Felix Salmon

Why Bill Gross’s mistake is excusable

Felix Salmon
Aug 31, 2011 22:01 UTC

Commenter Stevensaysyes asks if I could reassess my take on Pimco’s Total Return Fund, given its underwhelming performance year-to-date. Always happy to take requests!

So, first, and most obviously, you’d have to be an idiot to exit the Total Return Fund on the basis of its performance over the past nine months. This is a long-term investment vehicle, and has still comfortably outperformed nearly all of its peers over any reasonably long-term time horizon. Everybody is human, even Bill Gross, and Gross is more than happy to fess up to his mistakes and learn from them.

But of course it’s also important to look at exactly what Gross’s mistake was, and whether it was stupid or reasonable. And the answer is that it probably falls in the “reasonable” category.

The big picture here is that the Total Return Fund does what it says on the tin: it’s a fixed-income fund which tries to maximize the total return to investors. Fixed-income instruments come with a certain yield; all else being equal, the higher the yield, the higher the return to investors. And as a rule, Treasury bonds have the lowest yield of any fixed-income instruments. As a result, then, you’d expect the Total Return Fund, in normal times, to own no Treasury bonds at all.

When bond investors turn bearish, they do a couple of things. One is to reduce duration: sell bonds with long maturities and buy bonds with shorter maturities, which are safer. And the other is to reduce credit risk: to sell riskier bonds which are more likely to default, and buy safer bonds which are less likely to default. The safest bonds of all, in this respect, are Treasuries, which is why Treasuries tend to rally when the rest of the market is falling or bearish.

Buying Treasuries, then, is not something you should do every time you think they’re going to rise in value. If there’s a broad-based environment of falling interest rates, with yields on corporate bonds falling at the same rate as yields on Treasuries, then you’re still better off in the higher-yielding corporate bonds than you are in Treasuries.

So the only time that you’re wrong to sell out of Treasuries is in advance of a time when rates fall even as spreads rise. Holding corporate bonds makes sense over the long term, but in the short term, if credit spreads are rising, that’s likely to mean that prices are going down and you would have been better off waiting to buy. And, according to a handy S&P research note from earlier this month, credit spreads have been rising for most of this year.


This chart, in a nutshell, is why Gross’s decision was a bad one — he didn’t expect spreads to rise nearly as far or as fast as they did. And they did so in exactly the worst way possible for Gross — as Treasury yields were falling. Here’s what’s happened since the beginning of July:


That’s the kind of environment you very much want to be long rates and short credit — the one environment where owning lots of Treasury bonds makes you look smart.

Over the long term, though, I’d rather my bond-fund manager erred on the side of credit rather than on the side of caution. Pimco is one of the few fixed-income investors which does a huge amount of credit research; it should take advantage of that, and buy bonds which are trading cheap compared to their probability of default. Yes, it should play the rates game too. But as a general rule, if I want to maximize my total return, I don’t want to be holding vast quantities of low-yielding Treasury bonds. Gross is guilty of bad timing here. But I don’t for a minute think that this is the beginning of the end of the legend of Bill Gross, bond-market guru. Especially since he’s managed to do the one thing asked of all fixed-income managers, which is preserve value. His fund might be up less than those of some of his peers. But it’s still up for the year. Which counts for something.


Both short-term maturity bonds and long-term maturity bonds are out of favor as the economy presently stagnates. The result both the value and the yield is down.

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Do companies pay their CEOs more than they pay in taxes?

Felix Salmon
Aug 31, 2011 18:28 UTC

You might well have seen, this morning, the news that 25 of the 100 highest paid US CEOs earned more last year than their companies paid in federal income tax. The Reuters version of the story was linked to by the WSJ and retweeted by David Leonhardt; the NYT version already has 120 comments. Both versions, it seems, were based on embargoed copies of this report from the Institute for Policy Studies; because the reporters were given a copy of the report before it went up online, they were unable to link to it from their stories.

But if you do manage to find the IPS website and follow the links to download the full 46-page report, you’ll see that there’s less to it than meets the eye. Certainly it doesn’t come close to demonstrating that its title — “The Massive CEO Rewards for Tax Dodging” is justified. Yes, CEOs get paid vast sums of money. And yes, a lot of corporations pay very little in taxes. But what the report doesn’t do is demonstrate that CEOs who reduce their corporate tax rates get paid more. This kind of thing, from the NYT story, notwithstanding:

The authors of the study, which examined the regulatory filings of the 100 companies with the best-paid chief executives, said that their findings suggested that current United States policy was rewarding tax avoidance rather than innovation.

There are lots of ways that the authors of the study could have tried to back up that assertion. For instance, they could have taken a set of CEOs and split them into two groups: those who are paid more than their companies pay in taxes in Group A, and those who are paid less than their companies pay in taxes in Group B. Then they could have compared whether CEO salaries in Group A were higher than CEO salaries in Group B.

But they didn’t do that.

Instead, they did this:

Of last year’s 100 highest-paid corporate chief executives in the United States, 25 took home more in CEO pay than their company paid in 2010 federal income taxes.

These 25 CEOs averaged $16.7 million, well above last year’s $10.8 million average for S&P 500 CEOs.

Do you see what they did there? The initial set of CEO was the 100 highest-paid CEOs in the country. They then took 25 of those CEOs, and instead of comparing their pay to the pay of the other 75 CEOs in the group, they compared their pay to the average pay for a CEO in the S&P 500. This proves nothing: any subset of the 100 highest-paid CEOs in the country is going to have higher average pay than S&P 500 CEOs in general.

As for the central conceit of the paper — the one which made the Reuters and NYT headlines — that’s pretty silly too. 25 CEOs make more than their companies pay in taxes? Wow! Except, it turns out that only five of those 25 companies are paying any taxes at all, by IPS methodology. The lowest-paid janitor, at those 25 companies, makes more than the company pays in taxes. The driving force behind the IPS result is entirely a function of how IPS calculates the corporate effective tax rate, and the ease with which that can go negative. It has nothing at all to do with CEO pay. (The IPS ignores deferred taxes, which is justifiable; it ignores taxes paid to foreign governments, which is less so, in an era of global corporations operating in dozens or even hundreds of tax jurisdictions.)

This is one good reason, then, for every news organization to link to reports they’re writing about — doing so gives their readers the opportunity to see for themselves whether the report stands up to scrutiny. After all, the world of embargoed reports is clever that way. If you’re a think tank, you send them out to lots of journalists. Some will look at them and see little news there; they will ignore the report. Others will buy it, and write the report up. So the only stories you see about the report are from journalists who buy into its thesis. That’s a bias right there. And always linking to the report is one good way of helping readers and news organizations overcome that bias.


hsvkitty, it is called an annual report. Of course if you had more than two brain cells to rub together you’d already know that.

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Justice makes the right decision on AT&T

Felix Salmon
Aug 31, 2011 16:14 UTC

The Justice Department’s official complaint seeking to stop AT&T from taking over T-Mobile minces no words:

T-Mobile in particular – a company with a self-described “challenger brand,” that historically has been a value provider, and that even within the past few months had been developing and deploying “disruptive pricing” plans – places important competitive pressure on its three larger rivals, particularly in terms of pricing, a critically important aspect of competition… unless this acquisition is enjoined, customers of mobile wireless telecommunications services likely will face higher prices, less product variety and innovation, and poorer quality services due to reduced incentives to invest than would exist absent the merger. Because AT&T’s acquisition of T-Mobile likely would substantially lessen competition in violation of Section 7 of the Clayton Act, 15 U.S.C. § 18, the Court should permanently enjoin this acquisition.

One thing which fascinates me is the way in which neither the complaint nor the press release makes any mention of the fact that the proposed deal would give the merged company substantially all of the market in GSM cellphones — the only ones which work in most of the rest of the world. Americans who travel internationally pretty much have to get their cellphone service from one of these two providers — and they’re highly sensitive to exorbitant international roaming fees. Which would almost certainly go up in the event of this merger.

The noises coming from the FCC in the wake of this suit are supportive, with FCC chairman Julius Genachowski saying that he too has “serious concerns about the impact of the proposed transaction on competition.” He adds for good measure that “vibrant competition in wireless services is vital to innovation, investment, economic growth and job creation, and to drive our global leadership in mobile.”

AT&T hasn’t officially given up, but I can’t see it winning this particular fight with the law. This, then, is a good day for the American consumer, not to mention a great day for Sprint and Verizon. AT&T and T-Mobile have both put enormous amounts of management time and shareholders’ money into putting this merger together, all of which will now be for naught. Rather than fight the inevitable, they should go back to fighting each other where it matters: in the marketplace.


@Keng_CA says “All this talk about T-Mo doing horribly is not true – they just weren’t performing as well as DT likes.”

T-Mobile has not had an RoE above 7.1% in any year since 2006. For the last 12 months it has been 4.1%. For comparison, AT&T and Verizon (and indeed almost any healthy company) have RoE in the teens.

If you were a manager or shareholder of Deutsche Telekom, how would you justify investing the $3B settlement in a business that is returning 4-7% rather than distributing it to shareholders or finding a better use for the capital?

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Will AOL go private?

Felix Salmon
Aug 31, 2011 13:54 UTC

Some companies are in growth businesses; the stock market, as a rule, tends to love them. Other companies are in an inexorable secular decline; they tend to get punished by equity investors. There’s a good reason for that: stock-market investors are looking for stocks which go up over time, rather than stocks which are going to zero while paying out as much in dividends as they can along the way.

If you want an example of a business which is in a certain secular decline, it’s hard to come up with a better one than AOL’s hugely profitable dial-up business. And so it makes a lot of sense that, as Claire Atkinson reports today, AOL is looking at the idea of going private — perhaps with a sale to KKR. This is not a particularly revolutionary idea: Jonathan Berr has pushed it, and Bloomberg called it AOL’s “last, best hope”. AOL is on the record as having hired the most high-powered M&A advisors in the world; they’re no idiots, and only idiots wouldn’t look at a buy-out option for a company trading at a significant discount to its book value.

If I were a potential private-equity buyer, though, I’d do a sum-of-the-parts analysis and rapidly come to the conclusion that Tim Armstrong’s strategy is too much risk for too little potential reward. Take AOL, and sell off the non-core assets — things like Moviefone, MapQuest, AIM, and Advertising.com. What’s left? The AOL/HuffPo traffic-and-content monster, on the one hand, and the dial-up business, on the other. Armstrong’s idea is that you use the cashflows from the latter to beef up the former, so that when the dial-up revenue eventually disappears, the dial-up caterpillar has transformed itself into a glorious web-publishing butterfly. (Sorry, MSN.)

The problem is that the transformation from caterpillar to butterfly is extremely inefficient — there’s a lot of work and energy involved, to achieve a result which can be fleeting and fragile.

Now private-equity shops are actually a good place to quietly work hard on putting exactly that kind of strategy into effect. Without being distracted by the need to produce strong quarterly results, executives can concentrate on building businesses which are going to be worth lots of money over the long term.

But there’s no precedent for the idea that throwing hundreds of millions of dollars at a web content company will make it big and strong and self-sufficient. Expensive web content is expensive, especially when you’re trying to build out a network of thousands of locally-staffed sites. Meanwhile, profitable websites tend to be run on the cheap — including HuffPo, before it was bought by AOL. If I wanted to make a long-term for-profit investment in a website built on the genius of Jonah Peretti, I’d choose BuzzFeed over HuffPo any day.

So the ruthless logic of the market would seem to imply that the best thing to do with the dial-up business and the content business is to tear them apart. The dial-up business, on its own, is ripe for a managed decline, where you extract as much money as possible before it finally dies. Private equity companies do that kind of thing very well.

Meanwhile, the content business is still attractive, to someone — probably Yahoo, is my guess.

There’s a lot of deals to be done here, then. But the easy way to do it would be to simply sell all of AOL to KKR right now, at an attractive premium to the current share price. Then let KKR sell off all the content bits and pieces to Yahoo and/or others, leaving it with a dial-up business throwing off lots of juicy, high-margin cash.

Would Tim Armstrong do such a deal, though? That’s the big question. AOL’s share price — $15.68, this morning — is well below the $27 at which he took the company public at the end of 2009; his tenure there, if he sold the company for a price somewhere in the $20s, is likely to be considered a failure. So then it’s worth looking to how tough-minded AOL’s board is. Any insights on that front?


Hey they could make a ton of money off a reality show “Arianna and KKR” Imagine what it would be like to see those two try to work together.

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Nick Rizzo
Aug 31, 2011 12:43 UTC

The bounty that law firms pay for a Supreme Court clerk is up to $280,000. That’s a lot of money: more than any of the justices make, but less than Warren Buffett, whose Chief of Staff has the best business card ever.

Fox News’s Bill O’Reilly tried to get his wife’s boyfriend investigated by the police, Gawker claims.

Robert Shiller argues we can do stimulus without adding to debt.

Groupon’s unique visits fell 8.9% to 30.6 million in July, says Compete. LivingSocial saw an even faster decrease of 28% to 10.6 million.

Why the Fed needs to lead on payments

Felix Salmon
Aug 30, 2011 22:55 UTC

The US is often so big and lumbering that it lags well behind the rest of the world in terms of adopting new technology. Cellphones were one such; chip-and-pin technology on debit and credit cards is another. And more generally, as a comprehensive new Chicago Fed paper from Bruce Summers and Kirstin Wells shows, the US is and will for the foreseeable future lag most of the rest of the planet when it comes to immediate funds transfer, or IFT.

This is the problem that resulted in the founding of PayPal: the banks were so bad at doing anything about allowing people to send money to each other that they allowed PayPal to rise out of nowhere. And now there are roughly a gazillion startups like Dwolla and Square which also want in on the act. Even though the banks, if they just got their act together and put a basic and universal mechanism together, could put everybody else out of business pretty much overnight.

So, what are the chances of that happening? Slim to none, say Summers and Wells:

Within the last few years, IFT has become a fully functional nationwide means of payment in a number of countries, including four that we have examined in detail in this article. International experience with IFT shows that technology is a necessary but not sufficient condition for innovation in payments and that enabling real-time and universal access to deposit accounts at banks is the key to meeting the public’s needs for more certain, faster, and universal payment services. Perhaps the most critical enabling factor is strong sponsorship by a national body with the responsibility and motivation to stimulate continuous improvement in the national payment system. This body might be a consortium of private banks collaborating through a national payment association, a public authority such as the central bank, or a public–private partnership. It is not clear that such sponsorship can be readily found in the U.S., at least not at the present time, because there is no national body that takes responsibility for the development of the national payment system. As a consequence, IFT and other national payment innovations are likely to progress in a halting and incomplete manner and at a pace that lags innovation that is observable in other countries, such as those examined in this article.

What Summers and Wells don’t say, perhaps because they work for the Federal Reserve, is that it’s downright idiotic that the Fed doesn’t step up to the plate and take on its natural role as guardian of the national payment system. Why doesn’t it? I’m not sure, but I suspect it’s something to do with the fact that the Fed doesn’t really exist as a unified body: there’s just a network of regional federal reserve banks, with a board of governors in Washington.

Still, it’s about time that someone — if not the Chicago Fed, then either the New York Fed or the people in Washington — should take this issue seriously and start dragging America’s thousands of banks into the 21st Century. Because they’re not going to organize themselves. And that just means that the US is going to become more and more behind the times, in a world where everybody else is increasingly capable of transferring money immediately and securely to pretty much anybody they like.


New Technology Eases the Burden and Slashes the Cost of Peer to Peer Money Transfer

CHICAGO, Sept. 28, 2011- With the rise of the tech friendly society, one Chicago based business is changing the way people send money back and forth to each other. Payment Over Mobile Solutions (POMS) has developed a system to not only cut the burden that peer to peer (P2P) money transfer is traditionally accompanied by, but also cuts the cost anywhere from 50-80% for the consumer.

For generations, the staple in peer to peer money transfer has been methods like Western Union and Money Gram. With the shift of Americans to a more on-demand lifestyle, traditional money transferring will soon be taking the back seat with other relics of the pre-mobile tech era.

POMS is a new payment platform being developed in collaboration with key partners of the retail payment ecosystem. POMS will facilitate secure, real-time payments and services via web, mobile, or retail locations, giving consumers the most flexibility of any P2P system to-date.

“The problem with new startup payment companies and merchant solutions is the cost of technology. We have developed POMS utilizing legacy technology already in place at retail establishments across the country. By creating a turn-key software solution for our retail transaction processing partners, we have been able to keep the costs low and cut the financial, logistical, and time delay burden most consumers face with P2P money transfer today,” commented Rahier Rahman, Co-Founder and COO of POMS.

POMS will initially target the immigrant and underbanked demographics, particularly those who lack access to a payment card or are without a traditional banking relationship. There are approximately 80 million underbanked consumers in the U.S. This consumer segment receives approximately $1 trillion in annual income and relies heavily on cash for everyday transactions. POMS convenience store footprint dovetails well with the consumer’s retail activity at the local marketplaces leveling the playing field and serving as an alternative method to send and redeem P2P money transfers.

The POMS pilot program will be accepted at approximately 20,000 retail outlets across the United States including nationally recognized convenience stores which operate under brands like Shell, Chevron, Piggly Wiggly, and BP. “We are excited to receive such a positive reception from our partners who represent some of the leading retail convenience store brands across the nation. Working within their existing systems has been one of the top selling points for our scalable platform. We will be rolling out our test platform later this winter with much anticipation from merchants across the globe,” finished Rahman.

For more information on POMS technology including investor inquires, you can visit http://www.usepoms.com

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Why can’t the cost of flood insurance rise?

Felix Salmon
Aug 30, 2011 22:03 UTC

Ben Berkowitz has a big report on the the National Flood Insurance Program — something which is a veritable bucket of fail. In a nutshell, it undercuts private insurers and therefore is the only game in town; it insures only a small minority of homeowners; and it loses gobs of money. In September 2005, the NFIP was $1.5 billion in hock to the federal government; that number has now ballooned to $21 billion, and is certain to rise further.

There’s a simple answer to all these problems: let the NFIP raise its rates. And I don’t understand why it’s not being allowed to do so. If the rates rose, then that might allow private insurers into the flood-insurance game, giving consumers a choice and helping to get the word out about how insuring your home against flood damage is a really good idea. The NFIP could become profitable, and thereby start paying back all the money it owes. And while homeowners are quite price sensitive when it comes to flood insurance, the fact is that so few homeowners take out flood insurance right now that the number would be unlikely to fall dramatically if rates went up to a reasonable level.

The NFIP, then, is in a fundamentally much better place than, say, the Post Office, which is also losing billions of dollars but which doesn’t seem to have any way out of its present quandary. And I’m still very unclear on what the problem is here — what vested interests are preventing the NFIP from raising its rates. It’s not that people couldn’t afford flood insurance if the rates went up — the rates are very low right now, and in any case most people aren’t paying them anyway, with 95% of homes uninsured.

Are the 5% of homeowners who take out this insurance people with particular political clout, fighting hard and successfully to prevent even a modest increase in their modest premiums? Is the political opposition coming from legislators who don’t want to vote for anything which smells as though it might be related to global warming? Or is this just general low-level government dysfunction? Whatever it is, the problem seems to reside, weirdly, in the Senate rather than the House — a plan to allow NFIP to raise its rates has already passed the House by a vote of 406 to 22. If that lot can come to bipartisan agreement, what could possibly be the holdup here?


Anywhere near Marion County, pcFarmer?

http://www2.nbc4i.com/weather/2011/mar/0 5/flooding-central-ohio-ar-414531/

Does sound like your situation is borderline, though.

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Greece datapoints of the day

Felix Salmon
Aug 30, 2011 21:04 UTC

Nikos Tsafos has a fantastic post at his Greek Default Watch blog entitled “Ten Surprising Facts about the Greek Economy”. I normally hate listicles, but this one’s very good. For instance: it’s bad enough that Greek GDP won’t go back to its 2008 peak for the best part of a decade. But it’s worse that the two big drivers of Greece’s economy — tourism and shipping — are down 28% and 27% respectively in real terms since 2000.

Other parts of the list are equally surprising. Did you know that Greece’s 2011 budget deficit is just 40% of the size of its official tax arrears? Or that Greece has only really gone on a massive borrowing binge twice? Once between 1980 and 1993, and then again between 2007 and today. I, for one, didn’t know that Greece has the lowest level of private-sector debt in the eurozone — only about 150% of GDP, compared to well over twice that in Portugal.

One endgame for Greece is a managed departure from both the euro and the EU, with the ECB coming up with a mechanism for protecting depositors in Greek banks — George Soros, for one, says that “the Greek problem has been sufficiently mishandled by the European authorities that this may well be the best solution”. But that day is still a long way off. There’s no appetite in the EU generally for such a move, and even less in Greece. After all, the costs associated with ejection would be enormous — on the EU side for the bank deposit guarantees, and on the Greek side from the loss of all the benefits that come with EU membership. Meanwhile, the benefits on both sides are more amorphous and unpredictable. Argentina suddenly started growing after it devalued; Greece might not.

For the time being, then, the best we — and Greece — can hope for is more plans along the lines of “maybe if we tie two rocks together, they’ll float”. That, and continued austerity and stagnation. Joining the euro was, in hindsight, a really bad idea for Greece. But it’s one which is very unlikely to be reversed any time soon.


I would edit above sentence to say “Argentina, Indonesia, Malaysia, Thailand, Russia, Brazil, Mexico, the United States, the United Kingdom, Germany, Finland, Sweden, Norway, China and Italy suddenly started growing after they devalued, Greece might not.”

Further reading of Wikipedia would probably allow me to double the length of the list but those are just the ones I could think of off the top of my head.

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Steve Jobs’s philanthropy

Felix Salmon
Aug 30, 2011 16:26 UTC

Andrew Ross Sorkin takes a look at the private life of Apple’s chairman today, passing on rumors about activity he clearly doesn’t want publicized, in the face of stony silence from Apple. But hey, Sorkin’s a journalist, I guess that’s what journalists do.

The column is headlined “The Mystery of Steve Jobs’s Public Giving,” but really there’s no mystery at all: there is no public giving from Steve Jobs. Sorkin isn’t happy about this. “Most American billionaires have taken up philanthropy in a public way and helped inspire future generations of charitable giving,” he writes, concluding that “perhaps” in future years Jobs might “inspire his legions of admirers to give.”

Some of Sorkin’s points are good ones. There’s no good reason, for instance, for Jobs failing to reinstate Apple’s philanthropic programs, which he cut on the grounds of wanting “to restore the company’s profitability.” Similarly, Apple’s failure to match its employees’ charitable giving does make it stand out — and not in a good way — from its Silicon Valley peers.

I think this is maybe a downside of Jobs’s famous micromanaging: if he’s personally not interested in something, then his entire company becomes uninterested in it.

Now there are good reasons why Jobs might not be much of a philanthropist, at least in public. For one thing, it’s far from clear that seeing billionaires give away lots of money and put their names on hospital wings does any good at all in terms of inspiring other people to make charitable donations. So if a private man like Jobs wants to make his charitable donations privately or anonymously, I don’t see much if any harm in that. And the coverage of Jobs in recent days is proof positive that he’s hardly in need of good press.

On top of that, effective philanthropy is hard work. Just ask Bill Gates. If it’s as difficult to give away money as it is to make it, and if you’re already stretched between making Apple insanely great, spending time with your family, and dealing with personal health issues, then it’s reasonable not to even try on the philanthropy front.

The sad fact of the matter is that Jobs’s wife, Laurene Powell Jobs, will almost certainly outlive him; what’s more, she is more familiar with the philanthropic world than he is, sitting on the boards of Teach for America and the New Schools Venture Fund, among others. Jobs is a technology visionary; that doesn’t make him a great philanthropist. Maybe he’s simply and lovingly trusting his wife to be able to take care of such things after he’s gone. That would be a very admirable and selfless act.


It baffles me, absolutely baffles me, how so many people don’t care about billion dollar corporations NOT being philanthropic!

We absolutely SHOULD care when we see a human being, or a corporation, marinating in hundreds of millions of dollars (or BILLIONS) and not using some it to help other human beings or the world at large.

This is a lesson we teach our children: SHARE. But for some reason, when it comes to corporations and business people, it’s no longer about helping the environment or animals or humans; it’s about buying homes, yachts, and showcasing and hoarding your wealth!

Steve Jobs could have been a wonderful role model for not only someone who developed cool gadgets, but also for being humane and compassionate.

He is an incredibly innovative man — but he is also a pure, unadulterated, capitalist pig (like many, many other *supremely* rich humans on the planet).

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