Opinion

Felix Salmon

Why cab drivers should love Uber

Felix Salmon
Dec 12, 2013 01:18 UTC

Last month the city of New York raised more than $200 million by auctioning off 200 new taxi medallions — essentially, the right to operate a yellow cab in the city. Some 2,000 such medallions are likely to be sold in all, which means $2 billion of much-needed revenue for New York, if prices remain high. But will they? It’s surprisingly easy to justify a million-dollar price tag for a medallion — but in order to do so, you need to assume that medallion owners’ income will remain constant, in real terms, over time.

Historically, the impressive political power of the medallion owners has helped to keep their income steady. They’re good at keeping the total number of medallions relatively low, and they’re also good at pushing through periodic increases in metered fees. The combination of the two allows them to rent out their medallions to drivers for about $75,000 per year.

That’s a very good deal for the medallion owners, and a much less good deal for the taxi drivers, whose income, says taxi commissioner David Yassky, is “grindingly low” — something less than $150 per day, for a 12-hour shift.

Essentially, every time you take a cab, your money gets split roughly evenly between the driver and the medallion owner. Which means that when a company like Uber comes along, it can offer lower fares to riders and substantially higher income to drivers — a win for everybody except the medallion owners.

The key datapoint came in October, when Uber said in a blog post that when it lowered fares for its UberX product, its drivers’ income actually went up rather than down: in Boston, it rose by 22% per hour, which is a lot of money. The result has been that UberX is now priced near or below prevailing taxi rates in most cities: in Washington DC, for instance, UberX costs 18% less than a taxi. And the drivers of those cars are making significantly more money than they would make if they were driving a cab.

Details on driver income are a bit sketchy, but at least one driver seems to be grossing over $1,000 per day, on good days, while Uber’s own advertising talks about an income of $70,000 per year. If you’re tactically smart as an UberX driver — driving towards hotels when empty, or waiting for a while after dropping a passenger off at the airport in the hope of picking up a fare back — then a six-figure income does not seem to be uncommon. And demand for UberX cars continue to exceed supply: the only reason they’re not even cheaper than they are, in cities like New York, is just that the cheaper they get, the more people want to use them, and Uber just doesn’t have enough cars and drivers right now to meet such demand.

We’ve already reached the point, then, at which it makes sense for almost any taxi driver who doesn’t own his own medallion to give up the rickety old yellow cab, with all of its onerous regulations, and just drive an UberX instead. I’m sure that many have already done so, and that more will follow suit over the course of 2014. And while for the time being there’s probably a big enough pool of cab drivers that new ones can be found to replace the people who have started driving for Uber instead, eventually the medallion owners are going to have to start cutting their drivers a sweeter deal, to prevent them from defecting to the competition.

Back in 1999, Jim Surowiecki proposed that we should deregulate cab fares in New York. That was a bonkers suggestion back then, because in an era of street hails, you need to know how much a cab costs before you hail it. But with the arrival of apps like Uber, we’re getting much the same effect. When you e-hail an Uber, you have just as much of an idea how much it’s going to cost as you do when you hail a cab. And so then the various services can effectively start competing with each other on price and service.

Intuitively, that sounds like a bad thing for drivers, and I understand why cabbies in San Francisco might consider Uber and its ilk to be the enemy. After all, more competition means lower prices, right? And if passenger start using taxi alternatives rather than taxis, that means less income, overall, for the taxi industry.

But in this case, the cab drivers — at least the ones who lease their cabs on a per-shift basis — should think of themselves less as small business owners, selling their services to passengers, and more as valuable employees, selling their services to either taxi-fleet owners or to companies like Uber. Looked at that way, more competition means higher wages, not lower income.

Precisely because taxi fares are highly regulated, cab drivers have historically had almost no bargaining power when it comes to their own income. The fares are set, and even if fares rise, the fleet owners will waste no time in taking advantage of that rise in fares to simply raise the cost of leasing a cab. Especially in New York, where there’s a limited number of medallions, anybody who wants to drive a taxi basically has to just accept whatever deal is offered.

But now they have a choice, which is excellent news — for them, and also for the public as a whole, which clearly loves the ability to easily order cabs from indoors, rather than having to take their chances on the street or on the phone with a dispatch service of dubious reliability and punctuality.

On the other hand, it’s not good news for the owners of the fleets. If they have to pay more to retain their drivers, that’s going to eat into their profits. And in turn, that will mean that they’re in turn willing to pay less for medallions.

That’s fine by me. So long as the price of a medallion stays above zero, the number of taxis on the street will remain constant, and the arguments against Uber — which are based on the idea that taxis will become scarcer — won’t apply. What’s more, the continued existence of all those taxis will ensure that Uber will find it difficult to raise its rates. After all, it has already discovered that demand is much greater when prices are taxi-like than when they’re significantly more expensive than taxis.

But I do think that as UberX catches on, along with its various competitors, the price of a taxi medallion is sure to fall. And that’s especially true in a world of rising interest rates, where medallions are valued on a discounted cash-flow basis. So while both drivers and passengers should embrace the arrival of UberX, if I was a medallion owner, I’d be worried. And I certainly wouldn’t be looking to buy new medallions, at a million bucks a pop.

COMMENT

So cabbies know how to copy and paste the same comment over and over at least.

http://goo.gl/VCCB3R

Posted by indifferents | Report as abusive

Can you fact-check a twerking video?

Felix Salmon
Dec 10, 2013 23:09 UTC

 

Josh Benton of the Nieman Journalism Lab writes in, asking for a 2014 prediction for the world of news. My answer: 2014 is going to be the year of a big debate about what news is —and especially about whether and how news organizations can ethically report on activity in the virtual world.

The first time I saw this debate take place in public was in October, on Nick Denton’s Kinja commenting platform, where a fascinating conversation broke out between Denton, the founder of Gawker Media; John Cook, the editor of Gawker; and Neetzan Zimmerman, the viral wunderkind who singlehandedly generates most of Gawker’s traffic. Zimmerman had put up yet another of his dozen posts a day, all of which feature (which is to say, recycle) various pieces of content found on the internet. This post was headlined “Grandpa Writes Letter Disowning Daughter After She Disowns Gay Son”, and featured a letter which Zimmerman found on a gay-friendly t-shirt site named FCKH8.

Denton quickly jumped into the comments, saying there was something fishy about the way in which FCKH8 kept on finding such heartwarming letters; he also pointed out that the company’s founder, Luke Montgomery, has a long history of “stunts”.

Cook replied to Denton:

Part of our job is to make sure we’re writing about things that people are talking about on the internet, and the incentive structure of this company is organized to make sure that we are on top of things that are going viral. Neetzan is explicitly tasked with doing so. Unfortunately, that involves covering charlatans and bullshit artists, whether it’s Montgomery or Jimmy Kimmel

I’d rather be calling bullshit on stuff like this than calling attention to it… But we are tasked both with extending the legacy of what Gawker has always been—ruthless honesty—and be reliably and speedily on top of internet culture all while getting a shit-ton of traffic. Those goals are sometimes in tension.

Zimmerman, who’s surely one of the world’s greatest experts on viral content, then replied to them both, pointing out that the tension was even bigger than that:

Most viral content demands from its audience a certain suspension of disbelief.

The fact is that viral content warehouses like BuzzFeed trade in unverifiable schmaltz exactly because that is the kind of content that goes viral.

People don’t look to these stories for hard facts and shoe-leather reporting. They look to them for fleeting instances of joy or comfort. That is the part they play in the Internet news hole.

In other words, there’s things which are true on the internet — like that letter from a disappointed grandpa, or a video of a failed twerk. The internet is getting increasingly good at generating such content — so good, indeed, that the bar is getting raised, and the chances of successfully-viral content simply emerging naturally from the world are getting ever slimmer. There’s now so much fake content out there, much of it expertly engineered to go viral, that the probability of any given piece of viral content being fake has now become pretty high.

The result is stories like this one, in the NYT, headlined “If a Story Is Viral, Truth May Be Taking a Beating”, which says that “digital news sites are increasingly blurring the line between fact and fiction”:

When the tales turned out to be phony, the modest hand-wringing that ensued was accompanied by an admission that viral trumps verified — and that little will be done about it as long as the clicks keep coming…

Gawker, BuzzFeed, The Huffington Post and Mashable among them — do not see invented viral tales as being completely at odds with the serious new content they publish alongside them.

The NYT story even quotes Elan Gale, who hoaxed the internet with his Thanksgiving plane-ride tweets, saying that the people who embedded and Storified his tweets were “deceiving their audience” by doing so. The appeal of the moral high horse appears to be irresistible: look at Dave Weigel, for instance, tearing into BuzzFeed for their rebroadcast of the Gale tweets, calling it “the sort of shoddy reporting that would get a reporter at a small newspaper fired”.

What Weigel misses — and even Gale too, it would seem — is that the BuzzFeed story is not a journalist reporting about happenings on a plane. “Someone is rude on a plane” is not a news story. The BuzzFeed story is rather a journalist reporting about happenings on the internet — specifically, on Twitter. Here’s how BuzzFeed CEO Jonah Peretti sees his publication:

I think of BuzzFeed as this platform that enables us to understand how people are sharing and distributing things like entertainment content, journalism, branded content, all these various types of content that we distribute on this platform that we built…

What we’ve found is that content spreads on different networks for different reasons. There are underlying human dynamics for social content. There are reasons why people share.

This is where the tensions come in: the reasons that people share basically have nothing to do with whether or not the thing being shared is true. If your company was built from day one to produce stuff which people want to share, then that will always end up including certain things which aren’t true. That’s not a problem if you’re ViralNova, whose About page says “We aren’t a news source, we aren’t professional journalists, and we don’t care.” But it becomes a problem if you put yourself forward as practitioners of responsible journalism, as BuzzFeed does.

It has become abundantly clear over the course of 2013 that if you want to keep up in the traffic wars, you need to have viral content. News organizations want to keep up in the traffic wars, and so it behooves them to create viral content — Know More is a really good example. But the easiest and most infectious way to get enormous amounts of traffic is to simply share the stuff which is going to get shared anyway by other sites. Some of that content will bear close relation to real facts in the world; other posts won’t. And there are going to be strong financial pressures not to let that fact bother you very much.

Indeed, that fact doesn’t bother me very much. I very much love Analee Newitz’s “valley of ambiguity”:

original.jpg

It seems to me that if a site has a bunch of viral content, and some of it is on the left hand side of the valley and some of it is on the right hand side of the valley, then it’s entirely reasonable to apply journalistic strictures to the right hand side but not to the left hand side.

It’s also possible, if Facebook really does start cracking down on the left hand side of this valley, that the incentive to create fake viral memes will naturally dissipate. But that’s not going to happen in 2014. So expect, over the course of the coming year, a large quantity of debate about questions like whether it even makes sense to fact-check a twerking video.

My undergraduate philosophy thesis was about the semantics of belief ascription, and the way in which “Lois Lane believes Superman can fly” is true, and “Lois Lane believes Clark Kent can fly” is false, even though Superman is Clark Kent. I think this debate is similar: when you point to a twerking video, are you pointing to the video, or are you pointing to the actions which take place in the video? BuzzFeed says it’s doing the first kind of pointing, which means that it’s true, while the likes of Dave Weigel see instead the second kind of pointing, which means that it’s false. To a large degree, this is a discussion which only journalists, and maybe the occasional underemployed philosopher, could ever care about. But it’s going to be hard to avoid in 2014.

Update: In fact, you can fact-check a twerking video.

COMMENT

I am fascinated and interested in the internal Gawker debates. In the “old” world, we have tabloids and we have “real” newspapers. It is very clear which is which. This becomes difficult on the Internet because of the business model constraints, especially the fight over traffic. Part of the problem lies with us readers – clearly lots of people don’t care for the truth and just want to be entertained – somewhat delusionally believing they are reading news. This is analogous to the idea of reading Playboy for the articles.
I encounter this problem especially in science reporting. There are way too many sensationalist headlines and mis-reported results which are then passed around confidently. And then you mix in Big Data and we have one big mess.

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How online investment advisers add value

Felix Salmon
Dec 10, 2013 15:40 UTC

A year ago, I wondered whether there was an easy personal investment strategy which is better than Vanguard, and looked at two intriguing products — the RealRetirement funds from Pimco, and an online asset manager called Wealthfront.

Then, last month, I saw a headline about Betterment, which is a competitor to Wealthfront. “Betterment’s Jon Stein talks human-RIA coopetition but breathes fire about fellow online RIAs”, it said. An RIA is a registered investment adviser, and the “fellow online RIA” that Betterment’s Jon Stein was “breathing fire about” turned out to be none other than Wealthfront.

Now I’m familiar with Betterment: I wrote about the company a couple of years ago, calling it overpriced at 0.90% per year. Since then, its fees have dropped dramatically, starting at 0.35% for balances of less than $10,000, and falling to 0.15% for balances of more than $100,000. Those fees are assessed on top of the fees charged by the ETFs that Betterment puts you into, which will cost you an extra 0.13% to 0.16%. That’s a much more reasonable sum to pay for Betterment’s service, and it’s similar to what Wealthfront charges, which is nothing for the first $10,000 and then 0.25% for the rest — plus about 0.17% in embedded ETF charges. (A Vanguard target-date fund, then, is still significantly cheaper than both, generally charging 0.17% or 0.18% per year in fees.)

So, what was Betterment’s beef with Wealthfront? Here’s Jon Stein, breathing fire:

Our platform is far more sophisticated. Our asset allocation is better because we don’t have commodities, which are a poor asset to have in there. Our algorithm is better, because it invests all of your money down to fractional shares, because the tax optimization is actually better. I don’t want to sort of pull it apart point by point but things like their tax-loss harvesting algorithm I think is a joke and not the way that it should be done.

Them’s fighting words, and so I started looking into the two offerings. And, frankly, they’re both good. Betterment is sleeker than Wealthfront; it’s put more effort into design and user-friendliness, especially for people just starting out on a savings path. It has mobile apps, and it’s easier to move your money in and out of Betterment, or to change your asset allocation once you’re invested. (Although to be honest I’m not entirely sure that’s a good thing.) If you ask Stein what makes Betterment better than Vanguard, he’ll basically tell you that it’s just much easier to use, and is designed from the ground up as an intuitive, web-native savings vehicle. Betterment has five times as many customers as Wealthfront, partly for these exact reasons. If you want to see what the future of investing looks like, then look to Betterment, not Wealthfront.

Wealthfront, on the other hand, just like Vanguard, feels more old-fashioned. It’s not nearly as sleek, and in fact it’s quite nerdy. Its investors have significantly more money than Betterment’s: while they’re significantly outnumbered, they have invested 50% more money overall. The two companies seem to have a very different conception of what their product is: while Betterment concentrates on the how of investing, Wealthfront concentrates on the what.

The result is that Wealthfront has become something of a masterclass in how to squeeze extra basis points of return out of the basic stick-all-your-money-in-index-funds model. Just like Betterment, the Wealthfront team embraces the gospel of passive investing: they’re not stock-pickers. But that’s just their starting point. They then start geeking out, adding as many tweaks as possible to maximize total returns. The model is a bit like Amazon Prime: for your flat 0.25% fee, Wealthfront will provide an ever-expanding suite of services which in aggregate are worth much more than that.

This is where Stein’s criticisms of Wealthfront come in, and I think fall short. In terms of the sophistication of the investment product, Wealthfront beats Betterment. Wealthfront is built on the kinds of investment strategies which are normally available only to investors with well over $5 million, and which even then tend to be extremely expensive; it’s managed to democratize those strategies through software (and through more than $30 million in VC funding).

For instance, on asset allocation, Wealthfront uses no fewer than 11 different asset classes in its attempt to maximize risk-adjusted returns. (Most target-date funds toggle between just two: stocks and bonds.) Stein doesn’t like the fact that one of those asset classes is commodities — but the point is that it’s important to look at the overall picture. Wealthfront isn’t required to have much or even any exposure to commodities, but if it makes sense to do so, because of what’s happening with correlations elsewhere in the portfolio, it can. (One of the big investment risks right now is that bonds alone might not give you much extra diversification: it’s very easy for both stocks and bonds to fall quite far at the same time, if and when rates start to rise.)

Wealthfront also does rebalancing the smart way — by using inflows to buy the asset classes which have dropped in value, rather than selling the assets which have risen in value and thereby generating capital gains. If you save a certain amount monthly, then that money doesn’t simply get distributed evenly across your portfolio: it goes to rebalance your portfolio as necessary. And even if you’re not regularly putting extra cash into your account, Wealthfront will do the same thing with your dividend checks. Which seems obvious, until you realize that even highly-sophisticated passive investment shops like Dimensional don’t do that.

Then there’s the way that Wealthfront constructs different portfolios depending on whether the money is in a taxable account or in a tax-sheltered account like a 401(k). Initially, Wealthfront just did this the simple way: it would put the highest-income products, like REITs and taxable bonds, into the tax-sheltered accounts, and the rest of the portfolio into the taxable accounts. But then they ran some mean variance optimization analysis, and found a better way: what they call “differentiated” rather than “segregated” asset allocation. It isn’t for everybody: it works best for younger investors with most of their wealth in taxable accounts. (That’s the investor base Wealthfront is starting with; as the company expands, I’m sure that they will find a way to give you segregated allocations if that makes sense for you.) Again, the differences might seem small, but in the world of index investing, all differences are small. Which doesn’t make them any less important.

Finally, there’s Wealthfront’s tax-loss harvesting. Here, Stein is wrong: it’s not a joke, it’s a very sophisticated way to boost returns by a noticeable amount, especially in down years. Wealthfront has published a very detailed white paper explaining how it works, but at heart what happens is that the company’s algorithms are constantly scanning your portfolio, looking for positions which have declined substantially in value. When that happens, those positions get sold, generating a loss which you can claim against your income when you do your taxes. And the proceeds get put into a similar investment, with similar risk characteristics, for at least 31 days. After that time, the second-choice investment can be sold, the first-choice investment bought again, and you’re back to your optimal allocation.

Again, tax-loss harvesting isn’t some amazing rocket fuel for your portfolio. It works best for long-term investments, since in reality all it does is defer your taxes until the point at which you liquidate your portfolio. But it can give you a nice extra slug of cash to play with until you do liquidate — and that adds up. In the Wealthfront analysis, tax loss harvesting produced an annual “tax alpha” of 1.14%, on average, between 2000 and 2013 — and was over 5% in both 2000 and 2001. Especially when markets are falling, it can give you significant outperformance. And because Wealthfront does its tax-loss harvesting continuously and opportunistically, rather than just once at year-end like most financial advisors, it can make more money from it. This year, for example, nearly all of the 0.71% Wealthfront generated in tax alpha came in the single month of June.

Still, if you only have 11 ETFs in your portfolio, that means you only have 11 securities which give you the opportunity to sell at a loss. What if, instead, you had hundreds of such securities, all moving in different directions? That’s what Wealthfront has announced today: for investors with more than $500,000 in taxable accounts, Wealthfront will stop investing in a broad stock-market ETF, and instead will buy each of the 500 components of the S&P 500, plus one more ETF which represents smaller-capitalization companies. That gives Wealthfront the ability to do tax-loss harvesting at the level of individual stocks, rather than just broad index ETFs.

Being able to use hundreds of different securities in a tax-loss harvesting system can make a big difference: it would have generated tax alpha of more than 10% in 2000, and almost 8% in 2008. Of course, if you’re selling some stocks and buying others, you’re not going to track the S&P 500 perfectly: on average, the performance of the Wealthfront portfolio in any given year is going to differ from the performance of the S&P 500 by about 0.72%. (That tracking error might be in your favor or against you; over time, it will probably work out to be zero.) But in return for that tracking error, Wealthfront says that it can deliver extra tax alpha of more than 3% per year.

These kind of iterative improvements in the way that Wealthfront invests do add up, and I’m sure that Wealthfront hasn’t stopped yet. It could take a leaf from Betterment’s book, for instance, and offer fractional shares for investors with lower dollar amounts of savings. It could tweak its tax-loss harvesting algorithm so that rather than automatically switching back to the original allocation after 31 days, it waits for the perfect time to do so. It could try to lend out its stocks into the repo market, and get a bit of extra income that way. And I’m sure there are other tweaks I haven’t thought of.

It will even, at some point, start putting more effort into user-friendliness, much as Betterment has done. (I’m less convinced that Betterment is going to start adopting all of Wealthfront’s investment tweaks, just because its CEO is so rude about them.) Betterment, I think, has a superior understanding that while people might tend to say that they’re investing for the long term and have the stomach to withstand large market gyrations along the way, in reality life happens and there’s a good chance that the money is going to be withdrawn sooner rather than later. That diminishes the value of things like tax-loss harvesting, while increasing the value of more behavioral approaches, which make use of smart defaults, segregated goal-based accounts, positive feedback about whether you’re meeting those goals, and even observed behavior. The Wealthfront approach, by contrast, relies much more heavily on old-fashioned risk questionnaires, and does much less to automate the kind of hand-holding where human investment advisers add most of their value.

The big picture here is that none of these products are bad. Vanguard is the elephant in the room: it has massive economies of scale, it is certainly going to be around for decades to come, and it’s the gold standard which any other investment product should be judged against. It’s never a bad choice. Betterment and Wealthfront both have higher fees than Vanguard, but give you real value in return for those fees. Wealthfront’s value is more quantifiable, and the company makes an extremely strong case that it delivers more than 25bp in value for the money that it’s charging. But Betterment’s value is also important. There’s a large and distressing difference between investment returns and investor returns: investment returns assume a perfectly rational buy-and-hold investor, but humans don’t behave that way. That’s one reason why Pimco spends a lot of money hedging tail risk in its RealRetirement products. If Betterment’s behavioral-finance based user focus can substantially narrow the gap between investment returns and investor returns, that could be just as valuable as all of Wealthfront’s bells and whistles.

COMMENT

Betterment just announced that now offer TLH. Has anyone heard about this? What are your initial thoughts? They seem to do this better than their main competitor Wealthfront (they say 2x better), and with a lower minimum.

Posted by alphainvestor | Report as abusive

America’s rental crisis

Felix Salmon
Dec 10, 2013 00:13 UTC

Earlier today, a union organizer from Oakland named Max Bell Alper successfully (if briefly) trolled the internet with a stunt showing him shouting at a protestor. The protest was against Google’s buses: they use municipal infrastructure, but don’t giving anything back in return. Alper’s monologue, delivered in character as an obnoxious Google employee, went like this:

I can pay my rent. Can you pay your rent? … Well then, you know what? Why don’t you go to a city where you can afford it? This is a city for the right people. Who can afford it. If you can’t afford it, it’s time for you to leave. I’m sorry, I’m sorry. It’s time for you to leave. If you can’t pay your rent, I’m sorry. Get a better job.

OK, it’s not exactly Tony Award-winning stuff. But the attitude being skewered here — the idea that people who can’t pay their rent deserve no sympathy and should just move out of sight and out of mind — is actually deeply American.

The problem is simple arithmetic, as laid out in a sobering new report from Harvard University:

In 2011, 11.8 million renters with extremely low incomes (less than 30 percent of area median income, or about $19,000 nationally) competed for just 6.9 million rentals affordable at that income cutoff—a shortfall of 4.9 million units. The supply gap worsened substantially in 2001–11 as the number of extremely low-income renters climbed by 3.0 million while the number of affordable rentals was unchanged. Making matters worse, 2.6 million of these affordable rentals were occupied by higher-income households.

When you have 11.8 million households chasing 4.3 million affordable rental units, no amount of moving out of town is going to solve the problem, which is only getting worse, thanks to the way in which inequality is getting worse in America. Here’s the chart, which shows the inexorable rise of rents, even as the median income of renters has declined dramatically since 2000:

The result is the next chart: half of all renters now spend 30% of their income on rent, and a quarter spend more than 50%. This is an unprecedented squeeze on the people who can least afford the shelter they need.

The squeeze hits all non-rent expenses, naturally, including food: households in the lowest expenditure quartile spend $350 per month on food if they’re in affordable housing, but just $200 per month if they’re part of the group with severe rent-cost burdens. That works out to about $6.50 per day — and we’re talking millions of households, here. Overall, there are 21.1 million cost-burdened renters in America, including 83% of people with incomes under $15,000 per year.

In general, renting is a good thing: it improves labor mobility, and avoids forcing cash-strapped households to put an enormous proportion of their net worth into a single unreliable asset. But even as the number of renters has increased in recent years, the proportion of renters receiving any kind of government assistance has steadily declined. The result is that America as a whole is turning into a version of San Francisco — a place where the privileged rent expensive apartments, and not-so-secretly wish that everybody else would just go away. Annie Lowrey’s story today says it all:

“We’ve seen a huge loss of affordable housing stock,” said Jenny Reed, the policy director at the D.C. Fiscal Policy Institute. “We have lost 50 percent of our low-cost units over the past 10 years, and at the same time, the number of high-cost apartments, the ones going for more than $1,500 a month, more than tripled.”…

“Builders always are aiming at that higher end,” said Jed Kolko, the chief economist at Trulia. “And eventually, as those new units age, they trickle down to lower-income borrowers.”

But not now. With demand surging, inventories are shrinking, vacancy rates are falling and rents are rising at the low end.

The government, of course, is part of the problem, rather than part of the solution: sequestration, in particular, has hit housing programs (which weren’t exactly ubiquitous to begin with) very hard indeed. But if the government won’t step in here, the market is going to be no help for the foreseeable future. The economic recovery of the past five years has left millions of Americans behind — Americans who, increasingly, simply can’t afford to make rent any more. Those Americans are never going to be a source of great profits for private-sector developers. But getting them safely housed isn’t just a moral issue. Failure to find them affordable housing will, in the long term, cost us even more.

COMMENT

This is a pretty awesome article. One of those articles that you find after weeks of searching. And I am grateful that all of that searching was worth it. Because this article is pretty damn awesome. luis souto

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Adventures in art-market commodification, James Stewart edition

Felix Salmon
Dec 9, 2013 06:50 UTC

When I wrote my piece last week about art-market reporting, I didn’t name names, I was just trying to lay out some basic rules. And while I’m happy to engage in the occasional snarky tweet about some of the bad reporting out there, I generally won’t make an entire blog post out of such complaining. Because it’s boring, and also because it’s invidious to pick out just one bad article from hundreds or even thousands.

And yet, I’m going to make an exception for James Stewart. Mainly because anything I say about him is going to be water off a duck’s back: he’s one of the greatest financial journalists alive, and and will suffer no harm from this post. But also because the assumptions underlying his latest column are worth exposing: they speak volumes about the way in which the perception of art and the art market has changed — and has deteriorated — in recent years.

The headline on Stewart’s column is “Record Prices Mask a Tepid Market for Fine Art”, and there’s an accompanying chart which comes with the headline “Art Market in the Doldrums”. This, I guess, is what a tepid market is supposed to look like:

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This is a pretty crazy chart, on a number of different levels. Firstly, it shows the S&P 500 as gaining 175% since the end of 2002, which it didn’t. There are various different ways of calculating the number — this S&P 500 return calculator puts it at 148%, for instance, while the S&P 500 Total Return Index rose 156% over the period in question. But I can’t see how you get to 175%. (The nominal S&P 500 index rose almost exactly 100% over this period.) What’s more, measuring stock prices from the end of 2002 is itself a way of putting a pretty heavy thumb on the scales: that’s the very bottom of the dot-com bust.

Against the problematic S&P 500 line, Stewart has charted the even more problematic Mei Moses index, a creature of massive survivorship bias. The Mei Moses index looks at auction pairs: works of art which have been sold at auction twice. This method gives a very good idea of what has happened to the value of any given work of art over time, but it’s a very bad way of determining what has happened to the art market as a whole, since the kind of works which get auctioned multiple times are decidedly not representative of the broader art world. The auction houses tend to want only the hottest art, and then on top of that the index is going to be massively weighted towards the kind of work which gets bought and sold quite frequently — exactly the areas where you might find a speculative bubble.

Still, if you have to try to quantify what’s happening to the value of art, the Mei Moses index is one of the least bad ways of doing so. The real problem here is the way in which Stewart directly compares the Mei Moses index with the S&P 500. If you just saw the red line on its own, you would be quite impressed: it shows prices doubling over the course of a decade, which is (or should be) pretty amazing for art. After all, we’re talking about objects which haven’t changed for, in some cases, centuries: why should they double in value now? Very few other physical objects can be expected to do such a thing; if houses do it, then that’s prima facie evidence to start getting worried about a nasty bubble.

More to the point, the S&P 500 is an investable index of publicly-traded stocks, representing trillions of dollars of wealth. It’s designed as an investment vehicle, and millions of people around the world put their money into it just because they think that’s the best purely financial investment decision they can make. The Mei Moses index, by contrast, is not investable at all, and simply represents the degree to which art-lovers’ art collections might have appreciated in value over time. Art is not an investment in the way that the S&P 500 is, and all direct comparisons of the two have a way of invidiously changing the way we look at and think about art in general. Aesthetic value becomes subsumed into financial value, and the act of buying art becomes a subset of investing, which it never should be.

In any event, it’s pretty hard to see how a market which has doubled in a decade can be considered to be “tepid” and “in a doldrums”. So, how does Stewart do it? First, he says that “many works are selling near or below their low estimates or failing to sell at all”. This is a statement which is always true. After all, the estimates claim to be the auction house’s best guess of what a piece is worth, in today’s market; they’re also a way in which the auction houses try to persuade sellers to give up works for auction, and try to persuade buyers that the art in question is worth lots of money. In other words, there’s a strong upward bias to auction estimates.

Here’s Randy Kennedy, for instance, reporting on the way in which Christie’s is estimating the value of the works in the Detroit Institute of Arts: it’s a rare explicit admission, by the auction house, that its estimates are generally significantly higher than fair market value.*

The auction house determined the fair market value of the works, comparing them to similar ones that have sold recently. But Christie’s emphasized that auction estimates for the Detroit works — which auction houses use “to attract maximum bidding interest” — could be far different; such estimates would most likely be higher.

The inevitable result of setting estimates so high is that quite a lot of works will always sell at the low end of the estimated range, or not at all. What’s more, selling art is hard: we’re talking about unique objects, here, and an attempt to match each of those objects, individually, with the person who wants it the most and is willing to spend the most money to acquire it. An auction is one way of trying to do that, but it’s far from perfect. If the ideal buyer doesn’t hear about the auction, or doesn’t have the money on the day of the auction, then the resulting difference in price can be substantial.

Stewart, of course, never even tries to demonstrate that an increasing number of artworks are selling below their estimates, or not selling at all. I haven’t run those numbers myself, but I’d be prepared to wager that the proportion of auction lots falling into those categories is very stable, over time, or possibly even going down. Which means it can hardly be evidence of a “doldrums”.

Stewart’s next attempt is to look at the last two datapoints on the red line in his chart: the Mei Moses index “declined 3.3 percent in 2012,” he says, “and gained 2.2 percent through November”. Which is another way of saying that after surging to an all-time high in 2011, art prices have managed to remain at those all-time highs for the last two years, on massive (indeed, unprecedented) volume. Some doldrums that.

What we’ve seen over the past few years is ever-increasing quantities of art being sold at levels which would have been exceptional at any other point in history. We’re also seeing an explosion in the number of art dealers, the number of art fairs, and in general the size of the global art market. There’s nothing here to suggest a doldrums — unless you’re the kind of person who thinks that even the most extreme valuations for artworks will constitute a “tepid” market unless those prices are not only high but also rising rapidly.

Finally, Stewart wheels out the S&P 500, saying that stocks have increased in value more than art has. Well, yes — so has bitcoin. But even now it’s incredibly rare for anybody at all to buy art with the intention of selling it in a year or two’s time, and making a profit. Collectors are happy that the stock market is surging: they tend to have a lot of money in stocks, and so a rising market means they’re richer, and can spend more money on art. No one ever grumbles that they would have been better off putting their money in stocks instead.

So far, so unimpressive. But Stewart then starts getting into individual datapoints: maybe there’s something here! He notes that a Warhol car crash painting “sold for barely over $7 million”, bewails the fact that a Warhol portrait of Liz Taylor went for a mere $18 million, and all but gloats that a Norman Rockwell painting, “Walking to Church,” sold for “just” $2.8 million.

In fact, the prices paid for these works were $7.3 million, $20.3 million, and $3.2 million respectively; Stewart for some reason has decided to switch to hammer prices halfway through his column. No reporter should ever report hammer prices, because they mean very little. What matters is the total amount the buyer pays. The only reason to report hammer prices is to make the total amount paid seem significantly lower than it actually is.

But in this case, the numbers are enormous either way — all of the paintings Stewart mentions are worth multiple millions of dollars, even a Norman Rockwell which was designed in the first instance for mass reproduction on the cover of the Saturday Evening Post. When a magazine cover illustration — and a particularly silly one at that — sells for $3.2 million, that’s a sign to me that the art market is in fact perfectly healthy. (Rockwell was paid $3,500 apiece for his paintings, back when they were at the height of their popularity.)

Similarly, when Stewart bemoans the fact that Sanford Robinson Gifford’s “Sunday Morning in the Camp of the Seventh Regiment” went unsold against a low estimate of $3 million, he doesn’t consider that maybe that’s just because the sellers — New York’s Union League Club — were simply asking for too much money. After all, as Christie’s itself said, if the painting had sold, it would have set a new auction record for Gifford. I’d also note that the painting has more historical value than aesthetic value (just look at the thing), and that at 16 ½ x 30 inches, it’s a pretty small trophy for any well-heeled collector of Americana. A “masterpiece”, in Stewarts words, it isn’t. If you wanted a Gifford this week, you could have picked up a much more beautiful one at Sotheby’s for a six-figure sum — which implies that the Christie’s painting was simply overpriced, in the hope that someone would pay through the nose for it just because it had once hung in the Oval Office.

And when Stewart turns to a Dallas-based art market consultant to explain the high prices being fetched by contemporary art, we find this:

“Contemporary is so popular with this set of very rich, newly rich collectors,” Mr. Kusin said. “They can hang anything they want in their Manhattan co-ops or in Aspen and nobody can say that’s ugly because contemporary art has not been subjected to sustained critical appraisal. There are no markers of good or bad taste that have yet been laid down. It’s a safe place to park your money.”

This is just weird. Contemporary art is much more likely to be called ugly than anything which has withstood the test of time. The markers of good and bad taste in the contemporary-art market are being laid down all the time, at every party at every art fair in the world. And of course whatever else it might be, contemporary art is most definitely not “a safe place to park your money”. Not long ago, I accompanied a group of artists to an auction at Stair Galleries, in Hudson, NY. This is where art gets sold that the likes of Sotheby’s and Christie’s won’t touch — not even in their day sales. It was a depressing experience: lot after lot of once-celebrated artists, works which were originally sold for five- or even six-figure sums, getting hammered down for a couple of hundred bucks, maybe a couple of thousand. This is the fate of most art, and all collectors know it: to be forgotten, lost to history. There’s nothing safe about buying art, especially not when it’s brand new.

The most infuriating part of Stewart’s article, however, comes towards the end, where we find this:

The upshot is that the art market may not be nearly as inaccessible for people of more limited means as the headline prices suggest. Even at auction, most lots sell for under $100,000, and there are many that sell for less than $10,000.

This, rather than any sophomoric comparisons of a Warhol yellow to “the color of your urine”, was the passage which actually made me angry. Firstly, of course, it’s pretty disgusting for a popular, mass-market newspaper to suggest that “people of more limited means” might be able to pick up a few art-market bargains when they get sold for “under $100,000″. Who exactly does Stewart think he’s writing for?

All the way up to this point, Stewart had the ability to redeem his column. He could have ended it simply, by saying that the existence of lots of art which doesn’t sell for multi-million-dollar sums is wonderful news for the rest of us, who can buy great art at just about any price point. He could have said that if you’re not worried about whether or not the art you buy is going to go up in value, then the world is your oyster. He could even have mentioned places like Etsy, or arttwo50, or even the newly-relaunched 20×200, as places which are democratizing art and making it accessible to people who only want to pay two- or three-digit sums.

But he didn’t. Instead, Stewart chose to paint the art world as an elitist and inaccessible place, where art costing less than $100,000 counts as cheap. In Stewart’s art world, it seems, if you find something for less than $10,000 then you’ve got yourself a veritable bargain. And so he chose to end his column with a recommendation from that Texas consultant about where you can find “stable stores of value”, along with a warning from Michael Moses, of Mei Moses fame, that “buyers shouldn’t expect to recoup their money”.

In other words, Stewart has swallowed, unquestioningly, hook, line, and sinker, the downright poisonous idea that art is and should be an investment, rather than something bought out of love for something intrinsic in the art itself. That idea has persuaded millions of middle-class Americans that art is not for them — that if they want to be buying art, they should be spending tens of thousands of dollars and worrying about which parts of the market are most likely to hold their value. It has also persuaded thousands of art collectors, especially in the area of contemporary art, that they should buy only from auction houses or highly-respected galleries, because that’s perceived to be the financially safer route. Better to spend $100,000 at a blue-chip gallery than to spend $1,000 on a no-name artist: in the former case you’re making an investment, goes the thinking, while in the latter case you’re just throwing your money away.

This mindset has turned the art world into a Hobbesian winner-takes-all competition where a small number of highly-successful artists and galleries luxuriate in multi-million-dollar incomes, while thousands of equally admirable artists and dealers struggle mightily, and generally fail to make any money at all. And it’s so deeply woven into Stewart’s article that he doesn’t even notice that it’s there, let alone question it.

So here’s my investment advice, for anybody coming to me wanting to know what art to buy. It’s very simple: buy art you love, and which will grow on you as you live with it for many years to come. Buy from people whom you trust and admire, be they dealers or artists themselves. Assume that all the art you buy will have zero financial value the minute it goes up on your wall, and will stay at zero in perpetuity: if you still want to buy it, under those conditions, then do so with pride and gusto. And never, ever, let anybody shame you into thinking that you’re not rich enough, or not cultured enough, to buy art.

If anybody should have an inferiority complex, in this business, it’s the people who judge art by its price tag, and who think that anything inexpensive is therefore worth ignoring or scorning. If they need to pay thousands or millions of dollars just to reassure themselves that the art they’re buying is good, then leave them to their art-market analyses and their ever-present FOMO. They’re opening up the easiest and cheapest arbitrage in the world: the rest of us can get much more pleasure from our art than they do, even as we spend less than the cost of a high-end Miami hotel room.

Art doesn’t need to be expensive to be good. Let let the billionaires amass their vulgar trophies, outsourcing their taste to the market. The best collectors look for art which enriches their lives — art which will likely improve over time. Not art which will appreciate in price.

*Update: Christies emails with the wording of their letter, in which they do not say that auction estimates “would most likely be higher” than fair market value. That wording comes from Kennedy. The official Christies letter says only that “the individual values provided are not auction estimates”; it doesn’t explicitly say that they’re lower than the auction estimates would be.

COMMENT

Nope, just the word which came to mind.

Posted by FelixSalmon | Report as abusive

The truth about Blackstone and Codere

Felix Salmon
Dec 6, 2013 23:19 UTC

I’ve always felt that the Daily Show should do more financial stuff, and there’s no doubt that Wednesday’s piece on Blackstone was funny. But it was also extremely credulous about a single Bloomberg article from October.

Jon Stewart — a man who, according to the NYT, might be “the most trusted man in America” — said that the Bloomberg piece was “unbelievable story” of how Blackstone engaged in “incredibly egregious behavior” which “should be illegal” — strong words, which elicited smart reactions from both Matt Levine and Dan Primack.

In a sign of the degree to which Bloomberg is implicitly trusted, however, all concerned — Bloomberg View, the Daily Show, Fortune — take at face value the core assertion made by Bloomberg News: that Blackstone made a profit of “from 11.4 million euros to as much as 13.7 million” on its Codere trade.

The article attributes those numbers simply to “data compiled by Bloomberg”, but in fact it’s quite easy to see where they came from. Blackstone, according to Bloomberg, “held 25 million to 30 million euros” of credit default swaps on Codere. It then forced Codere into a technical default (repaying a loan two days late) — which triggered those swaps and forced a payout at 45.5 cents on the dollar. Therefore, the amount that Blackstone received on its CDS position was somewhere between €11.375 million and €13.65 million.

But that number is gross revenue, not profit. The profit on Blackstone’s CDS position can be looked at as being the difference between that payout, on the one hand, and the amount that it spent buying the CDS in the first place, on the other. (Although in fact, as we’ll see, it’s more complicated than that.) Unless we have some idea of Blackstone’s cost basis on this trade, we have no idea what its profit was. Bloomberg, however, seems to simply assume that Blackstone’s cost basis for the CDS was zero — that it managed to accumulate all that insurance without paying anything for it whatsoever.

To be sure, Blackstone are smart operators, and I don’t doubt that they’re making a profit on this trade. But we really have no idea how big that profit was.

And in any case the whole thing was part of a much bigger trade, which has yet to be unwound. Primack explains that “in the first half of 2013, Blackstone affiliate GSO Capital Partners purchased debt and credit default swaps in Codere” — in other words, it entered into a basis trade, where it bought debt in a troubled company and also bought insurance on that debt. But Codere was already a deeply troubled company in the first half of 2013, which means that Blackstone would have had to pay some nontrivial amount of money to buy its CDS position in the first place.

So before we take Levine’s lead and admire the “majestic beauty” of the Blackstone deal, let’s wait and see just how profitable it was. We’re not going to know that for a while, since Blackstone is now a major creditor of Codere, which is (still) at very high risk of defaulting on its debt: when the original Bloomberg article was published in October, Codere’s bonds were trading at a mere 53 cents on the dollar.

The way that Blackstone made some unknown amount of money on the CDS leg of its trade, then, was to take a huge direct exposure to Codere on the other side of its trade. It’s still entirely plausible that Blackstone’s current exposure to Codere could be written down sharply, and could even end up being bigger than the profits on its CDS trade.

Two other points are worth making, here. The first is, as Primack points out, that absent new money from Blackstone, Codere was pretty certain to default in any event. As a result, Blackstone can credibly be painted as the white knight here — as the company which managed to find a way to funnel money from the CDS market back into Codere, thereby avoiding a bankruptcy filing. That’s certainly Blackstone’s view: spokesman Pete Rose says that the trade saved jobs at Codere, as well as lots of money for Codere’s supplier-creditors.

What’s more, it’s worth stopping to ask who Blackstone bought the CDS from, in the first place. Not many people are in the business of writing single-name CDS on a troubled company like Codere, and the people who do engage in such transactions tend to be highly sophisticated investors — and indeed are probably engaging in some kind of relative-value trade of their own.

Add it all up, and I really don’t think that what Blackstone did was particularly egregious; there’s certainly no reason to believe that it should be illegal. The Daily Show basically accuses Blackstone of setting fire to Codere so that it could collect the insurance proceeds — but in fact Blackstone’s actions were a large part of the reason why Codere managed to survive. Far from being a pile of ashes, Codere now has a real chance of avoiding liquidation. For a piece of clever financial engineering, that’s an uncommonly positive societal outcome.

COMMENT

Every contract, in the US at least, includes an implied covenant of good faith and fair dealing. Blackstone’s actions as described appear to violate that covenant. Moreover, I wouldn’t be surprised if a motivated prosecutor could find a criminal violation here. It’s disturbing that the article focused on the amount of profit Blackstone made, and not the allegation that the company created the default it collected on. If that is business as usual in the derivative markets, something has to change. Get your moral compass fixed, Felix! Then ask the counter-party how it feels about paying off after Blackstone’s manipulation.

Posted by NYCEsq | Report as abusive

Tidings of comfort and joy

Felix Salmon
Dec 6, 2013 15:47 UTC

It’s the season of good cheer, and the BLS is doing its bit to make econowonks happy in December. The last jobs report of 2013 is a great one; it now looks as though Fed chair Ben Bernanke is going to be able to go out on a high note, having brought the unemployment rate down to the key 7% level.

Even more happily, the news that we’ve finally reached that level has not sent the markets into a panic. The number is important because at one point the Fed was saying that it wanted QE to be finished by the time that the unemployment rate reached 7%; in reality, it turns out, the taper hasn’t even begun yet. Of course, the 7% number was only ever a ballpark — and it had to be a “good” 7% number, due to fewer unemployed people, rather than a “bad” 7% figure, due to discouraged workers simply dropping out of the labor force.

Still, today’s 7% is a good number: the employment-to-population ratio rose, by a heartening 0.3 points, to 58.6%, even as the unemployment rate saw that big drop to 7.0% from 7.3%. And the rest of the report was good as well: the broad U-6 unemployment rate, for instance, fell a whopping 0.6 points to 13.2%. Still too high, of course — but moving sharply in the right direction. There were more than 650,000 full-time jobs created last month, the number of employed people rose by more than 800,000, the number of unemployed people fell by 365,000, and even the amount of money that people earn each week rose by 0.7%. Just about everything, in this report, was as good as could realistically be hoped.

That said, it’s important not to extrapolate too much from a single jobs report, and especially not from month-on-month comparisons with October, the notorious garbage in, garbage out report which covered the period of (and was delayed by) the government shutdown. And if the BLS is going to be nice enough as to cheer us all up on December 6, I’m still reasonably confident that the Fed will continue the good news by keeping QE in place, at its current rate, on December 18. The taper, if and when it happens, is going to fundamentally change the government bond market: the Fed is by far the world’s largest buyer of Treasuries right now, and no one on the Fed board seems to be in any rush to start tapering by the end of the year. As Justin Wolfers says, looking at this chart, there’s no particular reason to start tapering right now.

The more important chart, however, is this one, which shows the 10-year Treasury yield over the course of this week. What it shows is that the market’s knee-jerk reaction to an unexpectedly strong jobs report was pretty much exactly what you’d expect — but there were a lot of buyers at those higher yields, and a couple of minutes after the report was released, yields were right back to where they were ex ante. Indeed, the amount that the 10-year Treasury yield moved on Wednesday is going to turn out to be much greater than the amount it’s going to move today.

My reading of these particular tea leaves, then, is that the market is comfortable at its current levels, and that it has also made peace with the inevitability of the taper in 2014. My guess is that the taper will start on March 19, at the first open market committee meeting chaired by Janet Yellen, and that 10-year yields will be then more or less where they are currently, in the 3% range. Right now, given the almost insatiable demand for high-quality collateral, I’m reasonably sanguine about all this, and I suspect that the market will be able to step in to buy Treasuries at these levels even as the Fed steps out. Maybe this is just the short term effects of the good mood that the BLS put me in this morning. But I’m determined to try to keep smiling at least through the rest of the holidays.

Three cheers for small banks

Felix Salmon
Dec 5, 2013 22:55 UTC

Earlier this week, Matt Yglesias wrote a post about what he calls “America’s Microbank Problem”: this country has far too many banks, he says, and they’re far too small. A rebuttal soon came from Rob Blackwell of American Banker, who called Yglesias “dead wrong”. This is an argument which clearly needs to be adjudicated! And in this case, I’m afraid, Blackwell wins.

It’s undeniably true that for various reasons, most of them regulatory, America has way more banks than any other country. Take away that history of regulations, and we’d have the “dozens” of banks Yglesias wants, rather than the thousands we actually have. But, would that be a good thing or a bad thing?

Yglesias says it would be a good thing, on the grounds that America’s existing “microbanks” are poorly managed; can’t be regulated; and can’t compete with the big banks. But Blackwell is absolutely right that none of these arguments really stands up to scrutiny.

Taking them in turn, Yglesias starts — without citing any evidence — by saying that smaller banks are poorly managed:

You know how the best and brightest of Wall Street royally screw up sometimes? This doesn’t get better when you drill down to the less-bright and not-as-good guys. It gets worse. And since small banks finance themselves almost entirely with loans from FDIC-ensured depositors, nobody is watching the store.

Actually, you do get less in the way of royal screw-ups as banks get smaller. Small banks are lenders, at heart: they take depositors’ money, and lend it out to their customers. If the customers prove creditworthy, then the bank makes money. Big banks, by contrast, are much more complex institutions, larded up with derivatives and Central Investment Offices and leveraged super-senior tranches of synthetic collateralized debt obligations, and so on and so forth. What’s more, all of those things can generate multi-million-dollar bonuses almost overnight for the wizards dreaming them up: no one waits until maturity. It’s that kind of opacity and complexity which produces the real disasters, not the simple business of lending money to borrowers.

As for the idea that FDIC insurance makes small banks riskier — well, that’s just bizarre. The FDIC crawls all over small banks, precisely because it has so much at risk. And because small banks have simple operations which are easy to understand, the FDIC can and does step in early when they start getting into trouble. Effectively, small banks have the better of two management teams: the in-house one, or the FDIC. And the FDIC knows what it’s doing.

Ygelsias’s second argument is equally weird: that small banks can’t be regulated, since they get carve-outs from lots of bank regulation. Again, this misses the big picture, which is that they are regulated, and regulated well, by the FDIC. What’s more, if the FDIC ever has any difficulty regulating these banks, all it needs to do is raise its dues to make up for the extra risk that it’s facing. Essentially, the US banking system regulates itself: the dues from profitable banks go towards rescuing troubled banks. The rest of us never need to worry. Except, of course, when the bank is so big that the FDIC can’t afford to let it go bust. It’s the too-big-to-fail banks which are the real problem, not the little ones.

What’s more, the carve-outs, such as they are, tend to make perfect sense, for banks which as a rule aren’t even allowed to engage in the relevant activities in the first place. (When I was on the board of a small credit union, for instance, we briefly talked about using interest-rate swaps to hedge our interest-rate exposure, before finding out that our regulator would never allow a credit union of our size to do such a thing.)

Besides, as Blackwell notes, small banks in fact are governed by nearly all the regulations which apply to big banks — including Basel III.

Finally, Yglesias says that small banks can’t just compete with big banks: “Having a large share of America’s banking sector tied up in tiny firms only makes it easier for a handful of big boys to monopolize big-time finance.” Well, yes — the small banks don’t do big-time finance. That, as they say, is a feature, not a bug. The fact is that the second-tier banks that Yglesias has his eyes on — banks like Fifth Third or PNC — would be insane to try to compete with Goldman Sachs in the big-time finance leagues. The international capital markets have seen dozens of second-tier banks attempt that move; they all end up losing billions of dollars and retreating with their tales between their legs. There big-time finance league is actually highly competitive: it includes not only US banks like Goldman and Morgan Stanley and JP Morgan and Citigroup and Bank of America, but also international banks like Deutsche and UBS and Barclays and Credit Suisse. We don’t need more banks in that league: the one thing they all have in common, after all, is that they’re too big to fail. That’s the table stakes.

Blackwell also notes that smaller banks are actually more profitable than the behemoths: if you have assets of between $1 billion and $10 billion, your return on equity is 9.9%, on average. That’s better than the TBTF contingent: there might be economies of scale at the low end, but they completely disappear by the time you get to $100 billion, even as the biggest banks have balance sheets measured in the trillions.

And taking a step back from the original Yglesias blog post, in general it’s always a good thing for banks to be small rather than big. If you’re a small bank, you know your local economy really well. The biggest difference, for me, between talking to a small-town banker and a big international banker is that big international bankers tend to know a lot about banking. Small-town bankers, on the other hand, often know surprisingly little about banking: they don’t need to. Instead, they know about agriculture, or manufacturing, or whatever the local industry might be.

The main role of banks in an economy is to allocate capital to places where it can be most productively used. In international finance, that role is played by the capital markets — which is one reason why big banks aren’t as necessary as small banks. But at the local level, what we really need is bankers who know their neighborhood and can help it grow by funding the best businesses. And small banks are better at that than big banks, where underwriting decisions tend to be automated, with local branch managers having very little discretion.

Smaller banks can pose a systemic risk, as we saw in the S&L crisis. They still need to be assiduously regulated. But give me small banks over big banks, any day. I feel that one of the hidden strengths of America is precisely that it has such a richly diversified banking system. And as web-based banking platforms start becoming available at reasonable cost to banks of all sizes, I suspect that community banks are only going to increase their market share going forwards. Good for them.

COMMENT

It’s amazing how banking has evolved today. Financial services such as interest-free credit finance solutions are now being marketed online. This includes personal loans and business loans as well.

Posted by Funda-au | Report as abusive

When the 2-and-20 crowd drives economic research

Felix Salmon
Dec 5, 2013 00:42 UTC

Elizabeth Warren sent a letter to the CEOs of America’s biggest banks today, telling them to reveal how much money they give to Washington think tanks — policymakers and the public, she says, should know when they’re being fed a corporate-lobbying line, and when they’re getting valuable information from a genuinely independent think tank.

Matt Yglesias says that Warren’s letter is little more than “legislative subtweeting”, but she does have a point: the more that think tanks become beholden to vested interests, the less useful they become. If a think tank is working from an ideology and everything that it concludes is in line with that ideology, it’s really little more than a derp tank. On the other hand, if a think tank has a reputation for intellectual independence but is in fact secretly being controlled by ideologues or other people with a certain agenda, then more transparency is definitely in order.

But if you’re worried about Washington think tanks falling under the influence of the finance crowd, it’s not the bank CEOs you should really be concentrating on. Instead, it’s the 2-and-20 crowd, who are giving quite astonishing amounts of money to fund economic research in such places. Last year, for instance, Bill Janeway gave $25 million and George Soros gave another $50 million to The Institute for New Economic Thinking, which gifts spurred INET to announce that it was going to try to raise another $75 million on top of that.

Janeway and Soros were in their own way just following the lead of Pete Peterson, who contributed $1 billion to the Peter G. Peterson foundation, and has pledged to spend the vast majority of it on fiscal and economic issues. And today, Glenn Hutchins announced that he was spending $10 million to create the Hutchins Center on Fiscal and Monetary Policy within the Brookings Institution. The WSJ adds that as vice chairman of the Brookings board, he has also given himself the job of raising another $600 million for the think tank — the kind of money which will pay for an almost unlimited number of distinguished economics commentators. (WSJ columnist David Wessel is leaving the paper to head the new center.)

All of this rich-people money is making a real difference in policymaking circles. Wessel, in the WSJ, is quoted as saying that “there are few forums outside Fed-sponsored events” for questions about monetary policy to be discussed, and that he wants the new Hutchins Center to be the main such forum. This is great for Hutchins, who clearly wants to get his fingerprints on any institution where monetary policy is studied or practiced — he is, after all, already on the board of directors of the NY Fed.

The result is that the people who study monetary policy — academics and technocrats and career central bankers — are increasingly being funded not by the state, or by the academy, but rather by a small number of very rich individuals, most of whom made their fortune in finance. And while it can’t necessarily be identified with either the Democratic or the Republican party, there is a rich-people consensus on economic issues. Tax hikes are bad, first of all, while cuts to programs which serve the poor are much more acceptable. As Hutchins himself puts it, “the big problem is the political failure in this town associated with the inability to solve our government debt problems.”

It’s not news that people spend their money in a self-serving manner, of course, or that rich people in particular tend to be very sure that their own way of looking at the world is the true and right way of looking at the world. It’s not even news that rich people have a disproportionate amount of influence in public life. And different donors require very different degrees of fealty to their own economic vision. INET is a highly heterodox institution: it has no particular point of view, except to broaden the debate, and it has a natural economic curiosity which is in line with Soros himself, without necessarily mirroring Soros’s own opinions. If anything, I should imagine that Soros values INET not as a vehicle for his own ideas, but rather as a source for them. The Peterson Foundation, meanwhile, is at the other extreme: Peterson knows exactly what he thinks, and wants to propagate his ideas as effectively as possible. Hutchins is probably somewhere in the middle.

In many ways I’m glad that his center will now exist. The connection between fiscal and monetary policy is not well understood, but is absolutely central to the way the global economy currently works; if Wessel and Hutchins can help central bankers now, when they need all the smart analysis they can get, that is probably a good thing. (Academics are also studying these things, of course, but they tend to work at a much slower pace and be less policy-focused.)

Still, this is just another step in the Davos-ization of the world — just another way in which rich financiers are managing to institutionalize an astonishing degree of access to central bankers and other key economic policymakers. Hutchins chose Brookings for his millions because it is very good at influencing government, and driving the terms of wonkish debate. Influence is at heart a zero-sum game: if the financial sector has a lot of it, that means the rest of us have less. And given what the financial sector wrought in the 2000s, I don’t particularly trust it to get things right this time around.

COMMENT

Ok. Fine. I googled it. It relates to a quote by Warren Buffet in 2006 where he accuses hedge funds of taking 2% of you principal investment if they fail and 20% of your profits if they succeed.

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