $50 million to a qualified 00:29:36.150 --> 00:29:38.589 settlement fund, which is basically just a big 00:29:38.589 --> 00:29:41.369 escrow arrangement. Once that wire hits, the 00:29:41.369 --> 00:29:43.789 defendant is out. They are done. Their part is 00:29:43.789 --> 00:29:46.839 over. And the escrow agent or the fund administrator 00:29:46.839 --> 00:29:48.900 deals with the whole headache. They're the ones 00:29:48.900 --> 00:29:51.240 who have to find all the claimants, process the 00:29:51.240 --> 00:29:53.579 forms, deal with disputes and cut all the checks. 00:29:53.799 --> 00:29:56.099 And often they pay themselves their administrative 00:29:56.099 --> 00:29:58.799 fees right out of that fund. It separates the 00:29:58.799 --> 00:30:01.660 punishment from the logistics. Correct. And finally, 00:30:01.680 --> 00:30:04.420 in this section, we can't talk about stakes without 00:30:04.420 --> 00:30:06.559 talking about the origin of the term stakeholder. 00:30:07.420 --> 00:30:09.839 Gambling. The oldest form of risk, probably. 00:30:09.900 --> 00:30:12.680 If you and I bet $50 on the Super Bowl and we 00:30:12.680 --> 00:30:14.359 don't really trust each other to pay up. We give 00:30:14.359 --> 00:30:17.980 the money to a third guy. A neutral friend. The 00:30:17.980 --> 00:30:21.319 stakeholder. He holds the stakes. It's the purest 00:30:21.319 --> 00:30:24.140 form of escrow there is. It is. And it highlights 00:30:24.140 --> 00:30:26.640 the golden rule of the escrow agent, which brings 00:30:26.640 --> 00:30:30.079 us to the fine print section. The agent must 00:30:30.079 --> 00:30:33.400 be absolutely, completely neutral. Neutrality 00:30:33.400 --> 00:30:36.180 is key. The agent cannot care who wins the Super 00:30:36.180 --> 00:30:39.119 Bowl. They cannot care if the M &A deal goes 00:30:39.119 --> 00:30:41.619 through or falls apart. They only care about 00:30:41.619 --> 00:30:45.059 the written instructions. If Team A wins, pay 00:30:45.059 --> 00:30:48.579 Bob. That's it. They're a robot made of law. 00:30:48.799 --> 00:30:51.559 But what if the robot messes up? Being an escrow 00:30:51.559 --> 00:30:53.740 agent sounds incredibly stressful if you lose 00:30:53.740 --> 00:30:55.619 the money or send a million dollars to the wrong 00:30:55.619 --> 00:30:58.420 person. The liability is tricky. You would think 00:30:58.420 --> 00:31:00.640 they are held to the absolute highest legal standard, 00:31:00.740 --> 00:31:04.180 like a trustee. But the source points out. that 00:31:04.180 --> 00:31:07.000 many escrow contracts try to limit the agent's 00:31:07.000 --> 00:31:11.339 liability to just gross negligence. So an honest 00:31:11.339 --> 00:31:14.460 mistake, a simple screw -up, might be forgiven. 00:31:14.680 --> 00:31:17.099 It depends on the contract and the local laws. 00:31:17.660 --> 00:31:21.180 But they often include indemnity and hold harmless 00:31:21.180 --> 00:31:23.640 clauses. What does that mean? It basically says, 00:31:23.819 --> 00:31:26.359 if the buyer and seller get into a lawsuit with 00:31:26.359 --> 00:31:28.920 each other over this deal, leave me out of it. 00:31:28.980 --> 00:31:31.119 And if you try to drag me into it, you have to 00:31:31.119 --> 00:31:33.259 pay all my legal fees. They protect themselves 00:31:33.259 --> 00:31:36.460 first. They have to. But the one thing they absolutely 00:31:36.460 --> 00:31:39.380 cannot do, the thing that will send an escrow 00:31:39.380 --> 00:31:42.200 agent to jail, is commingling. Explain that. 00:31:42.279 --> 00:31:45.200 What is commingling? You cannot mix the client's 00:31:45.200 --> 00:31:47.019 money with your own business operating money. 00:31:47.140 --> 00:31:49.819 Ever. You can't use the money in the escrow account 00:31:49.819 --> 00:31:52.140 to pay your office rent for the month, even if 00:31:52.140 --> 00:31:53.980 you fully intend to put it back next week. The 00:31:53.980 --> 00:31:56.240 money has to remain sacred. It has to be separated. 00:31:56.599 --> 00:31:58.779 The moment you touch that client money for your 00:31:58.779 --> 00:32:01.730 own use, you have committed theft. It has to 00:32:01.730 --> 00:32:04.069 stay in the escrow area, just like the quarters 00:32:04.069 --> 00:32:06.630 in the vending machine. So we've gone from the 00:32:06.630 --> 00:32:10.009 medieval scroll, the escrow, all the way to the 00:32:10.009 --> 00:32:13.430 coin suspended in the soda machine, to the massive 00:32:13.430 --> 00:32:16.789 impound accounts for our property taxes, to the 00:32:16.789 --> 00:32:19.569 source code vaults of Silicon Valley. It's quite 00:32:19.569 --> 00:32:21.609 a journey. It's a journey through the architecture 00:32:21.609 --> 00:32:24.630 of trust itself. When you step back and you look 00:32:24.630 --> 00:32:27.509 at this whole landscape, what is the big takeaway 00:32:27.509 --> 00:32:30.069 for you? What's the core theme? For me, it's 00:32:30.069 --> 00:32:33.289 the realization that trust in a complex modern 00:32:33.289 --> 00:32:36.390 society isn't a feeling. It's not an emotion. 00:32:36.930 --> 00:32:39.089 It's a mechanism. It's an engineered system. 00:32:39.210 --> 00:32:41.549 An engineered system. We can't rely on knowing 00:32:41.549 --> 00:32:44.630 everyone personally anymore. We trade with people 00:32:44.630 --> 00:32:46.450 we will never meet who live on the other side 00:32:46.450 --> 00:32:48.569 of the planet. So we have to outsource the trust. 00:32:48.950 --> 00:32:51.779 We build a neutral zone. We build systems, whether 00:32:51.779 --> 00:32:53.819 it's a simple machine, a law firm, or a complex 00:32:53.819 --> 00:32:56.539 bank, that are designed to hold the pieces until 00:32:56.539 --> 00:32:58.799 the puzzle is complete. It's what allows the 00:32:58.799 --> 00:33:01.380 economy to function at scale without everyone 00:33:01.380 --> 00:33:03.539 needing to be best friends. It's the lubricant 00:33:03.539 --> 00:33:06.220 of capitalism. It really is. Without it, the 00:33:06.220 --> 00:33:08.420 gears would grind to a halt. I want to leave 00:33:08.420 --> 00:33:11.039 the listener with a thought today. We are moving 00:33:11.039 --> 00:33:13.640 very quickly into a world of smart contracts, 00:33:13.940 --> 00:33:16.839 of blockchain, of crypto, and we hear this word 00:33:16.839 --> 00:33:21.150 all the time. Trustless systems. Code is law. 00:33:21.529 --> 00:33:24.609 That's the mantra. Exactly. And in a way, a smart 00:33:24.609 --> 00:33:27.390 contract is just a fully automated escrow agent. 00:33:27.630 --> 00:33:30.569 It holds the digital assets and releases them 00:33:30.569 --> 00:33:32.589 automatically when the code says the conditions 00:33:32.589 --> 00:33:34.589 are met. The ultimate vending machine. The ultimate 00:33:34.589 --> 00:33:37.410 vending machine. But it raises a really profound 00:33:37.410 --> 00:33:42.849 question for me. If the code is the agent, who 00:33:42.849 --> 00:33:46.210 audits the code? Who is holding the scroll when 00:33:46.210 --> 00:33:48.450 the scroll is writing itself? That is the billion 00:33:48.450 --> 00:33:50.569 -dollar question for the next decade, isn't it? 00:33:50.630 --> 00:33:52.690 If there's a bug in the escrow code, there was 00:33:52.690 --> 00:33:54.950 no manager to call. There's no court to appeal 00:33:54.950 --> 00:33:57.250 to. Something to mull over the next time you 00:33:57.250 --> 00:33:59.329 put a quarter in a slot and wait for that clunk? 00:33:59.869 --> 00:34:02.170 Thanks for diving deep with us today. My pleasure, 00:34:02.250 --> 00:34:03.809 as always. We'll see you on the next one. Stay 00:34:03.809 --> 00:34:04.089 curious.