Felix Salmon

How Dave Eggers gets Silicon Valley wrong

Felix Salmon
Sep 30, 2013 04:12 UTC

Dave Eggers’ new book, a dystopian fantasia about social media, is excerpted in the NYT Magazine this weekend. The mag’s editor, Hugo Lindgren, gushes about how the book walks “the line between satire and bracing details that feel all too real” — but the fact is that, at least judging by the excerpt, Eggers strays so far away from verisimilitude that his book barely even feels like satire. Instead, Eggers is preaching to a group of people which has already made up its collective mind that social media is dangerous, and who love to one-up each other when talking about where the slippery slope might lead.

I’m sure that this book will sell very well in Germany. But for those of us who have a slightly more nuanced view of the costs and benefits of social media, Eggers’ glaring mistakes, when it comes to Silicon Valley culture, make it all too easy to dismiss his whole book as the work of someone who hasn’t got the faintest clue what he’s talking about.

Eggers, at 43, is now settling into Old Man mode: “I grew up doing all my homework in front of the TV, which baffled my parents and horrified my grandmother,” he tells the NYT. “Now younger people toggle between far more media and devices than I ever could.” Eggers is weirdly proud of his ignorance of social media: he has tweeted exactly twice, back in 2009, and he says in the NYT Q&A that he wanted to write this book from a position of ignorance:

I’ve never visited any tech campus, and I don’t know anything in particular about how any given company is run. I really didn’t want to…

There were a handful of times when I looked something up, or asked the opinion of someone more tech-savvy than I am, but for the most part this was just a process of pure speculative fiction.

The result is a Silicon Valley behemoth, the eponymous Circle, which combines aspects of Google, Facebook, and Twitter — and then adds a heavy-handed overlay of thought police.

“Let’s go back to your dad and this weekend. Did he recover O.K.?”

“He did. It was a false alarm, really.”

“Good. I’m so glad to hear about that. But it’s curious that you didn’t share this with anyone else. Did you post anything anywhere about this episode? A zing, a comment anywhere?”

“No, I didn’t,” Mae said.

“Hmm. O.K.,” Denise said, taking a breath. “Do you think someone else might have benefited from your experience? That is, maybe the next person who might drive two or three hours home might benefit from knowing what you found out about the episode, that it was just a minor pseudo-seizure?”

“Absolutely. I could see that being helpful.”

“Good. So what do you think the action plan should be?”

“I think I’ll join the MS club,” Mae said, “and I should post something about what happened. I know it’ll be beneficial.”

Denise smiled. “Fantastic. Now let’s talk about the rest of the weekend. On Friday, you find out that your dad’s O.K. But the rest of the weekend, you basically go blank. You logged into your profile only three times, and nothing was updated. It’s like you disappeared!” Her eyes grew wide. “This is when someone like you, with a low PartiRank, might be able to improve that, if she wanted to. But yours actually dropped — 2,000 points. Not to get all number-geeky, but you were on 8,625 on Friday and by late Sunday you were at 10,288.”

“I didn’t know it was that bad,” Mae said, hating herself.

This is certainly creepy, but it’s also the exact opposite of the way that Valley technology companies work. The success of Facebook comes from the way in which Mark Zuckerberg managed to observe and understand his Harvard cohort, in an outsider-looking-in kind of way. Or look at Tumblr, which actively hides follower counts so as not to turn the whole thing into a silly game. The product managers at these companies are certainly trying to create something which will become broadly adopted. But they know better than to think that the best way to do that is to encourage their own employees to use the product to the point of exhaustion:

There are problems with Silicon Valley and with technology — don’t get me wrong. But they’re insidious, rather than being overt: executives compete to find products that people want to use, rather than trying to impress upon the public the need to share, or the idea that doing so is so socially beneficial that you’re a bad person if you don’t do it. The Eggers excerpt ends with a scene straight from 1984, featuring a pep rally led by the company’s CEO:

“There needs to be, and will be, access and documentation, and we need to bear witness. And to this end, I insist that all that happens must be known.”

The words appeared on the screen:


“Folks, we’re at the dawn of the Second Enlightenment. I’m talking about an era where we don’t allow the majority of human thought and action and achievement and learning to escape as if from a leaky bucket. We did that once before. It was called the Middle Ages, the Dark Ages. If not for the monks, everything the world had ever learned would have been lost. Well, we live in a similar time, when we’re losing the vast majority of what we do and see and learn. But it doesn’t have to be that way. Not with these cameras, and not with the mission of the Circle.”

He turned again toward the screen and read it, inviting the audience to commit it to memory: “All that happens must be known.”

Mae leaned toward Annie. “Incredible.”

“It is, right?” Annie said.

Mae rested her head on Annie’s shoulder. “All that happens will be known,” she whispered.

The audience was standing now, and applause thundered through the room.

There are certainly criticisms of Google which run along these lines — see, for instance, Daniel Soar’s fantastic 2011 essay for the LRB, entitled It Knows. But the point is that you’ll never find rhetoric like this coming from inside Google. And certainly, if Google tried to change the world one Googler at a time, it would get absolutely nowhere.

Indeed, insofar as Silicon Valley is gamifying the world, the last thing that any company wants is for its own employees to consistently win the game. What’s more, if the game is social interaction, then the winners are never going to be a group of software engineers.

The thing about the Valley that Eggers misses is that it’s populated by people who consider themselves above the rest of the country — intellectually, culturally, financially. They consider themselves the cognitive elite; the rest of us are the puppets dancing on the end of their strings of code.

Besides, we all share the downside of being part of an always-on, networked society, whether we participate on social media or not. If you’re going to suffer the downside, you might as well enjoy the upside — that’s all the motivation that anybody needs to get involved, there’s no need for crude coercion.

In science, there’s a phenomenon called “herd immunity”: if you vaccinate a high enough proportion of people, the entire population becomes immune. The evolution of the web is similar: enough of us are connected, in many different ways, that no one has real privacy any longer. Eggers can see that, but he then tries to reverse-engineer how we got here, and, by dint of not doing his homework, gets it very wrong.

The Circle is a malign organization; you can almost see its CEO, Eamon Bailey, stroking a white cat in his suburban Palo Alto lair, dreaming of Global Domination. In reality, however, the open protocols of the World Wide Web led naturally and ineluctably to our current loss of privacy. Tim Berners-Lee is no evil genius; he’s a good guy. And the Eggers novel I’d love to read is the one dominated by the best of intentions. Rather than the one which thinks that if technology is causing problems, then the cause must always be technologists with maleficent ulterior motives.


Given the choice between Felix view of the Valley and Dave – no contest- Felix has my vote.

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The JP Morgan apologists of CNBC

Felix Salmon
Sep 29, 2013 04:14 UTC

I don’t know which producer at CNBC had the genius idea of asking Alex Pareene on to discuss Jamie Dimon with Dimon’s biggest cheerleaders, but the result was truly great television. What’s more, as Kevin Roose says, it illustrates “the divide between the finance media bubble and the normals” in an uncommonly stark and compelling manner.

The whole segment is well worth watching, but the tone is perfectly set at the very beginning:

Maria Bartiromo: Alex, to you first. Legal problems aside, JP Morgan remains one of the best, if not the best performing major bank in the world today. You believe the leader of that bank should step down?

Alex Pareene: I think that any time you’re looking at the greatest fine in the history of Wall Street regulation, it’s really worth asking should this guy stay in his job. In any other industry — I can’t think of another industry. If you managed a restaurant, and it got the biggest health department fine in the history of restaurants, no one would say “Yeah, but the restaurant’s making a lot of money. There’s only a little bit of poison in the food.”

This is a very strong point by Pareene — and it’s a point which was well taken by Barclays. When the UK bank was fined $450 million last year for its role in the Libor scandal, its CEO duly resigned. After all, a $450 million fine is prima facie evidence that the CEO really isn’t in control of his bank.

But $450 million is a rounding error with respect to the kind of fines that Dimon is now talking about paying — $4 billion, $11 billion, $20 billion, who knows where this will stop. Tim Fernholz has a good roundup of all the various things that JP Morgan is in trouble for; Libor manipulation is at #5 on his list of seven oustanding investigations — on top of another four settled investigations. If Libor manipulation alone was enough to mean the end of Bob Diamond, it’s hard to see how Jamie Dimon should be able to survive this tsunami of litigation.

Unless, it seems, you work for CNBC. In which case you just ignore Pareene’s question, and get straight onto the important stuff:

Duff McDonald: It’s preposterous. The stock’s touching a ten-year high. It’s a cash-generating machine.

Maria Bartiromo: Should we talk about the financial strength of JP Morgan? The company continues to churn out tens of billions of dollars in earnings and hundreds of billions of dollars in revenue. How do you criticize that?

This view — that profits cleanse all sins, and that so long as you’re making money, nothing else matters — is not normally expressed quite as explicitly as it was here. After all, there are licit and illicit ways of making money, and surely if your profits fall into the latter category, you should not be able to remain comfortably ensconced as a celebrated captain of industry. Besides, banks shouldn’t be obscenely profitable: they’re intermediaries, and in an efficient economy their profits should be quite easily competed away. When bank profits are high, that’s a sign that the bank in question is extracting rents from the economy, rather than helping it to grow.

The rest of the interview is a glorious exercise in watching CNBC anchors simply implode in disbelief when faced with the idea that JP Morgan in general, and Jamie Dimon in particular, might be anything other than a glorious icon of capitalist success. In the world of CNBC, the stock chart tells you everything you need to know, while the New York Times is a highly untrustworthy organ of dissent and disinformation.

Eventually, Bartiromo asks Pareene, with a straight face, who would be the best CEO of JP Morgan “from a shareholder perspective”. Since, clearly, the shareholder perspective is the only one that matters. Except, of course, it isn’t. JP Morgan’s balance sheet shows assets of $2.4 trillion and liabilities of $2.2 trillion, leaving $200 billion in total stockholder equity. Sure, the shareholders matter — but even in terms of the balance sheet they only matter about 8.6%. And in terms of the systemic importance of JP Morgan to the nation as a whole, its shareholders matter even less. The country was seriously damaged by JP Morgan’s lies and misrepresentations about its mortgages — much more than it would be damaged if the share price went down instead of up. And the public has every reason to want the individuals running JP Morgan to be held accountable when it gets into serious regulatory trouble over and over again.

Right now, the banks aren’t lending money to homeowners — the government remains the only game in town, when it comes to mortgages, and that isn’t healthy at all. JP Morgan’s shareholders might be happy with Jamie Dimon, but that doesn’t mean the rest of us should be. Jesse Eisinger wants the banks executives to face personal charges; whether that happens or not, it still behooves them to take responsibility for the long series of egregious errors that JP Morgan has made. Shareholders might not want to see Dimon go. But if JP Morgan does end up paying an 11-digit fine, then resignation would surely be the honorable thing to do.


The way I look at it, we have to reckon with one of two things here:

1. Dimon did not have control of the company and did not know what aspects of his business were going on with what, which makes him incompetent. I don’t personally think he is, honestly.


2. Chase is such a big entity that it is, effectively, ungovernable by its own leadership. This illustrates the inherent problem with letting entities get to the size they do in our corporate hegemony.

Well, there is a third option, pay 20 billion dollars in fines and allow our limp wristed government to simply make it go away, which is going to happen.

We’re doomed.

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The good and bad of Dave Ramsey

Felix Salmon
Sep 26, 2013 20:50 UTC


Back in June, Dave Ramsey declared war on professional financial advisers via Twitter. One thing led to another, and the upshot, now, is that I’ve published a 3,000-word article on Ramsey’s investment advice in Money magazine.

Who is Dave Ramsey? If you’re a member of the coastal elite, you might remember him from Megan McArdle’s feature about his budgeting advice, which ran in the Atlantic a few years ago. If you’re a more typical flyover-state American, on the other hand, you probably know his radio show at first hand: he’s the third-most-popular radio personality in the country, behind Rush Limbaugh and Sean Hannity but ahead of Glenn Beck. Ramsey’s show is a potent mixture of god and mammon: his Financial Peace University claims to present “a biblically based curriculum that teaches people how to handle money God’s ways”.

The problem is that when it comes to investing, God would seem to be something of a financial illiterate. For instance, in his Total Money Makeover book, Ramsey writes that “Aggressive Growth funds get the last 25 percent of my investment. (They are sometimes called Small Cap or Emerging Markets funds.)” Given that another 25% of Ramsey’s asset allocation goes to International funds, followers of Ramsey’s advice could end up putting 50% of their money in international stocks.

Ramsey also claimsfalsely but repeatedly — that it’s reasonable to expect a 12% return on your investments, and that therefore it is reasonable to take out 8% of your savings every year, after you’ve retired. This is a recipe for disaster: over the course of a 30-year retirement, the 8% withdrawal rate, adjusted for inflation as Ramsey recommends, would run out of money 56% of the time. Here, for instance, is a sample worksheet from his book, calculating that if you want to live on $30,000 per year, you’ll need a nest egg of just $375,000:



All of which would make it very easy to hate on Ramsey, and to side with the financial advisers he aligns himself against. But the fact is that it’s more complicated than that. The fact is that, realistically, the overwhelming majority of people who follow Ramsey’s advice are never going to reach the point at which they invest a penny. (Before they get there, they have to pay down all their debts, and then build up an emergency fund containing six months’ worth of expenses.) Ramsey isn’t harming people who don’t take his investment advice: if anything he’s helping them, by giving them something to aspire to.

Meanwhile, financial advisors cater to the rich, not to the mass market. If you sign up with Dave Ramsey, you will get financial advice, and it won’t cost you much if you’re not investing much. Yes, you’ll be steered into wildly inappropriate funds which carry up-front fees of somewhere north of 5%. And yes, Ramsey will get highly disingenuous when it comes to defending those indefensible fees. But, once again, Ramsey isn’t talking to people with seven-figure sums to invest: he’s talking to people who could never get past the front door at most financial advisers. A highly-recommended and beyond-reproach adviser like Galia Gichon charges $250 per hour: if you have just three sessions with her, that’s $750. And $750 is 5.75% of $13,000: if you’re investing less than that, in a weird way you’re saving money by paying up-front commissions.

To put it another way: there’s a tiny subset of Ramsey clients who do invest, and nearly all of them invest less than $10,000 per year. Those people neither can nor should be shelling out $250 an hour for financial advice — especially seeing as how they’ve already got themselves in a pretty good place by following Dave Ramsey. What they really need is someone to talk to, someone to hold their hand and encourage them to keep on saving, even after they’ve paid off their debts and built up their emergency fund.

Investing, no less than paying down debt, is all about discipline and goal-setting and having a clear idea of why you’re doing what you’re doing. But in some ways, investing is harder than paying down debt. Debt hangs over you; it’s a nasty, omnipresent cloud which never makes you feel better and often makes you feel worse. Under Ramsey’s plan, you budget carefully, cut up all your credit cards, and use only cash, pre-distributed into different envelopes dedicated to different types of expenses. Everything is worked out from your budget, and since your budget involves living within your means, there’s money left over to steadily pay down your debts. It’s an efficient and effective system, and once you’ve paid off a couple of your smaller debts, you can see that it works and that you’re on your way to becoming debt-free.

Once your debts are paid off, however, the temptations of the hedonic treadmill return. Without the dark cloud of debt, you’re free to spend every last penny you earn: free to buy that shiny bicycle, take that much-deserved vacation, replace that sagging mattress. Putting that sixth month’s salary into your emergency fund doesn’t feel as though it’s nearly as much of an achievement as does paying off your credit-card debt in full. And it’s hard to get support from your peers: personal finance is the last taboo subject, the one thing we never talk about in polite company.

So once you’ve paid off your debts, once you’ve put tens of thousands of dollars in the bank, who’s going to keep you on the straight and narrow? Who’s going to persuade you that continuing to pay for everything in cash, out of envelopes, is a good idea, rather than being an infantilizing embarrassment?

Some financial advisors might pretend that they’re charging money because they’re smart at picking investments, but really that’s the least valuable thing that they do. Ramsey’s advisors will accept anybody, and they will do the valuable thing — just being there, mainly, in a world where it’s incredibly difficult to find someone to talk honestly to about money — for what in dollar terms can be a very low sum.

I don’t like Ramsey’s investment-advice model any more than I like his investment advice. It’s based on hidden kickbacks from advisors to Ramsey himself, and the income Ramsey gets from the investment-advice arm of his empire is clearly a large part of the reason why his investment advice is so bad. If you’re disciplined enough to follow Ramsey’s advice on getting out of debt, then you’re disciplined enough not to need to pay an advisor 5.75% of your savings just to hold your hand. And you should be treated with respect, which means that you shouldn’t be lied to about the returns you can expect or the amount of money you’ll really need in retirement.

But I can’t hate Ramsey in general just because of the small part of his empire which gives investment advice. The rest of what he says is very solid — and he’s clearly done a great job of reaching a very wide audience. On top of that, there are lots of people who sincerely feel that they need individual investment advice — and most of those individuals are simply not catered to by the existing financial-services industry. Dave Ramsey’s advisers surely have their problems. But there’s a colorable argument that they’re better than nothing.

With a financial advisor, it’s that much harder to fall off the Dave Ramsey wagon: you’ve got a friend, now, whom you’re accountable to, every time you go over budget on your spending or fail to make a planned deposit into your investment portfolio.

And ultimately, when it comes to investing, that’s what really matters. It’s easy to get caught up in the narcissism of small differences, to argue whether it’s more realistic to tell people to expect 4% returns rather than 8% returns or even 12% returns. It’s even easier to extrapolate those returns over many decades, to make the difference in the end result look as large as possible.

But the fact is that the amount you end up with, at retirement, is not really a function of your investment decisions — not to a first approximation, and not even to a second approximation, either. The first and biggest driver of your total wealth at retirement is simply the amount of money that you managed to save, in total, over the course of your working life. The more money you put away, and the less money you spent, the more you’ll end up with at the end of the day.

After that, the secondary driver — and it’s much smaller than the primary driver — is general market returns, the market beta. If you’re lucky enough to be investing over the course of a thirty-year bull market, then you’ll end up with substantially more money at the end than if you were stuck in a nasty bear market for most of your working life.

Last, and very much least, comes the question of which specific investments you make: whether you’re in mutual funds, or in stocks, or in ETFs; whether and how you pay commissions; how tax-efficient your investments are; how much you pay in fees; how much your investments outperform or underperform the market; and so on. These questions tend to be the ones which investment professionals concentrate on, since they’re the questions where they have a professional advantage and can, in theory, make a difference.

But let’s keep things in perspective, here. Ramsey is good at the main thing, which is encouraging his followers to save as much as possible. He’s bad at telling them how to save, and of course he has no control at all over how well the market as a whole performs. But if you asked me to predict which person was likely to end up with the greater sum of money at retirement, I might well pick the person on the Ramsey program paying a 5.75% up-front fee on all of her investments, over a self-directed individual following first-rate advice from Jack Bogle. And the reason is that Ramsey’s followers are disciplined spenders. Which can make much more of a difference than any kind of investing strategy ever will.


The last sentence of your piece is for me the most telling.

Spending or more aptly a persons “spend rate” is a key component of any investing strategy.

Spend rates are a function of total overhead. Overhead includes such things as debt service and lifestyle. Once a family gets debt free they are partway to financial independence but only partway. If spending then spirals out of control, even without debt you’ll outlive your assets. There is simply no easy way out.

Based on our observations most (but not all) people have learned little to nothing since 2007-8. If they’re broke they are forced into a less desirable lifestyle. Those still making money in large part are still trying to maintain a pre-recession lifestyle in a post recession world.

I see that a christian person has posted a comment here. I’d ask David his opinion regarding the morality of investing in a QE/infinity, ZIRP world where anything resembling financial market regulation has been watered down via hundreds of millions of dollars worth of Wall Street lobbying.

I’m not a religious man, but I see a moral problem with people participating in the equity markets in this environment. It should seem that government and Fed policy now takes from the poor and gives to the equity markets. Lower class savers receive nothing while markets are bid up via zero interest rate policies. I don’t participate as an equity owner any longer preferring to park my assets as cash in stable credit unions and smaller banks (I research these institutions). Fortunately I can afford the low returns I get. I cannot feel good about making money on the backs of others. Not like this.

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The bitcoin bug bites SecondMarket

Felix Salmon
Sep 26, 2013 05:58 UTC

I have to admit I’m disappointed in this one. It’s no secret that I’m very skeptical about what’s likely to happen when small, risky investments start getting lots of publicity thanks to the ban on general solicitation being lifted. And I’m even more skeptical about funds which do nothing but invest in bitcoins. But at the same time I like quite a lot of the SecondMarket business model. They provide a valuable service to private companies, and they have every ability to carve out a nice little niche for themselves as an accreditation and investment platform — a one-stop shop which allows companies and funders both to avoid much of the onerous paperwork normally associated with private investments.

The problem is that SecondMarket isn’t just a service for issuers and investors. It has also, of late, become a lead-generation engine — or, to put it another way, a mechanism for selling schmucks to wolves. SecondMarket has contact details for a very large number of accredited investors, many of whom trust the company and the reputational capital it has built up over the years. If you send enough of those investors investment pitches for diamond funds, or art funds, or space-based vaporware, the sillier among them will bite. And, eventually, regret doing so. SecondMarket’s investor list is a valuable thing, but the company isn’t behaving in the manner that you’d expect of an owner of something precious and valuable. Instead, it seems to be happy renting its list out to just about anybody.

SecondMarket began life as a way to monetize illiquid fixed-income investments during the financial crisis; it then morphed into a quasi-exchange for Facebook shares. Both businesses were lucrative, but both also came to a natural end, and now it seems that the company is not particularly confident in its ability to make similar sums as a high-end services company. So observers who discerned a whiff of desperation when they first started receiving pitch emails are not going to be surprised by SecondMarket’s latest development: a bitcoin fund.

Bitcoin Investment Trust is basically exactly the same thing as the Winklevii’s bitcoin ETF, only it doesn’t need SEC approval — it’s limited to accredited investors. (But it can still be marketed in public, now that the general solicitation ban has been lifted.) That means it’s even more problematic than the Winkleproduct — it has all the same downsides, plus added illiquidity! If you buy into this trust, you still can’t do the single most useful thing that anybody can do with bitcoins, which is sell them or trade them. (Bitcoins are a combination of currency and commodity; this trust strips out the interesting bit, which is the currency part, leaving just the stupidly speculative commodity aspect.) You still have to pay a fee of 2% per year to SecondMarket for all the work they’re doing sitting on your bitcoins. And then, if you ever do decide to sell, you have to pay another 1.5% fee to get out. On top of that, if you buy into the trust after January 1, you’re also going to have to pay a 1.5% fee to get in.

SecondMarket CEO Barry Silbert is a big booster of bitcoins — he thinks that in 30 years’ time, they’ll be worth lots of money. He’s even put together a 14-page investor presentation, saying that bitcoins could be worth $7,692 apiece if they wind up being worth 1% of the value of the world’s gold today. So let’s say you invest $1,367 in ten bitcoins today: in 30 years’ time, they might be worth $76,920.

On the other hand, if you invest $1,367 in the bitcoin trust, and pay a 1.5% fee, then you only end up with 9.85 bitcoins. And then if you lose 2% of your bitcoins every year for the next 30 years, and then you lose another 1.5% when you sell, your total bitcoin holding in 30 years’ time will be just 5.29 bitcoins. Even if they’re worth $7,692 each, that’s a total of just $40,709 — you’ve ended up paying SecondMarket a full 47% the money you would have made if you’d just sat on the bitcoins yourself.

More profoundly, this announcement marks the end of SecondMarket as an agnostic platform, and the beginning of SecondMarket as a booster of specific investments. The company has already seeded its bitcoin trust with $2 million of its own money — it’s making a big bitcoin bet, and is actively encouraging all of its users to do likewise. Silbert knows that the bitcoin trust is risky: that the most likely scenario is that it goes to zero. It’s a lottery ticket, basically — but one which pays a constant stream of management fees to Silbert’s company, and which risks putting investors off SecondMarket for good if it fails.

Silbert has a Wall Street background, and SecondMarket is a registered and fully regulated broker-dealer. As such, it really should be bending over backwards to be as conservative and sober as it can — no one wants their broker-dealer to be some risky fly-by-night operation offering investments with massive downside. If you’re a broker-dealer, job one is always to be as trustworthy as possible. And getting involved in bitcoins is not a great way of demonstrating trustworthiness.

I have spoken to Silbert about this, at some length, but I still don’t really understand (a) why he’s doing this; and (b) why he’s doing this under the auspices of SecondMarket. Bitcoin does breed True Believers, and Silbert might well be one of them — but that’s no reason to put at risk the reputation of the company he’s spent so many years building up. I don’t necessarily think that SecondMarket has definitively jumped the shark today — I think that it can probably recover from this misstep if it tries. But a bitcoin trust is not a good idea. It didn’t make sense when the Winklevii first came up with it, and it makes no more sense now that SecondMarket has followed their lead. No sensible investor should go anywhere near it, and anybody using SecondMarket as a platform should be more than a little concerned that their trusted broker-dealer has taken this highly unorthodox road.


Mr. Salmon, you’re missing an important angle. To those who really understand Bitcoin, it is not just some payment system or fun/speculative investment. Bitcoin (if it grows to some certain level) will change the financial system of the planet.

Now, you can argue it will never get there. Or, you can argue that the changes wouldn’t be good (such as if you prefer governments control peoples’ private property). Whether one is right or wrong on those arguments, please understand that if Bitcoin does not fail, it will become something very powerful and very special. And it will be the set of individuals and businesses that seized the technology in its early years – when everyone else thought it was a joke or scam – who will be proudly looking back on what they helped accomplish for humanity.

Hyperbole? Let’s check back in ten years.

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Inter-dealer brokers’ inside information

Felix Salmon
Sep 25, 2013 15:55 UTC

It’s hard to keep track of all the charges coming out today, in a coordinated fashion, against inter-dealer broker ICAP. For those of you who like primary documents but who don’t fancy wading through 26 pages of the the English FCA complaint or 58 pages of the US CFTC order, let me recommend the juiciest one of the lot: the Justice Department’s criminal complaint against three ICAP defendants, Darrell Read, Daniel Wilkinson, and Colin Goodman.

Goodman is the cash broker, based in London, who called himself Lord Libor. Every day, he would send an email to the various banks which contributed to the daily Libor fixing, giving them “suggested Libors” for where they should report yen Libor at 1-month, 3-month, and 6-month tenors. Not all of the banks would follow Goodman’s suggestion all of the time. But most of them would take Goodman’s email as an important datapoint, and some of them would simply turn around and submit whatever Goodman told them the rate was. After all, yen Libor was, especially during the financial crisis, something of a fiction: it’s meant to represent the rate at which banks lend to each other in yen, but by the time of the crisis, there was exactly zero interbank yen lending going on. So yen Libor became simply whatever the banks said that it was — a recipe for manipulation.

The biggest manipulator of all was Tom Hayes of UBS, who was criminally charged back in June. Hayes made millions for UBS by entering into derivatives bets about where Libor was going to be. And he tended to win those bets not because of some unusual degree of prescience, but rather because he would tell ICAP where he wanted Libor to be, and then Goodman would put those numbers into his email to the various fixing banks. Essentially, ICAP made money by knowing what Hayes wanted, and then delivering it to him.

Hayes’s trades were very profitable not only for UBS, you see, but also for ICAP. Libor derivatives don’t trade on any exchange: they’re entered into bilaterally, between various institutions. And in the middle, taking no risk but bringing the different institutions together so that they can trade, sit the inter-dealer brokers like ICAP. Hayes didn’t use ICAP exclusively — he had a similar arrangement with Tullett Prebon — but he used ICAP a lot, and every time he traded through them, they would take a commission. On top of that, ICAP had an implicit deal with Hayes that in return for getting him the Libor fixings he wanted, he would be willing to face their other clients on unrelated trades. Essentially, if somebody phoned up ICAP looking to do a derivatives deal, they knew that Hayes would be there for them, at something approaching the market price, and would provide the liquidity the market needed.

There’s a lot of pretty funny internal ICAP politics in the complaint. Because Hayes was a derivatives dealer, his commissions went to ICAP’s derivatives desk — rather than to Goodman, who was on the cash desk. As a result, both ICAP and Hayes had to contort themselves to find some way to pay Goodman for his services. It turns out that Goodman was selling himself pretty cheap: he seemed to be satisfied with an extra £5,000 per quarter. Plus whatever “kickbacks” Hayes paid him directly. (Those, sensibly, weren’t discussed directly over email, although they were referred to: “As for kick backs etc we can discuss that at lunch and I will speak to Tom about it next time he comes up for a chat,” wrote Wilkinson to Goodman.

The world of inter-dealer brokers is one of the most lavish on Wall Street: deals are commonly lubricated with expensive meals, Champagne, tickets to sporting events or Las Vegas — even nights out at Lady Marmalade Adult Parties. The brokers don’t take on any risk, but they still get paid enormous sums — and the way they get the money is by persuading the big traders on Wall Street to use them rather than some competitor when putting together trades. If that involves staying up all night blowing rails, then that’s what the inter-dealer brokers are going to end up doing.

So while ICAP’s behavior here was particularly egregious, and probably criminal, there’s something endemic to inter-dealer brokers which is deeper and more troubling. The New York attorney general is worried about what he calls “insider trading 2.0″, where small groups of traders have information a few milliseconds before the rest of the market. But in the world of inter-dealer brokers, there’s really no such thing as public information at all: all trades are private, all information is private, and the way to make money is entirely a function of what connections you have and whom you’re able to befriend over the course of long evenings of lavish entertainment.

Or, to put it another way, ICAP’s (alleged) criminality is basically just an extension of its core business — which is dealing in information asymmetry. ICAP’s brokers know who wants to trade what, in which direction — and they use that information to make risk-free profits. In the case of Hayes, it looks very much as though they crossed a criminal line in doing so. But the bigger scandal, in many ways, is the amount of money they can make entirely legally, by monetizing information which they have and which no one else possesses. Shouldn’t Eric Schneiderman be worried about that?


I guess there is a broader question here, Felix. Is it legitimate to have a purely private investment market? And variables that are privately determined? Where all business is “Enter/Use at your own risk?”

We have a concept like that regarding accredited investors, for both sophisticated individuals and corporations. What’s happened here and in other places where you have “fixes” in the market price, is that the market has gotten so big that the position of the fix affects a wide number of players, and the variables affect some non-sophisticated players (e.g. an adjustable rate loan that floats off LIBOR).

I wrote an article on this a while ago:

http://alephblog.com/2012/07/05/on-inter nal-indexes-like-libor/

Now obviously, my opinion has been wrong with respect to how the tide of public policy has moved. My point is this: you can dig into a large number of complicated situations, and probably find someone taking advantage of information asymmetries. Is he a trader, an arb, or a felon? If a felon, there are going to be a lot of surprised people who though they were just making an internal market.

As always, I appreciate your work.


Posted by DavidMerkel | Report as abusive

The idiocy of crowds

Felix Salmon
Sep 23, 2013 21:47 UTC

Today’s a big, exciting day for anybody who has found it simply too difficult, to date, to throw their money away on idiotic gambles. Are you bored with Las Vegas? Have you become disillusioned with lottery tickets? Do micro caps leave you lukewarm? Does the very idea of a 3X ETF fill you with nothing but ennui? Well in that case today you must rejoice, because the ban on general solicitation has been abolished, and the web is now being overrun with companies like Crowdfunder and RockThePost and CircleUp which offer a whole new world of opportunity when it comes to separating fools from their money. You can even lose your money ethically, now, if that’s your particular bag. The highest-profile such platform is probably AngelList: as of today, founders like Paul Carr (alongside, according to Dan Primack, over 1,000 others) are out there tweeting at the world in an attempt to drum up new investors.

It is conceivable that over time, these equity crowdfunding platforms will learn from their inevitable mistakes, and the few which survive will learn how to be something other than a hole in which to pour millions of dollars. But right now we’re in the very early days, and there’s no conceivable reason why anybody should want to volunteer to be a sacrificial guinea-pig. All of the platforms, right now, feature what RockThePost rather touchingly calls “crowdsourced due diligence” — something which, if you read their FAQ, is detailed thusly:

Though RockThePost requires companies to include a certain amount of information before being eligible to list on the site, RockThePost does not conduct any due diligence on them or endorse any as attractive investment opportunities.

This is basically the Prosper business model, circa 2005: blind faith in the wisdom of crowds, leading inevitably to a toxic mixture of good-faith and bad-faith failed fundings. To be honest, the distinction is not one worth worrying about too much: in both cases, a business gets funded, the money disappears never to be seen again, and the funders are upset.

It’s worth noting, here, the highest-profile company to not get in on this game: Kickstarter. They decided in early 2012 that they were not going to open up their platform to people who were looking for equity investments — and that decision looks pretty smart today. After all, Kickstarter knows full well how big the reach/grasp disconnect can be for people taking to the internet to try to fund their new project with ambition and zeal. It’s easy, in the early days of a project, to massively underestimate the cost of meeting future obligations — even when those obligations are little more than sending out t-shirts in the mail. With crowdfunding, the obligations are much more onerous: business owners have serious responsibilities to their shareholders, and I suspect that very few of the businesses listed on the new platforms are actually equipped to meet those responsibilities.

What’s more, as Fred Wilson notes, there are a myriad of little ways in which startups can get tripped up by restrictions in the crowdfunding rules. Unless the company has very good lawyers and has already signed up some very experienced investors, the chances are it will end up inadvertently breaking the law somehow. And if it has signed up some very experienced investors, you have to expect that the fish swimming around the waters of sites like CircleUp are just going to get eaten alive by the bigger sharks doing custom deals.

One angel investor explained it very well in an email to me this morning:

These guys are building their business on the notion/dream that somehow the internet can disintermediate social and relationship capital. I’d argue that this is precisely what the internet can not do: if you’re going to invest in a startup, you’d better know the founders, and you’d better know something that most people do not know. Information asymmetry is the only way to lower the risk profile on such crazy risky investments.

In theory, these companies are providing a useful service for startups. Raising money is hard, logistically speaking — and once you’ve got your commitments all lined up, there are some good reasons why it makes sense to outsource a lot of the accreditation and paperwork to an outside company. The problem is that AngelList and its ilk don’t stop there: their main purpose, in fact, is not to take care of paperwork, so much as it is to act as a lead-generation service for startups which have failed to raise all the money they want through more legitimate avenues.

There’s something of an alternative-investment bubble right now: just look, for instance, at Saatchi Online’s truly insane “invest in art” project, which takes unknown artists and tries to sell their work as something which could be worth millions in a few years’ time. Five years of ZIRP will do that: first the bond markets get inflated, then the stock markets, and then, eventually, the really crazy stuff.

In that sense, right now — the tail end of the ZIRP experiment — is the absolute worst possible time to embark upon this general solicitation road. Far too much liquidity is chasing yield, with the result that even the smart money has started funding companies at utterly bonkers valuations. When you then open up the dumb money to projects which the smart money has passed on, the outcome is certain, and not pleasant.

The best case scenario, here, is that a bunch of people who can afford to lose some money end up doing just that. There’s no shortage of ways to invest badly, and the world isn’t going to come to an end just because there’s now one more. But I do fear that when the inevitable happens, the ensuing litigation will drag on for many years. If you want to avoid it, I would avoid all equity crowdfunding platforms as a matter of principle.

Update: Howard Lindzon (an investor in AngelList) responds.


Simple solution – only allow the huge number of new Chinese billionaires and mega-millionaires to invest – who cares if they are fleeced?

Posted by cirrus7 | Report as abusive

from Ben Walsh:

The opportunity cost of buying iPhones and Cronuts

Ben Walsh
Sep 20, 2013 22:33 UTC

Quartz’s Ritchie King did some excellent reporting this morning, producing the infographic of the day: “The line for new iPhones vs the line for cronuts”. The line for new iPhones is 250 meters, or 92% longer than the line for the iPhone.

What this analysis fails to capture is the opportunity cost of waiting in line for the iPhone compared to The Cronut™. Here’s a back of the envelope calculation:

Conclusion: The Cronut™ has lower opportunity costs in absolute dollar terms, but far higher relative opportunity costs. Also, if you going to wait in line for an iPhone, buy a 5S. Interestingly, while Dominique Ansel is selling a baked good, the cost to his customers almost entirely consists of waiting in line.

To complete these calculations, you have to make a slew of assumptions (always a sign you are doing serious economic analysis). And each assumption has caveats.

Assumption 1: Line length in yards can be reliably converted into line length in minutes, and that this conversion rate is reasonably constant for both lines.

For the Cronut™, this relatively easy. The Cronut™ can sell out, so the only way to ensure you will get one is to arrive at Dominique Ansel Bakery early. Really, really early. Like 5:45 am, two hours and 15 minutes ahead of the bakery’s 8:00 opening. Anything else, and you expose yourself to waiting in line, and not getting the Cronut™. This isn’t the venue to put a cost on that type of moral failure.

For the new iPhones, people began lining up two weeks ago (albeit at not at the Soho store). Again, putting aside the almost moral failure to secure a gold 5S, you need several hours of early morning waiting to ensure you get an iPhone.

  • Caveat 1: Imprecision and variability. I tried to be conservative in my estimation of wait times, erring on the shorter side, but a conservative estimate is still an estimate. Nothing comparable to  Dan Nguyen’s tracking of the wait times to get into MoMa’s Rain Room has been done for Apple lines. It’s very hard to know precisely how long the line at either store will take. For instance, when I called Dominique Ansel Bakery to ask how long the wait generally was based on how long the line was, an employee told me that it’s basically impossible to know. Some transactions, he explained, were very brief and involved a single Cronut™. Others took as long as ten minutes, involving multiple Cronut™s and lots of souvenirs, which he described as “the sort of things you could take on planes”. (Out-of-towners add a further layer of complexity: see caveat 2.)

Assumption 2: The salaries of the people waiting in both lines are uniform and equal, and equal to the average of the median individual incomes in New York and Kings County in 2011: $80,326 per year, which works out at $40.16 an hour using the standard 50 week, 40 hours per week, 2000 hours per year work year.

  • Caveat 2: Imprecision and variability again. There’s no good way of knowing precisely how much people’s time waiting in line is worth. Obviously, they make different amounts of money doing different things. Some of those things are the type of job (e.g. hourly-pay based job that they missing work hours at to wait in line) where waiting in line has a clear cost. But what about a salary worker who doesn’t need to be at work during the hours they are waiting in line? Does the lost sleep count as a monetary cost? If so, is it offset by the status signalling benefits of waiting in line? (See caveat 3)

Assumption 3: Waiting in line is a has a cost associated with it.

  • Caveat 3: Maybe the opposite is true! People line up for all sorts of nutty, yet identifiably human, reasons: They want to be part of something; they want to spend time with friends; they want to the chance to be venerated as a deity; or they are being paid to be there by other people who don’t have the time to read this post but have enough money to pay someone else to wait in line for them. For the people standing in line, these are all, to answer Paul Vigna’s question, good or mediocre reasons to be there. Which means, if there is an Apple-store-line-length arbitrage to be had (and there is! The line at the Meatpacking store is measurably shorter than the line on Fifth Avenue!), there’s a mediocre argument that you get the most return by going to the store with the longest lines.

Assumption 4: After waiting in line, customers buy one product.

  • Caveat 4: Maybe. After waiting in line and sensing that they just burned through a bunch of opportunity cost, some customers buy more than one iPhone or a bunch of Cronut™s. This is smart: after waiting in line for a fixed amount of time, buying more products reduces the opportunity cost as a percentage of the full cost.

Talk about opportunity costs!

I just wasted three minutes I’ll never get back reading this poppycock.

Posted by Lilguy | Report as abusive

The surprising value of not tapering

Felix Salmon
Sep 19, 2013 04:48 UTC

I’m very late to this — I was a bit distracted by other things today — but the big storyline of the day seems clear: the Fed didn’t taper, and markets surged in response.

So here’s my question. If you take the amount of tapering that the market expected yesterday, and the amount of tapering that the market expects today, what’s the difference, in dollar terms? In other words, by the time tapering ends, and the Fed is no longer engaging in quantitative easing, how much extra money will it have spent buying bonds, if current market expectations hold, compared to what the market expected on Wednesday?

Then comes the next question, which is this: how much did the value of US fixed-income assets rise on Thursday? And, for that matter, how much did the value of US stocks rise on Thursday?

I don’t know the exact answers to the questions, but I’m pretty sure that the latter numbers are much larger than the former — that the market reaction, in dollar terms, was hugely greater than the extra amount of QE that the market now expects.

If that is indeed the case, then what we’re seeing is what you might call the QE multiplier — the amount by which every dollar of QE effects the markets as a whole. I don’t know what we thought the QE multiplier was on Wednesday, but in light of Thursday’s market action we might need to revise our guesses: the QE multiplier is, I suspect, much larger than most of us would have pegged it at.

And that, in turn, is surely a reason to keep on easing. If QE does no good, then you might as well not do it. But the lesson we learned on Thursday is that the markets really, really love QE. And insofar as robust markets feed through into a healthier economy, the logical conclusion is that we should retain current policy well into 2014. The downside is limited — and the upside is much bigger than we thought it was.


Casinos really like it when you keep putting dollars in the slot machines, it pays out nicely for the house and a few winners.

Posted by 2Borknot2B | Report as abusive

Chart of the day, bank-lending edition

Felix Salmon
Sep 17, 2013 16:47 UTC

Well done to Matt Levine for finding — and explaining very clearly — the BIS’s special feature, by Ben Cohen, on the way in which the world’s banks have adjusted to higher capital requirements. Basically, the BIS, which sets the Basel capital requirements for the world’s banks, wanted to know how banks reacted when those capital requirements were raised.

The first thing that happened is that the banks did, in fact, become significantly better capitalized — and that is especially true of what the BIS calls “large, internationally active banks”. Since those are the banks we’re mainly worried about, this is definitely good news. Those banks were well below the Basel III minimum at the beginning of 2010, but they reached it by mid-2011, and they comfortably exceeded it by mid-2012, well ahead of the Basel III schedule.

The banks achieved this feat in the most painless way possible: they simply retained their earnings, rather than paying them out in dividends. And those earnings weren’t easy to come by, either. The banks in general shed what Levine calls “income that lots of people find naughty, prop trading and so forth”, which reduced their overall profitability. The banks instead had to make money the old-fashioned way, by lending it out at a higher rate than their cost of funds. Net interest income, across all global banks, rose substantially from the pre-crisis period to the post-crisis period: it was 1.34% of assets in 2005-7, and 1.62% of assets in 2010-12.

Here’s where the slightly disappointing part of the story comes in, though: despite the fact that their loans were more profitable than ever, the banks didn’t actually lend more, overall. The BIS report has some rather confusing charts on this, so here’s a FRED chart I put together, showing total US bank credit, in constant 2008 dollars, over the past 15 years:

The story here is clear. Total credit was rising at a very steady real pace for the decade running up to the crisis — but then it stopped growing when the crisis hit, and it has never really recovered.

Levine, and the BIS, put a positive spin on this, saying that the banks “are not cutting back on lending”. Which is true — but they’re not exactly fueling the recovery, either. Indeed, this chart is worse than what we would have seen if the banks had just rolled over all their existing loans and made no new loans at all.

That said, I’m not sure that this chart is really bad news. If you stipulate that there was too much lending in the economy in 2008, and that we needed to enter a period of slow deleveraging, this is actually exactly what the doctor ordered.

One way of reading the BIS report is to think of a set of trade-offs between three constituencies: banks, borrowers, and regulators. When the regulators got tough and implemented Basel III, the main losers were the banks, which lost a lot of permanent profitability. But borrowers were also hit: they’re paying more for loans, and they’re not being given as many loans as they were in the past. The big winner, meanwhile, was society as a whole, which significantly reduced the amount of systemic risk in the banking system.

The BIS is not entirely unsympathetic to the banks. In fact, in a quite astonishing passage which Levine picks up on in a footnote, they suggest that maybe the banks could form an informal cartel, passively agreeing not to compete with each other on lending rates:

The bank could seek to reduce the share of its profit it pays out in dividends. Alternatively, it may try to boost profits themselves. The most direct way to do so would be by increasing the spread between the interest rates it charges for loans and those it pays on its funding. While competitive pressures may limit how much an individual bank can widen these spreads, lending spreads could rise across the system if all banks followed a similar strategy and alternative funding channels (such as capital markets) did not offer more attractive rates.

Remember that from a regulatory perspective, a highly profitable bank is a significantly better bet than one with narrower profit margins. Regulators want banks to make good money: it makes their own job a great deal easier. And if that comes from charging borrowers higher rates, so be it.

What’s more, banks actually have the ability to do this relatively easily. Borrowers who don’t have direct access to the capital markets — which is the overwhelming majority of us — are not, in reality, particularly price-sensitive when it comes to lending rates. Payday lenders learned this lesson years ago: borrowers value convenience much more than they do lower interest rates. And as a result, banks actually have quite a lot of leeway to raise lending rates if they want to, at least when it comes to individuals and small businesses.

And in reality, a large part of the stagnation in bank lending has to be a consequence of the fact that the economy as a whole is evincing little demand for credit. Individuals are more interested in paying down their debts than they are in borrowing more; businesses, too, have learned the hard way that debt has a tendency to bite, hard, at the worst possible moment. If higher lending spreads help to discourage borrowing, at the margin — and maybe conversely encourage businesses to take some kind of equity funding, instead — then possibly they will result in a more resilient economy overall.

For the time being, as well, higher bank spreads are no big deal, just because the banks have such an incredibly low cost of funds: the actual nominal interest rates being paid by borrowers are still extremely low. My own bank recently offered me, out of the blue, a free, unsecured credit line at 6.3%: that’s well above their cost of funds, but it’s still a very low interest rate, in the grand scheme of things, should I find myself in a position where I need to take advantage of it.

So I’m with Levine on this one: so far at least, Basel III seems to be working in an almost optimal manner. We’re used to a world where the only way you can achieve growth is through leverage — and we learned, with extreme pain, that leverage is a very dangerous thing. This recovery, by contrast, is not being driven by leverage. And that is surely a good thing.


What’s the downside? I don’t know – what was the downside of the dot.com easy money bubble or the subprime/CDS easy money bubble? You are an inspiring figure Mr. Salmon – don’t know a damn thing about something as basic as this, yet hired on by a major news organization to write a financial blog. Keep up the good work, you may be plucky and ignorant enough to be a Federal Reserve Chairman someday.

Posted by PianoRoll | Report as abusive