Felix Salmon

Counterparties: Banning shorts in Europe

Peter Rudegeair
Jul 23, 2012 21:55 UTC

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A ban on short selling didn’t reverse a drop in stocks when the SEC imposed one covering 19 financial companies in July 2008, including, ahem, Lehman Brothers. Spain and Italy believe they can achieve more success — the countries have reinstated a ban on short selling the shares of their financial institutions.

Spain’s claim that the sell-off in bank stocks is overdone is made difficult by its continued negotiation of a $1.2 billion bailout of its financial banking system. That bailout looks increasingly necessary: The Bank of Spain reported that the economy contracted by 0.4% in the second quarter. And the fiscal health of the provinces continue to weaken. On Friday, the overly indebted region of Valenica sought financial aid from the central government in Madrid, and the tiny region of Murcia looks like it will do so as well. Those payments are getting increasingly expensive for the central government to fund. Yields on Spain’s 10-year bonds hit 7.52% today, a euro-era high.

Italy is in a relatively better position (emphasis on “relatively”). Sicily’s situation is causing alarm in Rome, as policymakers announced they would send the island $484 million in aid to stave off a liquidity crunch. Sicily, which some call “the Greece of Italy,” faces the same problems of bloated public payrolls and overly generous public pension contracts, as the country as a whole:

Today, Sicily’s regional government has 1,800 employees – more than the British Cabinet Office – and the island employs 26,000 auxiliary forest rangers; in the vast forestlands of British Columbia, there are fewer than 1,500.

Out of a population of five million people in Sicily, the state directly or indirectly employs more than 100,000 of them and pays pensions to many more. It changed its pension system eight years after the rest of Italy. (One retired politician recently won a case to keep an annual pension of 480,000 euros, about $584,000.)

And then there’s Greece itself. The WSJ reports that European officials have doubts about the new government’s commitment to austerity – and have compiled a laundry list of more than 200 delays to cuts to prove their point. The Germans are growing increasingly inured to Greece’s cries for help: While Prime Minister Antonis Samaras was telling Bill Clinton that Greece was in “our version of the Great Depression,” German Vice-Chancellor Philipp Roesler told an interviewer that a Greek exit from the euro zone “has long ago lost its terror”. – Peter Rudegeair

On to today’s links:

Wall St: Experts (including our own!) say eminent domain mortgage seizures are unconstitutional – SIFMA

New Normal
Economists predict US poverty to reach its highest levels since the 1960s – AP

Tax Arcana
Corporate tax breaks, why bother? They’re more trouble than they’re worth – WSJ

China’s glamour vs. service infrastructure problem – FT Alphaville

Bold Moves
Banks intrigued by idea of profitable, non-abusive ways to serve the poor – American Banker

Libor scandal is moving closer to becoming officially criminal – Reuters
Bob Diamond asked to resign from decreasingly prestigious jobs – Waterville Morning Sentinel

Less is More
Bank of America has 1,536 fewer ATMs than it had six months ago – American Banker

11,000 new business books are published each year – Businessweek

The main job of venture capital’s trade group: contradicting reports that Mitt Romney was a venture capitalist – Reuters

Good Questions
What is Yahoo? – NYT


Considering that 300,000 people visit each year to climb Mount Etna alone, there could be plenty of things for “auxiliary forest rangers” to do. It all depends on what exactly “auxiliary forest rangers” entails. Are they low-paid part-time employees who clean up trash on heavily visited trails and beaches? Or highly paid employees who “oversee” underutilized timber lands? Do “forest rangers” in British Columbia only include those that manage timberlands, or does it include interpretive rangers and visitors center employees at provincial parks? Without any information on what these positions actually entail, then the comparison is highly suspect.

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How not to report on the poor and the wealthy

Felix Salmon
Jul 23, 2012 18:24 UTC

The media has not exactly covered itself in glory when reporting on money-related research of late. For instance, consider Martha White’s blog post at Time.com on Friday. Here’s the headline:

Would You Pay $520 in Interest to Borrow $375? 12 Million Americans Did Last Year

White cites “a payday lending report” from Pew for her datapoint — but, unforgivably, doesn’t link to it. If she had linked to it, she might have read the report a bit more carefully: it’s clear that the average interest paid on a $375 loan is $65, not $520. The $520 figure comes from multiplying the $65 number by eight, on the grounds that the average payday borrower takes out a loan eight times per year. Which in turn means that the $520 in interest is paid on $3,000 in loans, not $375 in loans.

(Update: The vast majority of payday borrowers never take out more than one loan at a time, so most of the time, the maximum principal balance is $375. The Pew report was careful to say it was talking about eight $375 loans, which is a more accurate way of putting it than saying $3,000 in loans. But it’s doing 12 million Americans a disservice to imply that they are willingly entering into deals knowing that they will pay back $520 in interest on a single $375 loan, even if that’s how it often ends up.)

Then, over the weekend, a series of stories — starting with the Observer, and moving on to Reuters and elsewhere — started writing about the trillions of dollars sitting in offshore bank accounts. All of them use the word “hidden” or its cognates, and all of them were based on a report from the Tax Justice Network (me neither), which is very long on hyperbole. This, for instance, from the main section of the report, gives a flavor of how it reads:

The subterranean system that we are trying to measure is the economic equivalent of an astrophysical black hole… The way is hard, the work is tedious, the data mining is as mind-numbing as any day below surface at the coal face…

The assets of these countries are held by a small number of wealthy individuals while the debts are shouldered by the ordinary people of these countries through their governments… In terms of tackling poverty, it is hard to imagine a more pressing global issue to address.

The report does concede, grudgingly, that in fact the governments in question don’t have net debts at all: these countries, on a sovereign level and taking into account no private assets at all, are net creditors rather than net debtors. But still we’re told that “ordinary people” are shouldering massive debts which should somehow by rights be either serviced or paid off using the wealth of these countries’ plutocrats.

The reality is that the wealth of the global super-elite does not, actually, cause poverty; nor is there any obvious way of using it to alleviate poverty. Bill Gates, for instance, the richest of the lot, is putting an absolutely enormous amount of effort into trying to use his wealth to alleviate certain pockets of poverty; the jury’s still out on whether or when he might see real success on that front.

The conceit of the report is that if all offshore wealth was instead held onshore, and if that onshore wealth produced a certain amount of income, and that if all that extra income were taxed at top marginal rates, then there would be lots of lovely money for governments to spend on making poor people rich. Or something.

But the fact is that there’s a good reason why countries tax income and not wealth: for all that I personally think that a wealth tax is a very good idea, I can’t think of any country in the world, other than the USA, which could effectively levy such a thing.* The world’s wealthy don’t pay taxes on their wealth; they never have, and they never will. And because of the way they live, in a stateless cocoon, it’s a bit silly to expect them to reinvest most or all of their wealth back into their country of origin.

If you’re extremely wealthy and you come from one of the countries on the list here — Russia, Brazil, Mexico, Venezuela, Argentina, Indonesia, Nigeria, Malaysia, Ukraine, you get the picture — then obviously you’re going to keep a huge amount of money offshore, whether you made your money in a legal or in an illicit manner. And while some of the reason might well be tax avoidance, much of it is going to be simply the fear of expropriation and/or confiscation — again, be that legal or illicit. And since your investments are going to be global, it does make sense to park your money in jurisdictions which have proven themselves good at safeguarding individual wealth, as opposed to plundering it.

The total amount of wealth in the world is not an easy number to estimate, but it’s probably somewhere in the $250 trillion range. A lot of that wealth is financial, and a lot of financial wealth is held “offshore”, whatever that means these days. This new report says that roughly $25 trillion is held offshore by the wealthy, which just means that roughly $25 trillion is held offshore: after all, poor people by definition don’t have bank accounts in the Cayman Islands. That’s an interesting datapoint, but it’s not much more than that.

What’s unhelpful and sensationalist is to lead off your press release (and therefore lots of news articles) by saying that that amount “is equivalent to the size of the United States and Japanese economies combined”. That’s just a cheap way of comparing a stock with a flow, since GDP figures don’t measure wealth at all, but rather income.

“Rich people are rich” is not much of a story, although I can see why certain people want to make it one, by reframing it in terms of inequality or tax evasion. Similarly, “poor people find it difficult to stay on top of their finances” is not news either, and there’s therefore a temptation to sex it up a bit by making it seem that people are paying more in interest than they’re borrowing in principal. But as a rule, if you see a headline about these kind of issues and the story cites a report without linking to that report, be very suspicious. There might be a lot less there than the story you’re reading would have you believe.

*Update: There are in fact six countries with a wealth tax: France, Switzerland (in certain cantons), Liechtenstein, Holland, Norway, and Italy. In none of them is it an obvious success.


Based on the averages from the Pew report, the effective interest rate is 790.83%…

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Why finance can’t be fixed with better regulation

Felix Salmon
Jul 23, 2012 14:53 UTC

Jim Surowiecki and John Kay both have columns today looking at the way in which regulatory structure failed to stop abuses in the financial-services industry, and wondering how we might be able to do better in future.

Surowiecki says that we trusted the banks when we shouldn’t have: their incentive to preserve their reputation was not nearly big enough to override their incentive to make money. He’s right about that. But his proposed solution is vague: first, he says, prosecutors should “admit that fraud is a crime and throw some people in jail”, and secondly regulators should “be aggressive not just in punishing malfeasance but in preventing it from happening”. Well, yes. This is the rhetorical equivalent of throwing your hands up in the air: if you end up proposing something which absolutely everybody will agree with, then there’s almost certainly no substance there.

Kay, by contrast, has been looking at UK equity markets in detail, and has determined that the problem lies more with market structure than with anything within the realistic control of prosecutors or regulators. Surowiecki’s proposal basically boils down to “all you prosecutors and regulators are weak, weak people, you should man up and go to war”. I don’t know how many prosecutors and regulators he’s talked to, but this does them a disservice: there are serious institutional and legal constraints here. And what’s more, we can’t try to reform financial-services regulation by assuming that we can easily find a whole new breed of regulators: we can’t.

One reason why we can’t is laid out clearly by Kay:

Regulators come to see the industry through the eyes of market participants rather than the end users they exist to serve, because market participants are the only source of the detailed information and expertise this type of regulation requires. This complexity has created a financial regulation industry – an army of compliance officers, regulators, consultants and advisers – with a vested interest in the regulation industry’s expansion.

But this is in turn only a symptom of a broader problem, which is the way in which the consolidation and ever-increasing complexity of the financial-services industry has reduced the ability of firms to police each other and to earn each others’ trust, while at the same time increasing incentives to fraudulently game the system. Barclays’ Libor lies, for instance, started life as a way for its derivatives traders to make money: something which could never have happened when the banks reporting into the Libor system didn’t have derivatives desks.

A large part of the problem is the way in which financial tools which had a utilitarian purpose when initially designed have become primarily vehicles for financial speculation. Libor, for instance, was a way for banks to peg loan rates to their own funding costs, and thereby minimize their own risks while at the same time minimizing the amount that borrowers had to pay. Today, banks don’t fund on the interbank market any more, and Libor has become something else entirely: a number to be speculated on in the derivatives market, and, in times of crisis, an indication of how creditworthy banks are perceived to be.

Similarly, equities used to serve a capital-allocation purpose, and there was, as Kay says, a chain of trust running from investor to board to management. “Most asset managers want to do a good job – earning returns for their clients through strong, constructive relationships with the companies in which they invest,” he writes. “Most corporate executives also want to do a good job, leaving the companies they manage in a stronger competitive position.”

But that’s not the equity market we see today: “It is hard to see how trust can be sustained in an environment characterised by increasingly hyperactive trading, and it has not been.”

Kay’s conclusion is sobering spot-on: the entire financial-services industry, he says, needs to be restructured so as to create the kind of institutions which thrive on increased trust, rather than on maximized arbitrage of anything from news to interest rates to regulations.

In order for that to happen, we’re going to need to see today’s financial behemoths broken up into many small pieces — because at that point each small piece is going to have to earn the trust of the other small pieces which rely on it.

Of course, that’s not going to happen. And as a result, financial-industry scandals will continue to arrive on a semi-regular basis. When they do, they will always be accompanied by calls for stronger regulation: rules-based, or principles-based, or some combination of the two. But the real problem here isn’t regulatory, and as a result there isn’t a regulatory solution. The real problem is deeply baked into the architecture of too-big-to-fail banks. And frankly I don’t see any realistic way of unbaking that particular loaf.



Good points I would carry a bit further even if “off-topic”.

Would it not be equally true that “If politicians and bureaucrats believe themselves obligated only to grow government and agencies, then they will make decisions to achieve that result, without thought of the long term interests of “we, the people”? That would explain a lot of what we see today!

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When museum curators confuse price and value

Felix Salmon
Jul 23, 2012 03:17 UTC

Back in February, Janet Novack had a short piece in Forbes magazine, and a better, more detailed blog post, about one of the more bonkers tax fights out there: the one between the IRS, on the one hand, and the heirs of Ileana Sonnabend, on the other. Basically, Sonnabend owned a Robert Rauschenberg masterpiece, called Canyon, which cannot be sold — not even to a museum — because it includes a bald eagle. But the IRS wants her heirs to pay inheritance tax on it at a $65 million valuation, over and above the $471 million they’ve already paid in inheritance tax on other Sonnabend artworks they were bequeathed.

Novack couldn’t get a good explanation of where the $65 million number came from, although she did talk to the heirs’ lawyer, who said that the head of the IRS art panel, Joseph Bothwell, had said that even though it’s illegal for anybody to buy the work, “a recluse billionaire in China might want to buy it and hide it”. Which hypothetical Chinese billionaire was apparently enough for the IRS to ask for $29 million in taxes, plus a $12 million penalty for misstating the value of the work so grossly? Apparently what the estate should have done is mark the work not to where it can be sold legally (it can’t be sold legally), but rather to where it might conceivably be sold illegally, should there be Chinese billionaires interested in such things.

Today, the NYT’s Patricia Cohen picks up the story. She only really adds one thing, but it’s a very fascinating thing: she spoke to Stephanie Barron, who sits on the IRS’s Art Advisory Panel, and who was one of the group of people who jointly came up with the $65 million figure.

She said that the group evaluated “Canyon” solely on its artistic value, without reference to any accompanying restrictions or laws.

“The ruling about the eagle is not something the Art Advisory Panel considered,” Ms. Barron said, adding that the work’s value is defined by its artistic worth. “It’s a stunning work of art and we all just cringed at the idea of saying that this had zero value. It just didn’t make any sense.”

The assumptions baked in to this are both jaw-dropping and entirely unsurprising at the same time. Barron is the senior curator of 20th-century art at Lacma, which puts her at the pinnacle of the non-profit art world, the place where art is supposedly valued just for its own sake and not because it’s worth lots of money. And yet, faced with a literally priceless work of art, Barron and her fellow panelists “just cringed” at ratifying precisely that concept. If a work has great artistic value, in Barron’s view, it must have great financial value as well. And, conversely, if a work has no financial value, then it cannot have artistic value.

I’m sure that Barron would push back at the idea, expressed at one time by Tobias Meyer of Sotheby’s, that the most expensive art is the best art, and that there’s some kind of direct correlation between price and quality. But in a weak sense, she is clearly invested in the concept. While it’s common to find unlimited editions in museum design collections, they’re rarely found in museum art collections, precisely because they lack the artificial scarcity that confers financial value.

Over the course of the past 100 years or so, various artists, with varying degrees of success, have attempted to distance themselves from the art market and make work with no financial value. Rauschenberg himself, actually, was one of them: he was an early and important player in the world of performance art. But high financial valuations get attention, and museum curators are easily forced into a stance of worshiping those valuations, even if such a stance doesn’t at first come easily to them.

The way the art world works is that collectors collect art, and museums collect collectors: that’s how great museum collections are built up. Collectors are always rich, and while once upon a time that meant there was a lot of old money in the art-collecting world, those days are over now and the world’s biggest art collectors are nearly always new-money self-made men.

Now: suppose you’re a museum curator, and your job is to flatter some billionaire collector so that he will end up donating his collection to your institution. While you will surely talk about his great eye, and subtly disparage some hedge-fund whiz-kid without nearly the same degree of connoisseurship, there’s one thing you’ll never do, which is suggest that maybe there are much better collections out there which aren’t worth nearly as much money. For new-money art collectors, the art market is a constantly evolving judgment on what they have bought: if your art has gone up in value then that means you have a great eye and you’re very perspicacious; if your art has gone down in value, then that means you fell for some trendy fad, you fool. At its highest levels, art collecting is a highly competitive game — and mark-to-market valuations are the way that collectors keep track of who’s winning.

Ileana Sonnabend, who died with a billion-dollar art collection, surely ranks among the very best at playing that game. But at the same time she was the kind of person who would love Canyon, her Rauschenberg combine, all the more because it had zero financial value. And I’m quite sure that if she was on the Art Advisory Panel, and Canyon was owned by someone else, she would have taken great pleasure in assigning that work a value of $0.

For Stephanie Barron, a work’s financial value is defined by its artistic value. But for people like Robert Rauschenberg and Ileana Sonnabend, that was never the case. They both died wealthy, thanks to the art world. But I think they would have been genuinely horrified at Barron’s idea — the concept that if Canyon is worth nothing financially, then it must be worth nothing aesthetically. It’s a dangerous and invidious notion, and while it might fly with big-name LA collectors, it really has no place in any museum devoted to art rather than money.


“There are people who know the PRICE of everything, but the VALUE of nothing”. (Oscar Wilde)

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Counterparties: Marissa Mayer’s vacillating pay

Ben Walsh
Jul 20, 2012 22:03 UTC

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Read the headlines and you’d think Marissa Mayer has received the fastest series of pay raises in corporate history.

Yesterday, Yahoo’s new CEO was earning “over $40 million“. A few hours later, her compensation was worth “more than $59 million“. Or maybe just “as high as $59 million“. Then, overnight, she had secured “more than $70 million”. This morning, her value continued to climb, and she was set to “receive up to $100 million“. A few hours later, the number was a positively rococo “$129 million“.

Adding to the confusion, while some headlines were running the $40 million or $60 million figures yesterday, others had already broken the $100 million mark (the LAT and Business Insider). Even more confusing, as the successive waves of Mayer’s pay arrived, the filing and offer letter they were based on remained unchanged.

Using those documents, here’s how Mayer’s five-year pay package was reported within the massive range of $40 million to $129 million:

  • $1 million annual base salary (running total: $5 million)
  • Target annual bonus of $2 million for five years (running total: $15 million)
  • Potential annual bonus of an extra $2 million (running total: $25 million)
  • $14 million in restricted stock to compensate Mayer for lost Google stock (running total: $39 million)
  • $30 million in restricted stock as a “retention award” (running total: $69 million)
  • $6 million or more in restricted stock annually (running total: $99 million or more)
  • $6 million or more in stock options annually (running total: $129 million or more)

That’s $5 million to $25 million in cash, $74 million or more in restricted stock, and an additional $30 million or more in options. The information was publicly available from get go. So why did reporters play by business journalism’s version of “Price is Right” rules and incrementally ratchet up to the correct figure? – Ben Walsh

On to today’s links:

Corporate Welfare
Medicare bought billions in lethal drugs at elevated prices – WaPo

The human tissue industry: inadequate safeguards, limited patient disclosure and strong profit margins – International Consortium for Investigative Journalists

Banks would prefer to just settle this whole Libor thing amongst themselves – Reuters
Elizabeth Warren: “We cannot trust Wall Street to regulate itself – not in New York, London or anywhere else” – WaPo
Citi may have to pay more than Barclays’ $450 million to settle Libor claims – Fortune
Bank of England: “At no point did the [Fed] draw the attention of the Bank to evidence of wrongdoing” in Libor setting – Bank of England
Deutsche Bank and WestLB roped into Libor investigations – WSJ

Best Footnote Ever
430 words and almost 20 different entities – the footnote explaining how Bain owned Domino’s Pizza – Footnoted

It’s Academic
Old but awesome: “Japan’s Phillips curve looks like Japan” – QED

Morgan Stanley needs to look for a “rich uncle” – WSJ

Old Normal
A top executive “surrenders around 40 percent of his salary to the Bureau of Internal Revenue” – Fortune

President Obama’s Wall St BFF out at UBS – DealBook

Actually, we’re all rich kids on Instagram – Atlantic Wire

How Congress is killing the Post Office

Felix Salmon
Jul 20, 2012 19:31 UTC

The Post Office’s problems are the same today as they were back in September: the long-term secular decline of postal mail, on the one hand, combined with all manner of Congressionally-mandated restrictions which make a bad situation much, much worse. And now the inevitable has happened: we’re going to have a $5.5 billion default.

A default of that magnitude sounds scarier than it actually is. Congress requires the Post Office to make inordinately huge pension-plan payments, for reasons which nobody can really understand. But in the final analysis, USPS pensions are a government obligation, and it doesn’t make a huge amount of difference whether they come out of a well-funded pension plan, a badly-funded pension plan, or just out of US government revenues.

What does make a lot of difference is the degree to which the Post Office is hamstrung by Congress. There’s still room for the Postal Service to reorient itself and become a successful 21st-century utility — but there’s no way that’s going to happen if it’s constantly on the back foot and if Congress prevents it from entering new businesses, possibly including banking.

To put it another way: the Post Office is broken, in large part thanks to unhelpful meddling by Congress. And it won’t get fixed unless and until Congress gets out of the way and stops forcing it into the corporate equivalent of ketosis, essentially consuming its own flesh in order to survive.

The talking point from the mailing industry here is that multi-billion-dollar defaults “could make consumers lose confidence in the Postal Service”, and thereby make matters even worse. It’s a bit like the argument we saw in Detroit in 2009, when lots of people said that if the big auto makers went bankrupt, no one would buy their cars any more. That argument wasn’t convincing at the time, and it turned out not to be true. Similarly, I’m not worried about that bickering in Washington will directly affect the confidence that Americans have in their postal service.

On the other hand, it’s pretty much certain that bickering in Washington will unnecessarily make the situation at the Post Office much worse than it needs to be. And as such, it’s a prime example of US political dysfunction. As Zero Hedge says, if the muppets in Washington can’t get this right, what are the chances that they’re going to be able to do the right thing when the fiscal cliff arrives at year-end?

The best hope for America is that politicians are more likely to create fights and dysfunction for things which don’t rise to the level of outright crisis, but that they somehow manage to come together to find solutions when the alternative is catastrophic. That’s often a good bet — but not always. And so while I’m reasonably confident that we’ll get through the fiscal cliff somehow, I’m not at all certain of it. Meanwhile, I am reasonably certain that Congress will starve the USPS of the funding and freedom it needs to succeed over the long term. Which of course will cost taxpayers enormously for as long as postal workers are collecting pension checks.


I still think that either UPS or FEDEX needs to take over the postal service. It would take a huge burden off of the US government and, ultimately, the US taxpayer. UPS already operates “UPS Stores”, where they rent out post office-style mail boxes and sell postal supplies. FEDEX operates basically the same thing, but they’re called FEDEX/Kinkos. A lot of money could be saved if the post office were taken over by one of these two businesses.

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Counterparties: Why big companies are bad at innovating

Jul 19, 2012 21:39 UTC

Welcome to the Counterparties email. The sign-up page is here, it’s just a matter of checking a box if you’re already registered on the Reuters website. Send suggestions, story tips and complaints to Counterparties.Reuters@gmail.com

Today Nokia announced that it lost $1.7 billion in the second quarter, its fifth quarterly net loss in a row. Just a few hours before the announcement, the WSJ published a great piece revealing how, as early as 2000, the Finnish phone maker had designed a proto-iPhone – complete with a color touch screen and geo-location, gaming, and e-commerce capabilities. The phone, though, never moved into the mass production phase because of ”a corporate culture that lavished funds on research but squandered opportunities to bring the innovations it produced to market.”

While it’s not surprising that a lumbering, oversized multinational corporation failed on the innovation front, it’s clear that Nokia does not suffer from a dearth of ideas: It spent $40 billion on research and development over the past decade, almost four times what Apple spent over the same period. Nokia also developed and ultimately discarded not one but two operating systems, Symbian and MeeGo. Nokia’s deficiency lies in what Vijay Govindarajan and Chris Trimble call “the other side of innovation,” or the problem with executing new ideas, not just thinking them up.

If you believe Peter Thiel, this is also an affliction Google suffers from. At a debate at Fortune Brainstorm Tech this week, Thiel told Eric Schmidt that the $30 billion in cash Google has sitting idly on its balance sheet demonstrates that the company is “out of ideas” that are worthy of scaling up:

[T]he intellectually honest thing to do would be to say that Google is no longer a technology company, that it’s basically – it’s a search engine. The search technology was developed a decade ago. It’s a bet that there will be no one else who will come up with a better search technology. So, you invest in Google, because you’re betting against technological innovation in search. And it’s like a bank that generates enormous cash flows every year, but you can’t issue a dividend, because the day you take that $30 billion and send it back to people you’re admitting that you’re no longer a technology company. That’s why Microsoft can’t return its money. That’s why all these companies are building up hordes [sic] of cash, because they don’t know what to do with it, but they don’t want to admit they’re no longer tech companies.

After reading this exchange, Tyler Cowen noted that ”the revealed preference of our technological leaders is the best and most depressing argument for the great stagnation.”

At least some of tech’s big companies are trying to remain small or may have to downsize (see: Yahoo). Brad Stone wrote last spring about how Facebook’s Sheryl Sandberg believes that the Internet companies like Google that vastly expanded their staff during boom times “eventually came to regret the innovation-killing bureaucracy that resulted.” For that reason, she has favored automated systems, so Facebook can avoid increasing headcount. In capacity its new headquarters maxes out at 6,600 employees and it’s currently occupied by only a third of that total. – Peter Rudegeair

On to today’s links:

Slowing down
The world’s largest retirement community – “Disneyworld for adults” with 23,000 acres and 88,000 residents – Huffington Post

“Krugmenistan vs. Estonia”: How a blog post ignited an international economic spat – Businessweek

Simon Johnson: The Fed thoroughly failed the financial system by missing the Libor scandal – Baseline Scenario

The latest weapon in hedge fund divorces: bringing RICO cases against your spouse – New York Observer
Get used to generally crappy pension fund returns – Barron’s

Alien Equity
One-third of Bain Capital’s early investors were wealthy foreigners, most of whom invested through shell companies in Panama – LAT

EU Mess
A graph of euro doom – foreign capital’s flight from Italy and Spain – Telegraph
Spain’s 5-year debt costs hit new euro-era highs at an auction – Reuters

Duke pins CEO swap on problems at nuclear plant – WSJ
“It seems odd to me that if these issues were burning issues, I never heard about them from anybody” – WSJ

Morgan Stanley’s earnings drop 50%, and the company plans to cut an additional 800 jobs by year’s end – Bloomberg

Bad News
Nobody seems to be talking about the looming $500 billion in cuts to Head Start, childcare and AIDS programs – Politico

Check in the Mail
The Postal Service is going to default on a $5.5 billion healthcare fund payment – NYT

Welcome to DC
“The astounding thing … was the extent to which unemployment went unmentioned” – American Prospect

Blankfein: If there was an undo Dodd-Frank button, I wouldn’t push it – DealBook

Who Doesn’t
Rick Ross loves cheese – Bon Appetit


Angry, the iphone was a success before they started the app store, that just made them more entrenched (and the app store itself was innovative). Apple’s biggest luck is the incompetence of their competitors.

btw, what are you angry about?

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Is Kickstarter selling dreams?

Felix Salmon
Jul 19, 2012 13:24 UTC

My theory, when it comes to buying lottery tickets, is that if you have disposable income to spare, then often the dreams and fantasies that accompany your lottery ticket purchase are in and of themselves worth $1. This is true not because dreams and fantasies are wonderful amazing and valuable things, although they can be; it’s more true because $1 is a very small amount of money. All too many people spend a significant percentage of their disposable income on lottery tickets, and that is a tragedy.

Now Ian Bogost has come along with a similar theory, relating to Kickstarter. Funding projects on Kickstarter is in itself “another form of entertainment”, he says:

What if Kickstarter is more about the experience of kickstarting than it is about the finished products? When you fund something like OUYA, you’re not pre-ordering a new console that will be made and marketed, you’re buying a ticket on the ride, reserving a front-row seat to the process and endorsing an idea. It’s a Like button attached to your wallet.

Bogost is proud of a pen he spent $100 on but never uses: “it’s a memento of the excitement I felt after first seeing the product”, he writes:

When faced with the reality of these products, disappointment is inevitable–not just because they’re too little too late (if at all) but for even weirder reasons. We don’t really want the stuff. We’re paying for the sensation of a hypothetical idea, not the experience of a realized product.

This is a cute conceit, and contains more than a germ of truth. At the same time, however, it starts to fall apart when Bogost compares Kickstarter to QVC, saying that what QVC is really selling is “the excitement of learning about products for the first time and getting in early on the sale”. That might indeed be part of why people are so eager to pick up the phone and order when they’re watching home shopping channels, but it’s not what QVC shoppers think that they’re paying for.

A lot of the relationship between merchants and consumers, these days, is a kind of escalating cold war: as fast as merchants’ sales techniques become increasingly sophisticated, so do consumers learn to see through them and compensate for them. If we look today at advertisements from 50 or even 20 years ago, we’re astonished that they worked at all.

And so it seems to me that Kickstarter is in some ways much like QVC was when it launched: a state-of-the-art sales and marketing platform. It’s highly social: Jeanne Pi has determined that your chances of raising $10,000 on Kickstarter are just 9% if you have 10 Facebook friends, rising to 20% if you have 100 friends, and 40% if you have 1,000 friends. And it’s done a very good job of walking the fine line between do-gooding, on the one hand (charity campaigns are specifically banned), and overt commercialism, on the other. Many projects are rejected, and Kickstarter’s Yancey Strickler is keen that everything on the site be creative, in some way, rather than just being some superficially clever gadget that you might see in the SkyMall catalogue or in a late-night infomercial. He doesn’t always succeed, but if you strip out the outliers, the big million-dollar headline-grabbers, he’s doing a better job than you might think.

Or, to put it another way, the simple “you could win a million dollars” sales pitch works for selling lottery tickets only combined with a deeply-discounted $1 ticket price. Make something cheap enough, and you can sell just about anything. Kickstarter, by contrast, with a much more sophisticated pitch, manages to deal in much higher dollar amounts per transaction.

Here’s the problem: while “I’m buying a dream” makes a certain amount of sense for a $1 lottery ticket, it makes much less sense for $100 vaporware. Just speaking for myself, if I’m spending $100, I want significantly more than just a dream. That’s more money than I’ve spent on lottery tickets in my lifetime. And I’m rich — I’m reasonably sure that I have more money, and more disposable income, than the majority of the 40,000 people — and rising fast — who are funding Ouya.

Maybe that just makes me a tightwad, and maybe America has millions of people who are happy dropping $100 on the experience of funding some exciting new project, just for the way it makes them feel. But it seems to me that one of Kickstarter’s greatest successes is the way in which it has managed to change the way we think about cost. I funded Tomorrow magazine, for instance, to the tune of $15. (On average, the magazine’s 1,548 backers paid more than $25 each.) If some as-yet nonexistent magazine had sent me a piece of direct mail, asking $15 for its launch issue, I would never have paid that. Even if an existing magazine looked really good on the newsstand, and had a cover price of $15, I would similarly never pay that. But somehow the idea that by paying the $15 up front I was helping to create that magazine — that was enough to get me to pay. That, and the fact that the founders of Tomorrow magazine are in my social graph — I’m helping out friends as much as I’m buying a product.

I think that’s the real key here: I’m not paying for the sensation of a hypothetical idea, so much as paying to support the individuals whom I like and admire. And Kickstarter neatly wraps that charitable impulse in a commercial transaction, which makes it easier to ask for — and receive — more money than either approach would yield on its own.

The question is: how sustainable is this model? It’s common in capitalist societies for local merchants to be able to charge higher prices, largely because they’re more convenient. Has Kickstarter invented a new form of online commerce, where merchants who are close to you on the social graph, rather than in terms of physical geography, can thereby charge a premium for products which would never fly in the open market? (I don’t get many catalogues in the mail offering goods which don’t yet exist, and which might not ever arrive.) Or has Kickstarter merely perfected the art of sprinkling social fairy dust on what are fundamentally commercial transactions, and eventually, as other merchants do the same thing and the public gets wise, the effectiveness of the fairy dust will diminish?

I suspect the answer is somewhere in the middle, and that Kickstarter is a bit like Groupon in its adoption profile. The early adopters tend to be the most zealous about it, and as the platform matures, the added value that it can generate per customer will necessarily diminish. At the same time, the customer base will almost certainly continue to rise pretty quickly. So the aggregate value being generated by Kickstarter is likely to continue to rise.

Over time, I think that fewer projects will be able to raise millions of dollars selling clever as-yet-nonexistent gizmos for $99 each. These projects nearly always tend to understate the risks involved, and especially the risk that the project will fail, and the funders won’t actually receive anything at all. That’s natural: the founders are in sales-pitch mode. But as consumers get wise to those risks, especially if one or two high-profie million-dollar Kickstarter successes end up producing nothing at all, then at that point we’ll realize that the funders weren’t just buying a dream after all. They really thought they were buying a product.


I’m not paying for a hypothetical idea, I’m paying for the experience of watching someone else’s idea manifest. Ten of the ten projects I’ve contributed to, I either knew the person doing it or someone who knew them. They weren’t the best projects on KickStarter but I had a friend who had a dream and I wanted to see them go after it. Getting a small memento in the form of a purchase is of a much smaller value then seeing someone with a big idea go after it.

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Business ethics need to move beyond what’s illegal

Felix Salmon
Jul 18, 2012 22:37 UTC

Business school professor Luigi Zingales, with the full agreement of fellow business-school professor Justin Wolfers, has an important op-ed under a provocative headline: “Do Business Schools Incubate Criminals?”

Zingales’s point is a good one: that the way business-school students study ethics is much like the way that entomologists study ants. Quite aside from the fact that ethics courses are generally taught by relatively junior professors, they also tend to shy away from actually telling students to be ethical:

Most business schools do offer ethics classes. Yet these classes are generally divided into two categories. Some simply illustrate ethical dilemmas without taking a position on how people are expected to act. It is as if students were presented with the pros and cons of racial segregation, leaving them to decide which side they wanted to take.

Others hide behind the concept of corporate social responsibility, suggesting that social obligations rest on firms, not on individuals…

My colleague Gary Becker pioneered the economic study of crime. Employing a basic utilitarian approach, he compared the benefits of a crime with the expected cost of punishment (that is, the cost of punishment times the probability of receiving that punishment). While very insightful, Becker’s model, which had no intention of telling people how they should behave, had some unintended consequences. A former student of Becker’s told me that he found many of his classmates to be remarkably amoral, a fact he took as a sign that they interpreted Becker’s descriptive model of crime as prescriptive. They perceived any failure to commit a high-benefit crime with a low expected cost as a failure to act rationally, almost a proof of stupidity.

At business school, there are lots of classes where students try to maximize profits; that’s nearly always considered to be the way to win in business. It’s easy to see, then, how Becker’s framing of unethical behavior as something with costs and benefits essentially strips the ethics away, leaving only a simple decision of whether the actor wants to take the risk of punishment.

And frankly the headline on Zingales’s piece makes a similar error. What it implies is that we should be worried about criminal behavior, rather than unethical behavior more generally. But I’m with Zingales: we need to go further than that.

When the economist Milton Friedman famously said the one and only responsibility of business is to increase its profits, he added “so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” That’s a very big caveat, and one that is not stressed nearly enough in our business schools.

Lobbying to secure a competitive advantage from the government certainly does not represent “open and free competition.” Similarly, preying on customers’ addictions or cognitive limitations constitutes deception, if not outright fraud.

There are interesting ethical debates to be had as to where to draw the line: for instance, all those “free offers” which require you to hand over your credit-card details and then bill you regularly unless you cancel. They prey on cognitive limitations, I’d say, and are less ethical than companies which don’t do that. Should business-school professors tell their students that they should avoid implementing such schemes? I don’t know. But I do think that acting ethically, even if such actions are legal and don’t maximize profits, is something that many more business-school students should be encouraged to consider.

This is a very large step, of course, from the kind of discourse which excuses illegal bribes by Walmex on the grounds that, hey, everybody does it. And in a way it’s closer to what I’m urging in a journalistic context: less emphasis on bright lines, such as what’s legal and what’s illegal, and more emphasis on acting as ethically as possible on a day-to-day basis. Treating your employees well, for instance, is sometimes good for the bottom line and sometimes bad for the bottom line. But I’m uncomfortable with arguments that urge companies to treat their employees well on the grounds that doing so will increase profits: the implication is that if it doesn’t increase profits, then the reason to do it goes away.

Zingales says that business-school professors actively foster a culture of amorality; that’s right. But the real problem isn’t business school; it’s the idea that there’s something ethically dubious about doing anything other than maximizing profits for shareholders. Which is one reason why I’m such a fan of b-corps.


The problem with the golden rule in business is that every profit maximiser expects everyone else also to be a profit maximiser and hence justifies his actions by appealing to a level playing field in competition.

In other words, as a profit maximiser I use mis-leading/confusing commercials/pricing structures or whatever. Since I am highly sophisticated in the world of pricing structures I expect the same to happen to me whenever I am on the receiving end.

Therefore, I do unto others what I am happy to have done to me.

What we need is a little Rawls thrown in there.
http://en.wikipedia.org/wiki/Veil_of_ign orance
We need to protect the weakest and most vulnerable in our society.
So it needs to be the case that retail investors for example can’t buy highly complex derivatives.

Again, with the rules/laws.

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