Felix Salmon

The most expensive lottery ticket in the world

Felix Salmon
Apr 21, 2014 15:25 UTC

No Exit, the new book from Gideon Lewis-Kraus, should be required reading for anybody who thinks it might be a good idea to found a startup in Silicon Valley. It shows just how miserable the startup founder’s life is, and raises the question of why anybody would voluntarily subject themselves to such a thing.

A large part of the answer is that Silicon Valley is gripped by a mass delusion, compounded by a deep “fake it til you make it” attitude toward success. Why do so many people in Silicon Valley want to be founders? Because every founder they meet is always killing it, crushing it, having massive success, just about to close a huge round, etc etc. At some level, they must know this is impossible: if 90% of startups fail, it simply can’t be the case that all of the startups they know are succeeding. After all, failure is not something which just suddenly happens overnight, when you thought you were doing great all along. But people tend to believe the evidence of their own eyes, and what they see is a combination of two things: the founders they know all seemingly doing great, and also a steady stream of headlines showing other founders cashing out for millions or even billions of dollars.

On top of that, startup founders have Silicon Valley cachet: they’re the stuff of legend. Everybody wants to be Mark Zuckerberg or Steve Jobs or Jack Dorsey. There might be a generous paycheck in getting stuck on the Google bus for the next decade, but there sure ain’t any glory in it. And so a huge number of incredibly well qualified engineers, who in previous decades would have put their skills to work being a part of something much bigger than themselves, instead decide to go it alone.

There is no reason whatsoever to believe that computer engineers make particularly good entrepreneurs. Quite the opposite, in fact: engineers tend to do quite well in structured environments, where there are clear problems to solve, and relatively badly in the chaos of a startup, where the most important skills are non-engineering ones, like being able to attract talent and investors. No Exit makes it very clear that the life of a startup founder is a miserable one, and that engineers are invariably happier when they’re working for a big company.

Financially, starting up a company in Silicon Valley makes very little sense. You have a very high chance (indeed, a certainty) of having to scrape by on a very low income in a very expensive city. At a time of your life when you should be out enjoying life and meeting friends and generally having lots of fun, you will instead be unhappily tethered to your laptop at all times. In return for sacrificing a six-figure salary elsewhere and general enjoyment of life, you’re given a lottery ticket: you get a minuscule chance of making untold millions of dollars. Being that rich is, undoubtedly, nice. But is it so much nicer than the life of a well-paid computer engineer that you’re willing to give up your life, and hundreds of thousands of dollars in foregone income, in order to have a tiny chance of grasping that brass ring? I know a lot of happy people; there are a couple of successful technology entrepreneurs among them. But I would never say that the successful entrepreneurs are the happiest people I know. So where does it come from, this intense Silicon Valley desire to buy the most expensive lottery ticket in the world?

To find the answer, you have to look to the people running the lottery. In this case, those people are the angel investors and venture capitalists — the people who are throwing ever-greater sums of money at ever-greater numbers of startups, in the knowledge that the overwhelming majority of the companies they fund will end up failing.

What we’re looking at here is basically the Magnetar Trade, in human form. Magnetar had a long/short relative-value strategy in the subprime market: it was short a lot of subprime securities, while also being long a smaller slice of equity. While Magnetar was putting on its trades, the equity slice would make money; when everything blew up, the shorts made even more.

The Silicon Valley trade is also pretty close to being zero-sum. Even on a purely financial basis, if you add up all the profits from successful investments, they barely cover the losses on all the unsuccessful ones. A few big-name angels and VCs can do OK for themselves, but in aggregate the industry of investing in startups does not make money.

But the reality is much worse than that. Essentially the way that the startup ecosystem works is by taking the valuable labor of thousands of hopeful founders, and converting it into large amounts of capital for a tiny number of successes. The fulcrum of No Exit is the point at which it’s unclear whether the startup being followed by Lewis-Kraus will get its next round of funding: either it will raise a sum in the low seven figures, and survive, or else it will simply fail. And the message of the book is clear: the best possible outcome, in terms of the wealth, health, and happiness of the founders, would be the latter. Their startup fails, they get their lives back. They can work for a living and enjoy themselves and not stay stuck on the evil startup grind. If they do manage to raise their next round, that will only serve to prolong their misery.

Founding a Silicon Valley startup, then, is a deeply irrational thing to do: it’s a decision to throw away a large chunk of your precious youth at a venture which is almost certain to fail. Meanwhile, the Silicon Valley ecosystem as a whole will happily eat you up, consuming your desperate and massively underpaid labor, and converting it into a few obscenely large paychecks for a handful of extraordinarily lucky individuals. On its face, the winners, here, are the people with the big successful exits. But after reading No Exit, a different conclusion presents itself. The real winners are the happy and well-paid engineers, enjoying their lives and their youth while working for great companies like Google. In the world of startups, the only winning move is not to play.


The ultimate irony: Felix is leaving Reuters to join a start-up (okay, one with lots of money, he wont be miserable): http://gigaom.com/2014/04/23/felix-salmo n-is-leaving-reuters-for-the-fusion-netw ork-because-the-future-of-media-is-post- text/?utm_source=feedburner&utm_medium=f eed&utm_campaign=Feed%3A+OmMalik+%28Giga OM%3A+Tech%29

So these comments were probably the last Felix Salmon Smackdown.

Good luck there, Felix. I know I, and many other regulars here, will miss this place.

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The problems of HFT, Joe Stiglitz edition

Felix Salmon
Apr 16, 2014 00:04 UTC

Never mind Michael Lewis. The most interesting and provocative thing to be written of late about financial innovation in general, and high-frequency trading in particular, comes from Joe Stiglitz. The Nobel prize-winning economist delivered a wonderful and fascinating speech at the Atlanta Fed’s 2014 Financial Markets Conference today; here’s a shorter version of what Stiglitz is saying.

Markets can be — and usually are — too active, and too volatile.

This is an idea which goes back to Keynes, if not earlier. Stiglitz says that in the specific area of international capital flows, “there is now a broad consensus that unfettered markets are welfare decreasing” — and certainly you won’t get much argument on that front from, say, Iceland, or Malaysia, or even Spain. As Stiglitz explains:

When countries do not impose capital controls and allow exchange rates to vary freely, this can give rise to high levels of exchange rate volatility. The consequence can be high levels of economic volatility, imposing great costs on workers and firms throughout the economy. Even if they can lay off some of the risk, there is a cost to doing so. The very existence of this volatility affects the structure of the economy and overall economic performance.

The question is: does the same logic, that traders seeking profit can ultimately cause more harm than good, apply equally to high-frequency trading, and other domestic markets? Stiglitz says yes: there’s every reason to believe that it does.

HFT is a negative-sum game.

In the algobot vs algobot world of HFT, the game is to capture profits which would otherwise have gone to someone else. Michael Lewis’s complaint is that if there weren’t any algobots at all, then those profits would have gone to real-money investors, rather than high-frequency traders, and that the algorithms are taking advantage of unfair levels of market access to rip off the rest of the participants in the stock market. But even if you’re agnostic about whether trade profits go to investors or robots, there are undeniably real-world costs to HFT — costs like drilling through Pennsylvania mountains. As a result, the net effect of the algorithms is negative: they reduce profits, for everybody, rather than increasing them.

In theory, HFT could bring with it societal benefits which more than offset all the costs involved. In practice, however, that seems unlikely. To see why, we’ll have to look at the two areas where such benefits might be found.

HFT does not improve price discovery.

Price discovery is the idea that markets create value by putting a price on certain assets. When a company’s securities rise in price, that company finds it easier to raise funds at cheaper rates. That way, capital flows to the places where it can be put to best use. Without the price-discovery mechanism of markets, society would waste more money than it does.

But is faster price discovery better than slower price discovery? Let’s say good news comes out about a company, and its share price moves as a result — does it matter how fast it moves? Is any particular purpose served to seeing the price move within a fraction of a millisecond, rather than over the course of, say, half a minute? It’s hard to think of a societal benefit to faster price discovery which is remotely commensurate with the costs involved in delivering those faster price moves.

What’s more, faster price discovery is generally associated with higher volatility, and higher volatility is in general a bad thing, from the point of view of the total benefit that an economy gets from markets.

HFT sends the rewards of price discovery to the wrong people.

Markets reward people who find out information about the real economy. Armed with that information, they can buy certain securities, sell other securities, and make money. But if robots are front-running the people with the information, says Stiglitz, then the robots “can be thought of as stealing the information rents that otherwise would have gone to those who had invested in information” — with the result that “the market will become less informative”. Prices do a very good job of reflect ignorant flows, but will do a relatively bad job of reflecting underlying fundamentals.

HFT reduces the incentive to find important information.

The less money that you can make by trading the markets, the less incentive you have to obtain the kind of information which would make you money and increase the stock of knowledge about the world. Right now, the stock market has never been better at reacting to information about short-term orders and flows. There’s a good example in Michael Lewis’s book: the president of a big hedge fund uses his online brokerage account to put in an order to buy a small ETF — and immediately the price on the Bloomberg terminal jumps, before he even hits “execute”. The price of stocks is ultra-sensitive to information about orders and flows. But that doesn’t mean the price of stocks does a great job of reflecting everything the world knows, or could theoretically find out, about any given company. Indeed, if investors think they’re just going to end up getting front-run by robots, they’re going to be less likely to do the hard and thankless work of finding out that information. As Stiglitz puts it: “HFT discourages the acquisition of information which would make the market more informative in a relevant sense.”

HFT increases the amount of information in the markets, but decreases the amount of useful information in the markets.

If markets produce a transparent view of all the bids and offers on a certain security at a certain time, that’s valuable information — both for investors and for the economy as a whole. But with the advent of HFT, they don’t. Instead, much of the activity in the stock market happens in dark pools, or never reaches any exchange at all. Today, the markets are overwhelmed with quote-stuffing. Orders are mostly fake, designed to trick rival robots, rather than being real attempts to buy or sell investments. The work involved in trying to understand what is really going on, behind all the noise, “is socially wasteful”, says Stiglitz — and results in a harmful “loss of confidence in markets”.

HFT does not improve the important type of liquidity.

If you’re a small retail investor, you have access to more stock market liquidity than ever. Whatever stock you want to buy or sell, you can do so immediately, at the best market price. But that’s not the kind of liquidity which is most valuable, societally speaking. That kind of liquidity is what you see when market makers step in with relatively patient balance sheets, willing to take a position off somebody else’s book and wait until they can find a counterparty to whom they can willingly offset it. Those market makers may or may not have been important in the past, but they’re certainly few and far between today.

HFT also reduces natural liquidity.

Let’s say I do a lot of homework on a stock, and I determine that it’s a good buy at $35 per share. So I put in a large order at $35 per share. If the stock ever drops to that price, I’ll be willing to buy there. I’m providing natural liquidity to the market at the $35 level. In the age of HFT, however, it’s silly to just post a big order and keep it there, since it’s likely that your entire order will be filled — within a blink of an eye, much faster than you can react — if and only if some information comes out which would be likely to change your fair-value calculation. As a result, you only place your order for a tiny fraction of a second yourself. And in turn, the market becomes less liquid.

It’s important to distinguish between socially useful markets and socially useless ones.

In general, just because somebody is winning and somebody else is losing, doesn’t mean that society as a whole is benefiting in any way. Stiglitz demonstrates this by talking about an umbrella:

If there is one umbrella, and there is a 50/50 chance of rain, if neither of us has any information, the price will reflect that risk. One of us will get the umbrella. If it rains, that person will be the winner. If it does not, the other person will be the winner. Ex ante, each has the same expected utility. If, now, one person finds out whether it’s going to rain, then he is always the winner: he gets the umbrella if and only if it rains. If the other person does not fully understand what is going on, he is always the loser. There is a large redistributive effect associated with the information (in particular, with the information asymmetry), but no real social benefit. And if it cost anything to gather the information, then there is a net social cost.

HFT is socially useless; indeed, most of finance does more harm than good.

As finance has taken over a greater and greater share of the economy, growth rates have slowed, volatility has risen, we’ve had a massive global financial crisis, and far too much talented human capital has found itself sucked into the financial sector rather than the real economy. Insofar as people are making massive amounts of money through short-term trading, or avoiding losses attributable to short-term volatility, those people are not making money by creating long-term value. And, says Stiglitz, “successful growth has to be based on long term investments”.

So let’s do something about it.

HFT shouldn’t be banned, but it should be discouraged. The tax system can help: a small tax on transactions, or on orders, would reduce HFT sharply. “A plausible case can be made for tapping the brakes,” concludes Stiglitz. “Less active markets can not only be safer markets, they can better serve the societal functions that they are intended to serve.”


In the “umbrella” argument, isn’t it kind of the point that the guy who keeps getting rained on now has an incentive to get an umbrella of his own?

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Private equity math, Nuveen edition

Felix Salmon
Apr 14, 2014 13:32 UTC

The WSJ has the details of today’s big asset-management news: TIAA-CREF is buying Nuveen Investments for $6.25 billion.

The sale marks the end of an ill-fated acquisition by private equity shop Madison Dearborn in 2007, just before everything fell apart. Madison Dearborn paid a total of $5.75 billion for Nuveen — a premium of 20% to its market value. As the WSJ says, the buyers used $2.7 billion of their own money to pay for Nuveen, and then borrowed the other $3.05 billion. But then things got tough:

Within a year, Nuveen’s borrowing costs had risen as the financial crisis set in. The company eventually refinanced most of its buyout debt, which now stands at $4.5 billion and will be absorbed by TIAA-CREF.

With the TIAA-CREF deal, Madison Dearborn will have at least broken even on its Nuveen investment, a person familiar with the matter said.

On its face, this doesn’t seem right. If TIAA-CREF is absorbing $4.5 billion of Nuveen’s debt, that means it’s paying $1.75 billion in cash. That’s a billion dollars less than Madison Dearborn paid in 2007. Is it credible that Madison Dearborn has managed to dividend out a billion dollars of profit between 2007 and today?

No, it isn’t. If you look at Nuveen’s financial report, it shows net income in the five years from 2009 to 2013 to be minus $495,516,000. There’s another line, stripping out “Noncontrolling Interests” and showing net income “attributable to Nuveen Investments”; that one shows an even bigger cumulative five-year loss, of $540,752,000.

But it doesn’t end there. If you go back to the predecessor company and look at Nuveen’s results from the acquisition in 2007 through the end of 2008, you’ll find a net loss of another $1,941,588,000, and a net loss attributable to Nuveen Investments of $1,796,012,000.

Which means that either way you look at it, the cumulative losses that Madison Dearborn has overseen come to somewhere in the region of $2.4 billion.

So here’s my back-of-the-envelope math: you buy a company for $2.7 billion in cash, plus debt which you refinance a few times. While you’re running the company, it loses a total of $2.4 billion. And then you sell the company for $1.75 billion in cash. Total going out the door: $5.1 billion. Total coming in, at exit: $1.75 billion. Net loss: some $3.35 billion, give or take.

All of which raises some big questions about the WSJ’s claim that Madison Dearborn “will have at least broken even on its Nuveen investment”. If that claim is even close to being true, then at the very least we can’t take Nuveen’s public filings at face value at all. (Nuveen needs to make public filings even though it isn’t a publicly listed company, because it has issued public debt securities.) Somehow, Madison Dearborn will need to have turned losses for Nuveen into substantial profits for itself — the classic strip-and-flip strategy.

This is worth remembering, when private-equity types (think Mitt Romney) claim that their interests are aligned with the interests of the companies they buy. That certainly doesn’t seem to have been the case here. Nuveen is being sold with about $1.5 billion more debt than it started with, and with cumulative losses under Madison Dearborn’s ownership of some $2.4 billion. That’s not a great legacy for TIAA-CREF to inherit. If Madison Dearborn really is breaking even on this deal, that only goes to show the enormous disconnect between the economics of private equity companies — the wealthy rentiers of society — versus the economics of the real-world companies they buy and sell.

Update: Dan Primack has many more details on how Madison Dearborn is likely to end up breaking even here. For one thing, he says, “In addition to its $1.75 billion, Madison Dearborn will receive all of Nuveen’s balance sheet cash.” That’s a substantial sum: about $325 million or so. Then there are various successful investments that Nuveen made, as well as profit on the acquisition of a minority stake in Nuveen at a distressed price during the financial crisis. And most of those big losses were thanks to intangible asset writedowns. Which just goes to show how private equity really can come out ahead, even when the company it’s investing in seems to be struggling and losing billions.


Felix briefly mentions Nuveen’s intangible asset writedowns, but underplays them.

As Matt Levine notes – http://www.bloombergview.com/articles/20 14-04-14/how-bad-a-private-equity-invest ment-was-nuveen-investments – those impairments account for over 100% of the net losses posted by Nuveen during Madison Dearborn’s ownership. Those items are completely non-cash and are essentially a mark-to-market charge saying that Madison Dearborn overpaid for Nuveen in 2007. (That seems to be true, in the sense that Madison Dearborn would have taken a huge loss if it sold Nuveen in 2009 when, per Dan Primack, Nuveen’s annual EBITDA was $253 million, as compared to $404 million in 2013.) A key point to note is that GAAP dictates that these impairment charges are never reversed – there’s a requirement to test annually for impairment, but the amount that’s written down is never written back up.

Summarizing – the “$2.4 billion in losses” referenced by Felix are driven by required GAAP accounting for non-cash writedowns, and these losses are therefore completely meaningless for the type of analysis that he’s trying to carry out here.

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Five explanations for Greece’s bond yield

Felix Salmon
Apr 11, 2014 18:19 UTC

The biggest news in the sovereign debt world this week has come from Greece, which managed to sell some €3 billion in new 5-year bonds at a yield of just 4.95%. This is not what you might expect, given the macroeconomic situation:

Greece’s debt currently stands at about 320 billion euros, or 175 percent of GDP. It is rated nine notches below investment grade at Caa3 by Moody’s. Standard and Poor’s and Fitch rank Greece six notches below investment grade at B-.

So, how does one explain investors’ appetite to buy this debt at such low yields? Here are the top five reasons:

1. This is just part of a momentum trade.

The Greece trade has been astonishingly lucrative for the past two years. Here’s the chart, from the WSJ:


You could have bought post-restructuring Greek debt in May 2012 at a yield of 30%; it’s now down to 5%, and there’s no particular reason to believe that the trend is over. After all, Portugal, which hasn’t even had a restructuring (yet), has five-year bonds trading at a yield of 2.6%. As a result, so long as the “go long Greece and make lots of money” trade is working, there are going to be investors who are happy to jump on the bandwagon.

2. The yield is reasonably juicy.

4.95% might not seem like a lot on its face, but Greece has been suffering from deflation for the past year. Right now the inflation rate in Greece is about -1.5%, which means the real yield on this bond, for a Greek investor, is actually closer to 6.5%. Given that Europe is going to have a zero interest rate environment for the foreseeable future, that kind of real yield is undeniably attractive.

3. There’s potential for significant price appreciation.

With a coupon of 4.75% and a yield of 4.95%, you can buy €1,000 face value of bonds today for €991. Let’s assume that you hold this bond for 18 months, and that at the end of that period the yield has dropped to Portugal’s 2.6%. In that case, you would get three coupons along the way, totaling €71.25, even as the value of the bond itself would have risen to $1,071. If you sell the bond at that point, you’re not just getting your €71.25 in coupon payments, and you’re also getting €80 in capital gains — for a total profit of €151.25. Which is a 15.3% return in 18 months. Not too shabby, in a world of zero interest rates.

4. The chance of default is slim.

Greece has an unsustainable debt load, and will certainly default again in the future. But the key question for anybody buying this bond isn’t whether Greece will default. Rather it’s when Greece will default, and what instruments Greece will choose to default on. So long as Greece continues to pay the modest coupons on this modestly-sized bond for the next five years, it can prove to be a perfectly good investment even if the country is defaulting elsewhere. Similarly, if Greece defaults on its public bonded debt but does so after April 2019, again this bond will be unscathed.

The degree of pain inflicted on Greece’s private-sector bondholders in 2012 was so enormous, and the amount of privately-held debt which is still outstanding is so small, that it’s going to be the official sector’s turn to take a big haircut next time round. In other words, buying this bond does not constitute a bet that Greece, as a sovereign, will not default. It’s just a bet that this particular bond will not default. And that’s actually a bet I’d be willing to take.

5. Mario Draghi is going to do QE.

The worst thing that can befall Mario Draghi, the ECB president, would be deflation across the eurozone. And the German constitutional court notwithstanding, the markets are now convinced that if Draghi needs to implement some kind of quantitative easing in order to prevent eurozone-wide deflation, he will do so. And that no one, including the German constitutional court, will be willing or able to stop him.

Quantitative easing, of course, means buying bonds. And while no one can know exactly which bonds the ECB would buy, one easy and obvious option would be to simply buy the sovereign debt of all eurozone member governments. Including Greek debt. if that happens, Greek bond prices would surely rise, possibly quite substantially. After all, there’s not much point in Draghi doing QE unless he’s going to do it at serious scale.

I’m at the INET conference in Toronto this week, where there’s a lot of talk about “overt monetary financing” in the eurozone. Basically, the euro crisis isn’t over, and there are only three ways to resolve it. One is a pan-European fiscal authority; the second is a breakup of the eurozone. Since neither of those two things is politically possible, the third option becomes a necessity. Which, essentially, is that the ECB swoops in to save the day by printing money. Most of the people I’ve talked to here thinks that Draghi is bound to do that at some point. Which in turn helps explain those low bond yields in peripheral Europe.

None of these reasons, individually or collectively, are particularly good reasons to buy Greek bonds at 4.95%. It has always been very easy to lose a lot of money buying junk-rated sovereign debt at low single-digit yields; that hasn’t changed. But if you’re a bond investor, there’s a surprisingly large number of ways that you could end up making money after buying Greek debt at these yields. Which in turn explains why Greece found it so easy to sell €3 billion in bonds.


The idea that governments are going to take a bath and spare the private sector is laughable.

The idea that bond holders are some how going to benefit from currency devaluation is also a head scratcher… I make a 5% coupon return in a currency that gets devalued by probably at lest that much? Better than owning German notes but hardly a win.

Using the optimistic outcome outlined above you’ve basically got 15% max upside in 18 months. What’s your max downside -50%.

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The utility of switching lanes

Felix Salmon
Apr 11, 2014 05:42 UTC

Josiah Neeley has an evil, hour-long commute. But unlike most of us with traffic issues, he actually decided to do something constructive with it: according to the flip of a coin, he either commutes normally, switching lanes when doing so seems sensible, or else sticking religiously to the left-hand lane and just sweating it out, no matter how fast or slow it goes.

Neeley doesn’t have a statistically significant result yet, but initial indications are pretty much what you might expect, if you understand the psychology of traffic: if you just sit in a single lane, you spend no more time in traffic than if you aggressively switch lanes and try to go as fast as possible at all times.

There are two possible conclusions to draw from this. The first is that, rationally, no one should switch lanes when they’re stuck in traffic. It doesn’t make them get to where they’re going any faster, but it does slow down the road as a whole.

The second, however, is the exact opposite. As Neeley says:

The hardest part of the experiment is just sticking to it. When it’s a left hand lane only day, it’s often quite difficult to keep to the plan when my lane is going forward at a crawl. But then I remind myself that this is for Science, and I soldier on. Perhaps more importantly, I’ve noticed that my subjective sense of how bad the traffic is on a particular day doesn’t necessarily line up with the objective data. On many a day I feel like my drive has gone on forever, only to find that it wasn’t any longer than on previous days where it felt like I was flying down the highway.

This is important: the really painful part of being stuck in traffic is not, really, the actual amount of time that it takes to get from Point A to Point B. Rather, it’s the “stuck” bit. As a result, the best way to minimize the suffering involved in a long commute is not, necessarily, to simply get to your destination as fast as you possibly can.

One of my lesser-value skills is that when my wife and I are stuck in highway traffic, and she’s driving, I’m quite good at looking at the live traffic maps, from Google and Apple, and finding a way to use surface streets to skip forward a couple of exits. My guess is that 90% of the time, when we do that, we don’t actually save time. But pretty much 100% of the time we both end up significantly happier than we were when we were crawling up the freeway. If you go a longer distance at a modest speed, but you’re not stuck in traffic on an ugly highway, you feel as though you’re getting somewhere.

The same is true when you stay on the highway, rather than leave it: the act of changing lanes, and thereby briefly overtaking the car which up until a moment ago was in front of you, makes you significantly happier than just sitting there like a passive schmuck. Which is why we all do it.

In other words, if you want to understand utility functions, don’t talk to an economist. The economist will find a proxy for utility — in this case, time — and then try to work out what kind of behavior optimizes for the proxy. If Neeley had discovered that changing lanes frequently only served to cause a significant increase in time spent commuting, he would probably just opt to sit in a single lane henceforth, even when doing so was difficult, and even when doing so increased the number of days where it felt like his drive had gone on forever.

The more interesting experiment, I think, would be to judge not actual time spent commuting, but some kind of subjective measure (say, on a four point scale) of how brutal the commute was that day. The important thing isn’t whether you shave a minute here or there: it’s how you feel once you get to your destination. This is something I’ve noticed since switching almost exclusively to Citibike when I bike around New York — while the Citibikes are undoubtedly slower than my regular bike, that doesn’t make me more impatient in traffic. Quite the opposite, indeed: I feel as though I’ve become a more zen biker as a result of the switch.

If you look at subjective rather than objective measures, I’m pretty sure that all our lane switching will turn out to have a useful purpose after all: it makes us feel as though we’re in control of our own destiny. Which, ultimately, is more important than an extra minute’s commute.

Yes, the SEC was colluding with banks on CDO prosecutions

Felix Salmon
Apr 9, 2014 23:23 UTC

Back in 2011, I asked whether the SEC was colluding with banks on CDO prosecutions. And now, thanks to an American Lawyer Freedom of Information Request, we have the answer: yes, they were.

This comes as little surprise: it beggared belief, after all, that every bank would end up being prosecuted for one and only one CDO. But now we have chapter and verse: the key precedent, it seems, was the first one, Goldman Sachs.

The SEC filed its case against Goldman and Tourre on April 16, 2010. Three days later Goldman reached out with a $500 million settlement offer, according to an email that Reisner sent Khuzami. Although that proposal was close to the final payment, it took another three months to announce a settlement. As Khuzami described to Kotz, Goldman wanted a global settlement that resolved not just the Abacus investigation but the SEC’s probes into roughly a dozen other Goldman CDOs.

Khuzami didn’t want to give Goldman that public victory. When the SEC and Goldman announced on July 16, 2010, that the investment bank would settle the Abac­us case for $550 million, the SEC said in a press release that the settlement “does not settle any other past, current or future SEC investigations against the firm.”

Khuzami was determined that Goldman’s payment only be linked to ABACUS. “This was not a $550 million settlement for 11 cases,” Khuzami told Kotz. “We may tell Goldman that we are concluding our investigations in these other matters without recommending charges, but that doesn’t mean we’re settling them. And that was an important point for us, because we didn’t want them out there saying, you know, they settled 12 CDO investigations for an average of $30 million each, and, you know, didn’t [Goldman] get a great deal.”

Yet in its statement on the Abacus settlement at the time, Goldman said that the SEC had concluded a review of other CDOs and did not anticipate recommending claims for now.

It’s quite impressive how quickly and accurately Goldman nailed the amount of money that it would have to pay the SEC to settle the case: when it took three months to come to the $550 million settlement, I for one assumed that Goldman had to be dragged kicking and screaming to that point. In fact, however, Goldman was happy to offer half a billion dollars right off the bat. The tough part of the negotiation was not over the Abacus fine — it was over the question of whether the SEC, with the Abacus prosecution successfully under its belt, would then go after Goldman for a dozen other deals which were functionally equivalent.

The answer was a clear no: Goldman might be equally culpable for 11 other deals, but the SEC quietly assured Goldman — but not the public at large — that none of those deals would result in any charges.

And with the Goldman deal now public knowledge, we can assume that the same nod-and-a-wink deal was struck with all the other one-and-only-one CDO bank prosecutions: Citigroup, JP Morgan, Merrill Lynch (which evidently included Bank of America), Mizuho Securities, Wachovia, Wells Fargo, UBS. Add them all up, and I wouldn’t be surprised if there are 100 unprosecuted CDO deals out there, all of whom had victims just as deserving as the ones who got paid out on the prosecuted deals. Basically, there’s a CDO lottery, and, thanks to the way in which the SEC cozied up to the big banks, the average CDO investor has a very small chance of having won it.

As Khuzami says, if you look at them on a per-CDO basis, the big headline numbers suddenly become much more modest and affordable for Wall Street banks. So there’s a real scandal here: firstly, the SEC was not being fully honest with the public about the deals it was cutting. Secondly, the SEC failed to stand up for CDO investors it should have fought for. Thirdly, the SEC tried to make it look as though it was levying massive fines for single deals, when really the settlements were omnibus deals covering some unknown quantity of CDOs.

Now that this information is public, the SEC should apologize to all of us for its behavior, and promise not to collude with Wall Street again. If it doesn’t, that’s a clear sign that Wall Street’s most salient watchdog is still as captured as ever.


Nothing new here. The SEC is controlled by politicians who receive millions of dollars from Wall Street firms to make sure regulations and enforcement favor Wall Street and not investors. And, SEC attorneys will eventually work for Wall Street firms for five times the money they are paid by the SEC. This is collusion at a high level. The solution is in Washington, but apathetic investors/voters have let politicians make collusion a way of doing business. They stay in power and retire with millions of dollars. Only the American public can fix this. But, they are not motivated to fix it – Americans rarely react until problems are out of control. The political problem may get their attention when they cannot afford to retire and are looking for someone to blame. Start with the senators from your state.

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Felix Salmon
Apr 9, 2014 11:51 UTC

My article on the wonk bubble, at Politico, came out not only at the same time as the launch of Vox.com, but also, coincidentally, with the release of comments from both Michael Wolff and Marty Baron on the same subject.

Baron is much more constructive and optimistic than Wolff, but he shares with Wolff a certain skepticism when it comes to what Ezra Klein, in particular, is doing. It’s worth quoting Baron at some length:

What Ezra said when he came to senior executives at the Post — and I was the first one he came to, as far as I know — was that he wanted to create an entirely new news organization, something entirely separate from the Post. And that he would be in charge of it — he would be the president, the CEO, the editor-in-chief, he would select the technology, he would select the advertising chief — pretty much everything. And it would exist outside the framework of The Washington Post.

It was not a request for more financing for his venture within the Post called Wonkblog, which we had financed to the tune of millions of dollars over many years — we had grown it. I don’t know how well people knew Ezra before he worked at The Washington Post, but I know that after he worked at The Washington Post, they knew him quite well. It was a great platform for him, and he was great for us as well…

What he had in mind was a separate news organization. And what he really wanted to know — what he wanted to know was whether Jeff Bezos would be willing to finance that.

And that’s fine, and we obviously ran that up the pole. But I don’t have a venture capital fund available to me. I’ve looked all around — I’ve looked in the files. I don’t have a venture capital fund. And our publisher, I don’t believe, has a venture capital fund either. The company is owned 100 percent by Jeff Bezos, so any decision to fund a new venture would be his to make. And, as it turned out, the amount of money that apparently was being sought, you know, was somewhere roughly equivalent to 10 percent of our newsroom budget. And, you know, I think it’s safe to say that I would not have been too happy if 10 percent of my newsroom budget had been earmarked for [this project].

The first thing to note here is that Baron is factually wrong when it comes to whether his publisher has a venture capital fund: Bezos does indeed invest venture capital into news projects, most visibly into Business Insider.* In principle, therefore, there was no particular reason why Bezos might not support Klein with a similar sum of money, especially when that sum would get him 100% ownership of the new product, rather than just a minority stake in somebody else’s business.

But of course there was a much bigger problem than Bezos. Baron was clearly quite offended that Klein would want to set up an arm’s-length business in parallel to WaPo, rather than simply expanding Wonkblog under the existing WaPo umbrella. After all that the Post had done for Klein, all of the millions of dollars it had paid him and his team, all of the brand value it had gifted him, it was downright ungrateful for Klein to want to move as far as he could from the newsroom and the Post’s CMS.

Baron’s reaction was understandable, since Klein was in effect saying, with his proposal, that he didn’t think the Washington Post could really do something revolutionary given its existing architecture and leadership. No boss likes being told that he’s part of the problem.

But here’s the thing: Klein was right. Just as the big sell-side banks proved incapable of keeping up with the small nimble high frequency trading shops, big legacy media organizations are never going to be able to move with the speed and inventiveness of the best new-media shops. Vox is a great case in point: Klein joined on January 26, and launched the new Vox.com on April 6. That’s 15 weeks, which is less than half the amount of time it took Nate Silver to launch fivethirtyeight.com. (Silver joined ESPN on July 19, and launched his site on March 17.) And while both sites are very much still works in progress, Vox.com, at launch, is definitely a more advanced product than fivethirtyeight.com — despite, or perhaps because of, the fact that his corporate parent has almost infinitely deep pockets.

In general, the bigger and more entrenched the media company you’re part of, the harder it is to get stuff done. (I should know.) Klein had intimate, first-hand experience of the Washington Post bureaucracy, and he also saw the way in which Kara Swisher and Walt Mossberg managed to build a world-class franchise in AllThingsD, once they negotiated for themselves almost complete independence from their corporate overlords. They would never have had the same success had they been part of WSJ.com. What Klein wanted — and, ultimately, received, from Vox — was just the freedom to build something new and potentially amazing, outside the strictures of Marty Baron’s newsroom. Baron, and his employer, said no, as was their right. But you can feel the defensiveness in Baron’s remarks.

In case you didn’t notice Baron’s rhetorical sleight of hand, when he says that “the amount of money that apparently was being sought, you know, was somewhere roughly equivalent to 10 percent of our newsroom budget”, he is not saying what he seems to be saying. He’s deliberately conflating stock with flow: while Klein was reportedly asking for a total investment of roughly $10 million, Baron’s newsroom budget is $100 million per year. In other words, for a total investment of 10% of just one year’s budget, Klein was offering to create something which could profoundly change the course of digital journalism — and to keep all of the intellectual property within the Washington Post.

Baron and Bezos, of course, passed on the opportunity, which Vox Media jumped at. And the Posties passed despite being acutely aware of the Politico precedent. That outcome was probably for the best: I’m sure that Klein is much happier at Vox than he ever would have been trying to build something akin to Vox.com from scratch. Vox is a technology product as much as it is an editorial product, and Klein is no technologist: he has been given a massive headstart thanks to Vox’s first-rate technology team and content management system. Insofar as Vox ends up being a success, then, that doesn’t mean that it would have done just as well as part of the Washington Post Company.

Still, Baron’s defensiveness is not a positive sign, if you’re someone who wishes the best for the Washington Post. His newspaper’s natural local-news monopoly is not remotely sufficient to support a $100 million-per-year newsroom, which means that he’s going to have to start getting a substantial national audience somehow. Bezos paid $250 million for the franchise; he’s also beefing up the newsroom’s digital staff, which is a welcome development. But there’s no reason for him to have all of the Washington Post’s eggs in a single basket. The Klein opportunity was a rare one: no one else of Klein’s caliber would have approached Baron with the opportunity to fund their startup. And Baron’s language is a clear indication that he has very little interest in building a sandpit where anything else can thrive, either. At least the old Washington Post had the Slate Group; the new one has nothing.

If Baron is optimistic about the Post’s business, he should read the Michael Wolff interview. Wolff has a blinkered view of the world; he thinks that the only way that journalism will ever generate meaningful revenue is by selling adjacencies to advertisers, just as it has done for decades. And because that business doesn’t work well online, Wolff is a perennial digital bear. I’m much more constructive than Wolff is on the economics of things like Vox, because I know that there are lots of potential revenue streams associated with the format. Just about every company with a reputation problem, for instance, should be jumping at the opportunity to be able to tell their story using Vox’s technology and platform.

But if Baron is going to overcome the Wolff diagnosis and build a sustainable digital franchise for the long term, he — and his new owner — are going to have to take some risks. As I say in my Politico piece, the wonk space is exactly where a huge amount of of news innovation is happening right now, and I’m frankly doubtful that the Post’s newsroom is the best incubator for such ideas. Baron has made some great hires, including my friend and former colleague Ryan McCarthy. But it’s really, really hard to turn a print newsroom into something natively digital. Klein had the right idea: do something at arm’s length first, and then let the technology and ethos trickle back to the mothership. Because if you try to build something new within the mothership, it’s often liable to get suffocated.

*Update: OK, if you want to pick nits, the publisher of the Post is Katharine Weymouth, and Bezos is the proprietor. But since Weymouth is spending Bezos’s money, the distinction doesn’t seem to be hugely important to me.


I agree with Ryan Tate. The underlying meaning of Baron’s point is abundantly clear – giving Klein the deal that he wanted would require approval at the Bezos level, not just from the day-to-day management team at the Post. Felix calls him Baron out for a factual error but presents no evidence to contradict that basic point.

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Michael Lewis’s high-speed journalism

Felix Salmon
Apr 7, 2014 15:17 UTC

My full review of Flash Boys is now up at Slate. Tl;dr: he’s right for the wrong reasons. HFT is a bad thing, but not because it rips off small investors.

There’s a separate question worth asking, though: why is this book weaker than Lewis’s other books?

Partly, it’s because Lewis took a bet on the unknown. Lewis tells stories by focusing on individuals, and he clearly felt that he hit the jackpot when he found Brad Katsuyama, the founder of IEX. Katsuyama would in any case have been a compelling choice as the person through whom to explain HFT. But in this case Lewis managed to go one better: he caught Katsuyama at a very auspicious time, which meant that he could actually follow him, in person, through the launch of his new company. As a result, Lewis found himself unable to control the arc of his story: from the point of view of the narrative, Flash Boys was going to go wherever IEX went, even if IEX’s future was very unclear at deadline.

And while first-person access should in principle make the book better, because Lewis can add the kind of details which he can never find by talking to participants ex post, in practice, it often doesn’t. Rather, it means that Lewis seemingly felt compelled to, well, add the kind of details which he could never find by talking to participants ex post:

Don leaned with his back against the window, along with Ronan, Schwall, and Rob Park, while Brad stood in front of the whiteboard and took a whiteboard marker out of a bin…

Schwall looked over the desks and shouted, “Whose phone is that?”

“Sorry,” someone said, and the ringing stopped.

This isn’t novelistic color, it’s more akin to the famous drunk looking for his keys under the lamppost. When Michael Lewis knows exactly what story he wants to tell, he can talk to people and piece it together like no one else in the business. But in this case, Lewis chose the story before he knew how it was going to end, and so he ends up writing what he saw. Which is sometimes important, and sometimes isn’t. It’s a common problem when a journalist gets exclusive access to something: just because you’re the only person to witness something, doesn’t mean it’s particularly worth witnessing.

To make matters worse, Lewis felt the need to bulk up the book by dropping in, more or less verbatim, his entire Vanity Fair article on Sergei Aleynikov. That story was excellent: one of the best things that Lewis has written, which is a very high bar. But its narrative doesn’t fit with that of Brad Katsuyama; in some ways, the two are diametrically opposed. Aleynikov should probably have appeared in the book somehow, as an example of the way in which the big banks were thrown in panic by the rise of HFT. But that would have required Lewis writing the Aleynikov story all over again, a second time around — when the first time was already such a success. So he simply did a copy-and-paste job, which is not what his bigger story really required.

Overall, a lot of the weaknesses with this book are ironically the same as the weaknesses with the stock market: it’s just too fast. With a bit more time and care, Lewis could have broadened his story a bit, put Aleynikov into better context, and explained the real dangers of HFT rather than just the “you’re being ripped off” hyperbole. He could also have avoided some silly mistakes: Secaucus is west of Weekhawken, for instance, not east.

Then again, maybe Flash Boys is a sign of where book publishing is going. It will probably be read more on electronic devices than in print; it will probably be read mostly in the next few weeks, and become dated very quickly. It’s an event; it’s highly salient right now, but it doesn’t have the legs that, say, Liar’s Poker does. Books used to be objects with permanence; as they become increasingly electronic, they can start moving towards the more disposable model of, say, Vanity Fair style magazine journalism.

Which makes possible what you might call the Reputation Arbitrage. The Newsweek cover story on Satoshi Nakamoto got enormous amounts of attention just because it was a Newsweek cover story, appearing, in print, on the front page of a physical magazine with a storied brand. If exactly the same story had appeared on a lesser-known website, it would have caused much less of a fuss. Similarly, Flash Boys is getting enormous amounts of attention just because it is a book by Michael Lewis. If he had simply written the NYT Magazine story, without a book behind it, the article would still have been shared a lot, but I don’t think we would have seen the same response from, say, US law enforcement.

In the digital age, media are converging faster than people think they are. Certain formats — the magazine cover, the hardback book — retain a certain amount of vestigial reputational capital, which can cause people to write about them more than maybe they should. If only the same amount of attention had been paid to, say, Matt Taibbi’s scoop about SEC document-shredding. That is something to really get angry about.


There might be literary issues with the book but given the fact that excerpts from the NYT and other articles and news stories went viral in the day after”60 Minutes” featured the book says one thing – people want to know where OUR money went and is going and now we do. Even more important, we know that there are some people who are trying to change the system. That is what most of us want.

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Stop adding up the wealth of the poor

Felix Salmon
Apr 4, 2014 18:59 UTC


It’s the meme that refuses to die. It started, back in 2011, with the Waltons: six members of the family, we were repeatedly told, were worth as much as the bottom 30% of all Americans combined. I tried to address this silly stat back then, but now it’s gone global: back in January, Oxfam announced that the world’s 85 richest people had the same wealth as the bottom half of the global population. And now Forbes has come along to say that, actually, it’s not 85 people — it’s a mere 67.

Oxfam does a pretty bad job of footnoting its report, but I did manage to finally track down how it arrived at this conclusion. The 85 (or 67) number is easy: you just start at the top of the Forbes billionaires list, and start counting up the combined wealth until you reach $1.7 trillion. The harder question is: where does the $1.7 trillion number come from?

The answer is that it comes from a pair of tables in Credit Suisse’s 2013 Global Wealth Databook. First of all, you have to find the total wealth in the world, which you can find at the bottom of the fourth column on page 89: it’s $241 trillion. Then, you flick forwards to page 146, where you find the proportion of all global wealth held by each of the world’s income deciles. The top 10% have 86% of the wealth; the next 10% have 7.8%, and so on. Add up the bottom five deciles, and you get 0.7% (not 0.71%, which is the number in the Oxfam report; I have no idea where that extra basis point came from). And if you multiply $241 trillion by 0.7%, you get $1.7 trillion.

All of which makes a certain amount of sense, until you start looking a bit closer. For instance, notice anything odd about this chart?

Screen Shot 2014-04-04 at 2.02.31 PM.png

The weird thing is that triangle in the top left hand corner. If you look at the tables in the Credit Suisse datebook, China has zero people in the bottom 10% of the world population: everybody in China is in the top 90% of global wealth, and the vast majority of Chinese are in the top half of global wealth. India is on the list, though: if you’re looking for the poorest 10% of the world’s population, you’ll find 16.4% of them in India, and another 4.4% in Bangladesh. Pakistan has 2.6% of the world’s bottom 10%, while Nigeria has 3.9%.

But there’s one unlikely country which has a whopping 7.5% of the poorest of the poor — second only to India. That country? The United States.

How is it that the US can have 7.5% of the bottom decile, when it has only 0.21% of the second decile and 0.16% of the third? The answer: we’re talking about net worth, here: assets minus debts. And if you add up the net worth of the world’s bottom decile, it comes to minus a trillion dollars. The poorest people in the world, using the Credit Suisse methodology, aren’t in India or Pakistan or Bangladesh: they’re people like Jérôme Kerviel, who has a negative net worth of something in the region of $6 billion.

America, of course, is the spiritual home of the overindebted — people underwater on their mortgages, recent graduates with massive student loans, renters carrying five-figure car loans and credit-card obligations, uninsured people who just got out of hospital, you name it. If you’re looking for people with significant negative net worth, in a way it’s surprising that only 7.5% of the world’s bottom 10% are in the US.

And as you start adding all those people up — the people who dominate the bottom 10% of the wealth rankings — their negative wealth only grows in magnitude: you get further and further away from zero.

The result is that if you take the bottom 30% of the world’s population — the poorest 2 billion people in the world — their total aggregate net worth is not low, it’s not zero, it’s negative. To the tune of roughly half a trillion dollars. My niece, who just got her first 50 cents in pocket money, has more money than the poorest 2 billion people in the world combined.

Or at least she does if you really consider Jérôme Kerviel to be the poorest person in the world, and much poorer than anybody trying to get by on less than a dollar a day. All of whom would happily change places with, say, Eike Batista, even if the latter, thanks to his debts, has a negative net worth in the hundreds of millions of dollars.

Now $1.7 trillion is undoubtedly a lot of money: there is an astonishing amount of wealth inequality in the world, and it’s shocking that just 67 people are worth that much. You could spread that money around the “bottom billion” and give them $1,700 each: enough to put them squarely in the fourth global wealth decile. But let’s look at just the top two-fifths of the 3.5 billion people referred to in the Oxfam stat. That’s 1.4 billion people; between them, they are worth $2.2 trillion. And they’re a subset of the 3.5 billion people who between them are worth $1.7 trillion.

The first lesson of this story is that it’s very easy, and rather misleading, to construct any statistic along the lines of “the top X people have the same amount of wealth as the bottom Y people”.

The second lesson of this story is broader: that when you’re talking about poor people, aggregating wealth is a silly and ultimately pointless exercise. Some poor people have modest savings; some poor people are deeply in debt; some poor people have nothing at all. (Also, some rich people are deeply in debt, which helps to throw off the statistics.) By lumping them all together and aggregating all those positive and negative ledger balances, you arrive at a number which is inevitably going to be low, but which is also largely meaningless. The Chinese tend to have large personal savings as a percentage of household income, but that doesn’t make them richer than Americans who have negative household savings — not in the way that we commonly understand the terms “rich” and “poor”. Wealth, and net worth, are useful metrics when you’re talking about the rich. But they tend to conceal more than they reveal when you’re talking about the poor.


So what if there is huge wealth inequality around the globe? Governments will never be able to correct it on a society wide basis, let alone a global one.

No, the best way to extract wealth from the rich is to provide them with a service or product which they cannot live without. They will gladly, and I mean gladly with a smile on their face, hand you more money than you will ever believe.

The only difference between the rich and the middle class is that the middle class buy products, the rich buy services.

The internet has made it so that only the least imaginative cannot engage in some form of entrepreneurial enterprise.

Governments will never be able to extract and redistribute to any one person to change any individual’s lives. But one individual can indeed tap into the trillions that flow around the world if they provide a quality, superior level of service at a superior price.

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