Opinion

Felix Salmon

The HFT debate

Felix Salmon
Apr 1, 2014 21:35 UTC

CNBC might be guilty of a tiny bit of hyperbole when they say that their HFT debate today, between the CEOs of rival exchanges IEX and BATS, “stopped trading on the floor of the New York Stock Exchange” and “Twitter stopped too”. Still, they undoubtedly caused a lot of buzz, and the debate — coming, as it does, in the wake of the release of Michael Lewis’s new book on the subject — is an extremely important one, and it is indeed of great interest to that most endangered of species, the NYSE floor trader.

Because CNBC lives on maximizing cacophony, the debate ultimately created more noise than illumination. But at least there was a debate, which is great: it’s very important to get these people talking at the same venue, because if that happens often enough, they might conceivably stop talking at cross-purposes to each other, and maybe even start agreeing on some useful changes which can be made to market structure.

There is the potential for finding common ground here. Brad Katsuyama, the founder of IEX and the hero of Lewis’s book, is no white-hat absolutist: he doesn’t like the way in which the term “HFT” is used to cover a multiplicity of different behaviors, and in fact he is all in favor of computerized trading. (Which makes sense, seeing as how he runs a dark pool.) And BATS president Bill O’Brien is happy to concede that the market has become too complex. He said only that the complexity needs to be “managed”, rather than simplified, but in reality simplification is by far the most effective way to manage complexity. A market with only three or four order types, for instance, is a lot simpler and easier to manage than a market with hundreds.

Can the market be fixed? Michael Lewis says he would like to see that — but at the same time he says that he welcomes the way in which the FBI and the New York attorney general are launching investigations into HFT, to see whether anything in that world can be considered criminal insider trading or market manipulation. My feeling is that if you want prosecutions, then law-enforcement should launch investigations — but that if you really want to fix things, then creating a highly adversarial relationship between HFT shops and the government is not going to help and is in fact almost certain to hurt.

After all, a long sub-plot of Lewis’s book concerns the way in which law enforcement is completely clueless about high-frequency trading, and ends up jailing the innocent rather than doing anything constructive. HFT is very, very hard to understand, and trying to break it down along legal/illegal lines is unlikely to be helpful. If we want to make markets safer both for big real-money investors and in terms of the system as a whole, then the exchanges, along with their HFT paymasters, need to be part of the solution, rather than lawyering up and entering a defensive legal crouch.

And frankly the buy side — which gets a complete pass in Lewis’s book, as the guileless victim — needs to be part of the solution as well. Right now, most investors’ orders are passed to certain broker-dealers not on the basis of which broker offers the best execution, but rather as part of a “soft dollar” system which rewards good research, access to IPO roadshows, and the like. In other words, it’s not traders who decide which brokers to use — it’s portfolio managers.

Most invidiously, soft-dollar fees are paid out of brokerage commissions — which is to say, they’re paid by the investors in the funds. If the system moved to a hard-dollar fee-for-service approach, where traders were incentivized to use the brokers with the best execution, then those fees would be taken out of the management fees which are currently being pocketed by the portfolio managers. And it turns out that portfolio managers are much happier paying commissions out of their investors’ money than they are out of their own income.

All of which is to say that fixing the market will take a lot more than just the FBI coming in with a blunderbuss. It will mean deep reform across a huge swathe of the financial markets, some of it seemingly far removed from HFT. Which in turn means that I’m not holding my breath.

COMMENT

The problem with HFT WHICH everyone is overlooking:
HFT inovolves a lot of CIRCULAR TRADING in between the moments when “real orders” show up, which literally creates/sustains a fake price point. I am NOT convinced of the soundness of price signals in presence of HFT pay for volume games which is a sophist term for circular trading. Entire HFT strategies: Stat Arb, market making etc are irrelevant to absolute price discovery/

They are literally printing the tape like QE prints money in lieu of US Treasuries not having to be repaid on maturity by US govt b/c the fed is returning the principal at maturity back to US gov.

People are bamboozled.

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Michael Lewis’s flawed new book

Felix Salmon
Mar 31, 2014 21:11 UTC

I’m halfway through the new Michael Lewis book – the one that has been turned into not only a breathless 60 Minutes segment but also a long excerpt in the New York Times Magazine. Like all Michael Lewis books, it’s written with great clarity and fluency: you’re not going to have any trouble turning the pages. And, like all Michael Lewis books, it’s at heart a narrative about a person — in this case, Brad Katsuyama, the founder of a small new stock exchange called IEX.

The narrative is interesting enough — but so far I haven’t seen anything that would qualify as the “lighting in a bottle” he promised Boris Kachka. We were promised scoops, but so far it’s hard to see what the scoops are supposed to be. The most interesting thing I’ve discovered so far is the existence of something called “latency tables” — a way for HFT shops to work out exactly which brokers were responsible for which orders. The trick is to realize that because every brokerage is in a slightly different physical location, each house’s trades will hit the various different stock exchanges in a slightly different order. And so by looking at the time difference between a given trade showing up on different exchanges, you can (or could, at one point) in theory identify the bank behind it.

This vagueness about time is one of the weaknesses of the book: it’s hard to keep track of time, and a lot of it seems to be an exposé not of high-frequency trading as it exists today, but rather of high-frequency trading as it existed during its brief heyday circa 2008. Lewis takes pains to tell us what happened to the number of trades per day between 2006 and 2009, for instance, but doesn’t feel the need to mention what has happened since then. (It is falling, quite dramatically.) The scale of the HFT problem — and the amount of money being made by the HFT industry — is in sharp decline: there was big money to be made once upon a time, but nowadays it’s not really there anymore. Because that fact doesn’t fit Lewis’s narrative, however, I doubt I’m going to find it anywhere in his book.

Similarly, Lewis goes to great lengths to elide the distinction between small investors and big investors. As a rule, small investors are helped by HFT: they get filled immediately, at NBBO. (NBBO is National Best Bid/Offer: basically, the very best price in the market.) It’s big investors who get hurt by HFT: because they need more stock than is immediately available, the algobots can try to front-run their trades. But Lewis plays the “all investors are small investors” card: if a hedge fund is running money on behalf of a pension fund, and the pension fund is looking after the money of middle-class individuals, then, mutatis mutandis, the hedge fund is basically just the little guy. Which is how David Einhorn ended up appearing on 60 Minutes playing the part of the put-upon small investor. Ha!

Lewis is also cavalier in his declaration that intermediation has never been as profitable as it is today, in the hands of HFT shops. He does say that the entire history of Wall Street is one of scandals, “linked together trunk to tail like circus elephants”, and nearly always involving front-running of some description. And he also mentions that while you used to be able to drive a truck through the bid-offer prices on stocks, pre-decimalization, nowadays prices are much, much tighter — with the result that trading is much, much less expensive than it used to be. Given all that, it stands to reason that even if the HFT shops are making good money, they’re still making less than the big broker-dealers used to make back in the day. But that’s not a calculation Lewis seems to have any interest in.

In his introduction to the book, Lewis writes this:

The average investor has no hope of knowing, of course, even the little he needs to know. He logs onto his TD Ameritrade or E*Trade or Schwab account, enters a ticker symbol of some stock, and clicks an icon that says “Buy”: Then what? He may think he knows what happens after he presses the key on his computer keyboard, but, trust me, he does not. If he did, he’d think twice before he pressed it.

This is silly. I’ll tell you what happens when the little guy presses that key: his order doesn’t go anywhere near any stock exchange, and no HFT shop is going to front-run it. Instead, he will receive exactly the number of shares he ordered, at exactly the best price in the market at the second he pressed the button, and he will do so in less time than it takes his web browser to refresh. Buying a small number of shares through an online brokerage account is the best guarantee of not getting front-run by HFT types. And there’s no reason whatsoever for the little guy to think twice before pressing the button.

HFT is dangerous, I’d like to see less of it, and I hope that Michael Lewis will help to bring it to wider attention. But my tentative verdict on Flash Boys (I’ll write something longer once I’ve finished the book) is that it actually misses the big problem with HFT, in the service of pushing a false narrative that it’s bad for the little guy.

COMMENT

This article might be misinformed because Felix Salmon did not care to read the book. All he found interesting was the “latency tables” which are in the first part of the book.

But instead of informing himself more and read the book he writes another article on Slate on the rest of the book defending Virtu, the HFT Trader that had to postpone the IPO because of the book.

Not Solomon thinks the book is about Vertu (although he admits that Lewis never writes about it) and finds this unfair. And the few cents the retail investors might loose on the trades would not matter, therefore there was no victim.

This is either very sloppy journalism or outright corrupted (Reuters actually makes a lot of money from market data, so this might explain it).

The small investor is also a victim because he trades at prices that are older than the ones the hft traders (and most institional investors which most of the time invest pension fund money) see.

What Lewis critizes most ist the flawed incentives, that brokers sell their order flow to hft firms so they can profit from these slow orders instead of ensuring that their orders get executed at a fair price. That the big banks created dark pools and let the orders of big clients there for some time instead of ordering it to the exchanges with the best prices because they can keep more of the fees if it is traded in the dark pools and because the HFT Traders pay to get fast access to these pools so they can skim a few cents off every order there if the market moves in the right direction.

Felix Salmon, please read the book before you write the next article about it. This book will be so widely read that your articles make you look very stupid or corrupt if people read it after reading the book!

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The Wu-Tang’s self-defeating unique album

Felix Salmon
Mar 28, 2014 17:11 UTC

I’ve had a couple of requests to write about the economics of the The Wu – Once Upon A Time In Shaolin, the new album from the Wu-Tang Clan. The album is being released in a beautiful box, in an edition of exactly one:

Like the work of a master Impressionist, it will truly be one-of-a-kind.. And similar to a Monet or a Degas, the price tag will be a multimillion-dollar figure.

Wu-Tang’s aim is to use the album as a springboard for the reconsideration of music as art, hoping the approach will help restore it to a place alongside great visual works–and create a shift in the music business.

This might be innovative, but it’s also more than a little bit peevish. Go to the official website for the album, and you’ll find a manifesto, of sorts, which basically boils down to art-market envy.

History demonstrates that great musicians such as Beethoven, Mozart and Bach are held in the same high esteem as figures like Picasso, Michelangelo and Van Gogh. However, the creative output of today’s artists such as The RZA, Kanye West or Dr. Dre, is not valued equally to that of artists like Andy Warhol, Damien Hirst or Jean-Michel Basquiat.

Is exclusivity versus mass replication really the 50 million dollar difference between a microphone and a paintbrush? Is contemporary art overvalued in an exclusive market, or are musicians undervalued in a profoundly saturated market? By adopting a 400 year old Renaissance-style approach to music, offering it as a commissioned commodity and allowing it to take a similar trajectory from creation to exhibition to sale, as any other contemporary art piece, we hope to inspire and intensify urgent debates about the future of music…

While we fully embrace the advancements in music technology, we feel it has contributed to the devaluation of music as an art form…

The music industry is in crisis. Creativity has become disposable and value has been stripped out.

Mass production and content saturation have devalued both our experience of music and our ability to establish its value.

Industrial production and digital reproduction have failed. The intrinsic value of music has been reduced to zero.

This is all rather misguided, on a number of levels.

Firstly, you shouldn’t aspire to being like Andy Warhol and Jean-Michel Basquiat, for the very good reason that Andy Warhol and Jean-Michel Basquiat are dead. Posthumous market success can make lots of money for dealers, collectors, and heirs — but neither Warhol nor Basquiat ever sold a painting for anything near $50 million during their lifetimes.

Secondly, the contemporary art market is in the midst of an unprecedented bubble right now. Different bubbles have different dynamics, but all of them are based, in one way or another, on price spirals. The general public needs to be able to see a given asset — tulips, dot-com stocks, houses, Richters, you name it — going up in price at an impressive clip. In order for any asset, or asset class, to become expensive, it first needs to start cheap, and work its way up. The Wu-Tang Clan not only want to create a whole new asset class; they also want that asset class to be valued at bubblicious levels right off the bat. Sorry, but markets don’t work that way.

Thirdly, the Wu can’t work out if they want their album to be treated as a piece of fine art or as a luxury good. They say that their approach “launches the private music branch as a new luxury business model for those able to commission musicians to create songs or albums for private collections”. It’s true that the distinction between art and luxury is eroding, with artists like Takashi Murakami and Damien Hirst at the forefront of that trend. But there is still a distinction, and the Wu-Tang Clan clearly want their album to be on the art side, rather than on the luxury side: they want to be artists, not artisans. At the same time, however, the ornate packaging of their album signifies an emphasis on artistry, rather than art. I suspect that they would have been better off selling a simple USB thumb drive for a couple of million dollars, rather than trying to create a new class of luxury object.

Fourthly, there actually isn’t as much of an economic difference between the contemporary art market and the contemporary music market as the Wu would seem to think. Kanye West and Dr Dre, to use their own examples, are making just as much money as any contemporary fine artist you might care to mention: both markets have skewed themselves towards a winner-takes-all model where a very small number of people are making gobsmacking amounts of money, while everybody else struggles. That said, the gross size of the contemporary music market, however you measure it, is still orders of magnitude greater than the gross size of the market in contemporary art. And musicians can always tour — an option which isn’t even available to fine artists. All in all, while there are many struggling artists in both camps, the average professional musician is probably still going to be better off than the average professional artist.

Fifthly, industrial production and digital reproduction have not failed — they have succeeded enormously. While the profits of record labels have fallen, the global experience of music is broader and deeper than ever. Today, everybody has a music player in their pocket — and billions of hours of music are listened to every day. Music consumers have never had it so good, and musicians have never had access to a larger audience. The business being lost is just the business of selling physical objects on which music can be imprinted. But it’s silly to say that the value of those physical objects is, or ever was, the same as “the intrinsic value of music”. After all, if the price of a CD really was the intrinsic value of the music on that CD, then essentially all music would have identical value.

Lastly, and most importantly, the Wu-Tang Clan here are flying in the face of the very nature of music itself. Art and music are at two different ends of an important spectrum: art appreciation is fundamentally a solitary experience, which is one reason why people like to live with art in their own homes, and generally dislike overcrowded museums and galleries. Music, by contrast, is fundamentally a social experience. You might prefer small venues to large arenas — but you’d still rather go see a gig at a small venue than have a band play a set for you and you alone. That would be weird.

It’s true that recorded music is often enjoyed in a solitary manner, through headphones. But even then the shared experience is important: file-sharing sites exploded in popularity not only because they allowed free access to music but also because the first thing that you want to do, when you listen to something you love, is to share it with others. The world’s biggest recording artists, including the Wu-Tang Clan, don’t achieve success purely through the intrinsic value of their music; they achieve success through the way in which their music is loved and shared. The love of music is a fundamentally communal experience, in a way that the appreciation of fine art is not. To turn an album into a unique object, belonging to just one person, is to defeat the very nature of music and music-making. This model from the Wu-Tang Clan does nothing for the cause of “reviving music as a valuable art”, to use their words. Instead, it simply mummifies and fetishizes it. It’s silly, and I hope it doesn’t catch on.

COMMENT

Music will be art again when most listeners start to listen to good music again. The music industry died in 1980 with the election of Ronald Reagan and the increase in facist brainwashing. The thing is, you can brainwash many people and they will follow you, but they are morons and not a useful army. They also don’t buy music that is thought provoking or increases introspection, which are exactly the best types of music. They also are not productive people and so unless you subsidize them, they have no money to buy music.

“Bazooko’s Circus is what the whole hep world would be doing Saturday nights if the Nazis had won the war. This was the Sixth Reich.” The Nazis lost the war, but they lived on and came to america in the form of corporatist bankers and the GOP. Their message is in the music and radio and television they work so hard to control. The message of consumption and conformity.

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Against beautiful journalism

Felix Salmon
Mar 27, 2014 05:22 UTC

Have you seen that site’s gorgeous new redesign? Every article has a nice big headline, huge photos, loads of white space, intuitive and immersive scrolling, super-wide column widths — everything you need to make the copy truly sing.

I’m over it.

Part of this is because I have a long-standing soft spot for ugly. It’s easy, of course, for a web page to become too messy, too noisy — especially when the mess and the noise is mostly ad-related. On the other hand, I grew up in a culture where today’s journalism is tomorrow’s fish-and-chips wrapper, and where in general journalism isn’t taken nearly as seriously as it is in the US. That’s healthy, in many ways, and it encourages a lightness of touch, as well as a gleeful let’s-try-everything approach, and a general feeling that the publisher won’t be offended if you stop reading this and start reading that instead.

The stripped-down, minimal approach to page design has its place — but most of that time, that place isn’t for news stories, which by their nature are mostly snack-sized things written on deadline and designed to be consumed quickly and easily, rather than long meals designed to be slowly savored.

More to the point, news websites have always struggled with any one-size-fits-all approach to stories. A format which works for a 6,000-word feature is not going to work well for a 150-word brief. Web designers have known this for years, but still news sites tend to put all of their stories into exactly the same template — and increasingly that template is designed for ambitious longform storytelling. Which, of course, generally accounts for only a tiny fraction of the material on the site.

For a prime recent example of the disconnect, check out NYT public editor Margaret Sullivan’s recent post on trend stories in general, and that monocle trend story in particular:

Media watchers received the story like a Christmas present, tearing off the wrapping to get at the goods. The fun began on Twitter, after the story went online but well before its print publication. Dustin Gillard tweeted: “NYTimes does a trend piece on monocles. It is about as good/bad as it sounds.” (No one ever said the Internet was good at nuance; the wags ignored that the short piece was tucked inside the Styles section in its “Noted” column, treating it instead as if it were front-page screaming-headline news.)

But here’s the thing: on the internet (which, Sullivan admits, was for a long time the only place where you could read the story), the story wasn’t “tucked” anywhere. Instead, it looks like this:

mono2.tiff

Everything about the way that this story is presented online screams This Is Important. In the physical paper, I’m sure there were lots of design cues telling the reader not to take the story too seriously; online, they all got stripped away.

I like to flick through the NYT in the morning, and recently I’ve been playing with the replica edition on the iPad, rather than the native iPad app. (All print subscribers get free access to the replica edition, seven days a week, although the NYT doesn’t make it easy to find.) The replica edition is just the newspaper as it is laid out on paper — with different-sized headlines, classifieds, display ads, everything. It has no hyperlinks (although every headline is clickable, to be read more easily) — but instead it provides something the online and iPad editions lack: the large amount of information presented by the fine page designers of the NYT. You can see what’s important, and you can revert to old-fashioned serendipity when it comes to things like stumbling across a wonderful obituary, even when you would never deliberately decide to read the obituary section in the iPad app.

The replica edition is not a replacement for the native app, so much as it’s a complement to it — and something which shows just how good the NYT is at its native medium of print. And the NYT isn’t even close to being the best-designed newspaper out there: I might be biased, but I think it’s generally accepted that most English newspapers are better designed than nearly all US papers. When it comes to the visual display of news, newspapers daily convey vast amounts of information which is simply lost in the translation to digital. At the top of the list: any indication of the importance of any given story.

Today, when you read a story at the New Republic, or Medium, or any of a thousand other sites, it looks great; every story looks great. Even something as simple as a competition announcement comes with a full-page header and whiz-bang scrollkit graphics. The result is a cognitive disconnect: why is the website design telling me that this short blog post is incredibly important, when in reality it’s just a blockquote and a single line of snark? All too often, when I visit a site like Slate or Quartz, I feel let down when I read something short and snappy — something which I might well have enjoyed, if it just took up a small amount of space in an old-fashioned reverse-chronological blog. The design raises my expectations, even as the writers are still expected to throw out a large number of quick takes on various subjects.

This is a problem for user-generated content, too. Look at Medium, for example. It wants to be a self-expression platform, much like Twitter or Facebook — but its design is daunting: for all that it’s easy to use, people intuitively understand that the way that their story looks implies a certain level of quality and importance. That can be a good thing: it encourages contributors to up their game. But equally, it can simply result in people giving up, on the grounds that they don’t particularly want such a grand-feeling venue for their relatively small idea.

It’s time for websites to put a lot more effort into de-emphasizing less important stories, reserving the grand presentation formats only for the pieces which deserve it. In theory, most content management systems these days support various different story templates; in practice, however, there’s a kind of grade inflation going on, and everything ends up getting the A-list treatment.

One of the many small pleasures of reading the New Yorker is the way that it presents its poems: they’re clearly distinguished from the right-justified body text, but mainly just by giving them more white space, more room to breathe. While poems look great that way, however, no one has ever suggested that the magazine would be improved if everything were given so much space. I hope that the web learns that lesson soon, and starts to bring back a little bit of noise and clutter. Which is, after all, the natural state of nearly all journalism.

COMMENT

The aesthetics of Medium and Quartz over-promise & under-deliver on the quality of the content they’re pushing. Without doubt, this is true.

And editors should exercise more vigilance and discrimination over the content they push to their readers. The content-regurgitation-with-snappy-headli ne model of BI and HuffPo is not one Slate or TNR should deign to imitate.

But how readers consume information and how they share it too, figures large. And if you can get a toehold in the smartphone news market early, like Quartz and Medium seem to be doing, there’s some possible value realized there (in having achieved that early mover advantage).

So it’s important for to keep in mind the visual mediums that we or other people imagine the web with too. How content get organized visually – on desktop screens versus tablets versus phones – is a matter of kind, and not just degree.

And there’s huge growth potential in the developing world. Their primary point of entry for the internet will be the mobile phone:

http://mashable.com/2011/02/04/web-devel oping-world/

How to effectively present information through that narrow medium of visualization will be a continuing challenge. And there’s a huge market out there for those developers addressing it, since the physical means by which people interface with and consume their news is by no means a settled process.

If only 10 years ago, our primary physical medium was the actual newspaper, who’s to say what our primary medium will be 10 years hence?

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Mark Zuckerberg, the Warren Buffett of technology?

Felix Salmon
Mar 26, 2014 06:06 UTC

What does Mark Zuckerberg think he’s doing, spending $2 billion on Oculus? You could take him at his word — that he sees virtual reality as “a new communication platform” where “truly present” people “can share unbounded spaces and experiences”. Basically, virtual is the new mobile, and Zuckerberg wants to get in on the game early.

But note what Zuckerberg doesn’t say, as much as what he does. There’s no mention of “social”, no mention even of “Facebook”. Zuckerberg is one of the greatest product managers in history, but his legendary focus is nowhere to be seen here: it’s all big, vague, hand-waving futurism. And note too one of the quieter members of Zuckerberg’s board of directors: Donald Graham, the CEO of what used to be called the Washington Post Company, and old friend of Warren Buffett.

Buffett, of course, is the classic conglomerator: he’ll buy any business, so long as it’s good. Graham is similar: he inherited a grand media property, and added on all manner of unrelated businesses. Eventually he sold the Washington Post to Jeff Bezos, for $250 million — and is still the CEO of a company, Graham Holdings, which is worth more than $5 billion.

Is it too early to declare that Zuckerberg has ambitions to become the Warren Buffett of technology? Look at his big purchases — Instagram, WhatsApp, Oculus. None of them are likely to be integrated into the core Facebook product any time soon; none of them really make it better in any visible way. I’m sure he promised something similar to Snapchat, too.

Zuckerberg knows how short-lived products can be, on the internet: he knows that if he wants to build a company which will last decades, it’s going to have to outlast Facebook as we currently conceive it. The trick is to use Facebook’s current awesome profitability and size to acquire a portfolio of companies; as one becomes passé, the next will take over. Probably none of them will ever be as big and dominant as Facebook is today, but that’s OK: together, they can be huge.

Zuckerberg is also striking while the iron is hot. Have you noticed how your Facebook news feed is filling up with a lot of ads these days? Zuckerberg is, finally, monetizing, and he’s doing it at scale: Facebook’s net income grew from $64 million in the fourth quarter of 2012 to $523 million in the fourth quarter of 2013. At the same time, his stock — which he is aggressively using to make acquisitions — is trading at a p/e of 100. If you’re going shopping with billions of dollars in earnings multiplied by a hundred, you can buy just about anything you like.

Eventually, inevitably, Facebook (the product) will lose its current dominance. But by that point, Facebook (the company) will have so many fingers in so many pies that it might not matter. Zuckerberg, here, is hedging. Oculus might be valuable to Facebook if the social network grows. But it will be even more valuable to Facebook if the network shrinks. Zuckerberg has seen the astonishing speed with which products come and go online; he knows that his flagship won’t last forever. So he’s decided to build himself a flotilla.

COMMENT

There are essentially no examples in tech industry of this as a successful process. There are lots of failed examples from MS, Dell, HP, etc., including Google who still has no other successful product line replacing or even likely to replace search. It has a bunch of failures and a lot of “product lines” Youtube, cloud, office, chrome, android, google play, etc. They all more or less serve search and advertising.

Apple and perhaps Samsung have made the changes but not by buying other companies, Apple with major disruptive innovation and Samsung fast follower or copier.

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Why it makes sense for Larry Page to donate his billions to Elon Musk

Felix Salmon
Mar 25, 2014 17:50 UTC

Three years ago, with a post entitled “philanthropy isn’t for profit”, I expressed the hope that we had finally reached a turning point, and that people would “do good to do good, rather than simply declaring that the best way they can do good is to chase profit as zealously as possible”. And maybe I was right. That post was directed in part at Matthew Bishop, who had written a silly article asking whether IBM had done more good for the world than the Carnegie philanthropies. But this evening, when I ran into Bishop at an event for rich people in a swanky midtown club, he couldn’t bring himself to defend Larry Page, who said something similar at TED:

Rose asked him about a sentiment that Page had apparently voiced before that rather than leave his fortune to a cause, that he might just give it to Elon Musk. Page agreed, calling Musk’s aspiration to send humans to Mars “to back up humanity” a worthy goal. “That’s a company, and that’s philanthropical,” he said.

Page’s comments have already been attacked by Kevin Roose, and, as I say, they’re not going to be defended by Matthew Bishop. But here’s the weird thing: Page’s ideas aren’t nearly as dumb as they might seem at first blush. In fact, even I can defend them — and I’m the kind of person who generally hates the way that rich people give away their money.

Page, with his unorthodox idea, deftly sidesteps most of the mistakes that rich people make with their charitable donations. Most importantly, there’s nothing self-serving about Larry Page giving his money to Elon Musk: there isn’t any ego boost involved, and there isn’t even a tax deduction. Instead, Page is simply trying to work out how his money is most likely to have a positive transformational effect on the world.

The fact is that private philanthropy almost never has such an effect: big-picture changes to the world come from commerce and from government, not from gifting. Exxon Mobil has changed the world; Phillip Morris has changed the world. Apple and Microsoft and Cisco and Intel have changed the world. Monsanto and Cargill and ADM have changed the world; Pfizer and Roche and Novartis have changed the world. Certainly Great Britain and France and Russia and China and the US of A have changed the world, many times each.

And, as Page knows better than anyone, Google has changed the world.

Page is convinced (I agree with him on this, but I’m not going to argue the point here) that Google has been a positive force in the world. Indeed, it has been a more positive force than at least 99% of philanthropies. A philanthropist with $100,000 in 1998 who wanted to make the world a better place could hardly have done better than Andy Bechtolsheim, the first funder of Google — even if you ignore any good that Bechtolsheim might end up doing with the billions that investment ultimately became.

Of course, it’s impossible ex ante to know which startup is going to be the next Google. But Page is someone who has already changed the world once; he knows that there’s a 99% probability that his philanthropic activity will end up being orders of magnitude less effective and less important than his tenure at Google. It’s important to put philanthropy in perspective: for all that very rich people are indeed very rich, they generally aren’t rich enough to really move the needle on a societal level. Page is worth about $30 billion; the budget for the New York City department of education is almost that much per year. Famously, Bill Clinton has said that he will never be able to achieve, over the entire lifetime of his charitable foundation, the same effect that he could have with a two-second stroke of the pen while he was president. Or, to take a slightly more controversial example, look at the amounts of money pledged in the wake of natural disasters like the Haiti earthquake or Hurricane Sandy. The public is invariably extremely generous when such things happen — but government money always dwarfs private contributions.

Page is also smart enough, and hangs out with enough very rich people, to know that philanthropy is hard — and that there’s absolutely no reason to believe that the luck and skill he has demonstrated founding and running Google would read across to similar philanthropic success. There is exactly one technology billionaire who has put an enormous amount of personal time, effort, and money into running his personal philanthropy; not everybody can be Bill Gates, and it’s unfair to expect that other billionaires should be Bill Gates.

In other words, Page probably lacks both the ability and the inclination to create some world-changing philanthropy on his own — as we can see by the way in which Google.org and the Google Foundation have had relatively little impact. Let’s assume that he’s self-aware enough to know that. And now, in that light, let’s revisit the “idealistic vision” of his TED interview:

It’s a vision that includes everything from widespread artificial intelligence to self-driving cars to high-altitude balloons that bring internet access to the far reaches of the world…

Rose also asked him about his fascination with transportation systems, which Page said started while waiting in the snow for the bus at his alma mater, the University of Michigan. That fixation has led to Google’s self-driving cars project, which Page hopes will someday transform the world’s cities…

Page had words that sounded harsh even in his soft voice for businesses that lacked the same lofty goals of an Elon Musk or a Google. “Most people think companies are basically evil. They get a bad rap. And I think that’s somewhat correct,” Page said. “Companies are doing the same incremental thing that they did 50 years ago, 20 years ago. That’s not really what we need. Especially in technology, we need revolutionary change, not incremental change.”

That may be an easy thing to say when your company’s stock is trading near $1,200 per share and your main business of selling ads makes tens of billions a year. But Page certainly seems like someone for whom those ads are only a means to an end, and that end is not making himself rich. Page wants to build the future that we all may very well end up living in.

The point here is that Page’s ambitions are vast: they require vision and also the kind of resources which can be marshaled only by massive corporations, rather than any individual. And the question then arises: what can Page do with his personal wealth which could play on the same playing field as the ambitions he has at a corporate level?

The answer, surely, is help create another Google — another company which can change the world for the better. And if you look around for someone capable of pulling off such a feat, Elon Musk is always going to be at the top of the list.

Does that mean, pace Roose, that Page considers buying stock in Microsoft to be a credible alternative to giving money to the Gates Foundation? Of course it doesn’t. For one thing, the chances of Microsoft transforming the world again are pretty low. And for another, who said anything about buying stock?

If your philanthropic intent is to help Elon Musk change the world, there are lots of things you can do which are better than simply going out into the market and buying stock in Tesla. That stock has already been issued; the money Musk raised by selling that stock is already in Tesla’s coffers. If you buy the stock from some hedge fund, all you’re doing is transferring money to a hedge fund, you’re not particularly helping Elon Musk.

On the other hand, the glory of corporate capital structures is that they allow your money to be leveraged many times, in a way which is very difficult in traditional philanthropic contexts. (Indeed, if you give money to a foundation and then the foundation gives away just 5% of its capital every year, then you effectively have substantial negative leverage on your donation.)

So let’s say that Elon Musk issued a new class of stock. In the UK, such things are often called a golden share. Such stock would have voting rights and possibly quite substantial voting rights at that; it might even come with one or more board seats. But it would represent a negligible economic interest in the company: it would have no right to dividends, for instance. (For an example of how such a structure might work in the event of an acquisition, take a look at how the Reuters Founders golden share still has an important role to play within Thomson Reuters.)

The money used to buy the golden share would go straight onto the asset side of the corporate balance sheet, where it could support the issuance of more equity and more debt: it would punch well above its weight. It could help Musk’s company to grow faster, to be more ambitious, to be less beholden to common shareholders and/or bondholders. It might not, ultimately, make any difference at all — but, on the other hand, if the sum of money involved were in the multiple billions of dollars, it might make a very large difference indeed. In short, Page would have ended up buying the possibility of changing the world — again.

At that point, Page just needs to start comparing probabilities. What is the probability that he would change the world through traditional philanthropy? What is the probability that he would change the world if he bought a golden share from Elon Musk? If the latter is greater than the former, that’s a pretty strong reason to choose Musk over some tax-exempt foundation.

One of the big problems with contemporary philanthropy is that it’s obsessed with results: everybody wants to ensure that their money is making a real difference. In the case of unconditional cash transfers, for instance, which are pretty trendy these days, you know with certainty that after you give $1,000 to a poor person, that person is $1,000 richer. It’s a clear and unambiguous outcome, and there’s a lot of evidence to suggest that making poor families richer does wonders for their quality of life.

From the point of view of someone like Larry Page, however, it’s easy to see how the idea of simply giving his money directly to the poor might not appeal. The short-term effects would be wonderful, but also limited; the long-term effects would be relatively slim and hard to discern. Certainly the outcome would be minuscule compared to the long-term effects of, say, the invention of the printing press.

Which means that if you’re a person with Page’s ambitions and Page’s wealth, the trick is to take risks, rather than try to engineer a certain outcome. Better a small chance of creating a permanent and positive change to the way the world works, than a much larger chance of making a much more limited intervention. It’s a reasonable stance to take.

COMMENT

FingersFly… “Do you want to help disabled students, or the gifted ones?” good question. Will the gifted ones do things to help disabled students? That’s really what this discussion is about isn’t it?

Elon Musk is one of the gifted ones. He wants to help the world through sustainable energy and has the pieces to make a huge shift in humankind in that and by taking us to a new world. But he might not have the money (he’s trying to make SpaceX profit fund the settlement of Mars).

Of interest, he also recognises that humanity moves in stages, it doesn’t always go forwards, and there’s a real possibility that we could lose our ability to colonise Mars in 100 years if we don’t do it soon. Unlikely – but environmental catastrophes or war etc could hit us hard. A Mars city will be a potential protected pocket of civilisation that can do things we won’t be able to do on Earth, and ultimately bring much good to Earth.

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Trish Regan, Einhorn apologist

Felix Salmon
Mar 24, 2014 17:56 UTC

Ever since the story first broke, more than five weeks ago, that David Einhorn was suing Seeking Alpha, the Israeli financial website has been very, very quiet on the topic. Sometimes they have simply failed to respond at all to requests for comment (including mine); other times, as with Andrew Ross Sorkin, a spokesman will formally decline to comment.

So it was a big deal when Seeking Alpha president David Siegel appeared on Bloomberg TV today, and answered Trish Regan’s questions about the Einhorn lawsuit. Or, at least, it would have been a big deal, if Regan had actually bothered to ask him any of the obvious questions. Like, for instance, whether he’s going to fight it, or what he thinks of the merits of the case.

Instead, however, Regan decided that the best use of her time would be to deliver to Siegel a lecture on (and, presumably, an example of) Proper Journalism:

Trish Regan: David Einhorn has expressed his concern. He would like to know the name of the Seeking Alpha blogger who revealed one of his investments. Who was it?

David Siegel: (laughs, in a WTF kind of way) Well, we’re not going to tell you right now. But, um…

TR (interrupting, just as Siegel might be about to say something newsworthy): Why — Why hide behind anonymity? Why not put your name on something?

DS: We vehemently believe that it’s critical to have an open platform, where everyone can discuss, and debate, without necessarily having any repercussions to that. With that said, we have 24/7 monitoring on everything… it’s incredibly important to us to create the right forum, and we believe that that forum is —

TR: But why, why…

DS: — is a, anonymous…

TR (pushing over anything Siegal might want to say, because she has something more important of her own to declaim): I know but why — why not reveal — I mean, to me, and call me old-fashioned, but part of journalism is when you write an article, you put your name on it. You don’t hide behind anonymity. Why allow your bloggers to do that?

DS: It’s part of our philosophy. We need to have an open environment, and a flexible environment, for people to feel comfortable posting what they need to. We have a very, very rigorous background check process.

TR (giving Siegel four seconds to answer the big question, and burying it under another one): You can understand why David Einhorn would be upset, why he’d want us to actually know who this person is. I mean ultimately will you guys be held responsible?

DS: David Einhorn is a legend, and we have tremendous respect for him, absolutely.

The whole interview is just bizarre. I have no problem with aggressive, adversarial journalism, but the proper place for that is when your interlocutor is refusing to give a straight answer to a straight question. Seeking Alpha has always been very open about offering anonymity (or, more precisely, pseudonymity) to bloggers who request it, for very simple and obvious reasons: many of them are financial professionals whose jobs might be at risk if their identity were made public. Journalists like Regan give anonymity to their own sources on a regular basis, for exactly the same reason.

What’s more, anonymity is hardly unheard-of even among very mainstream publications: the Economist, for instance, has no bylines at all, while even the NYT will occasionally withhold a byline from a reporter in a dangerous country, if revealing that person’s identity would put them at risk.

Let’s say that the blogger in question had phoned up Regan and told her (off the record, but with Regan knowing her source’s identity) that Einhorn was buying up shares of Micron Technology. That might have turned into a nice little scoop for Regan, if she had confirmed it with other sources — all of whom would themselves surely have insisted on anonymity as well.

If Regan had published that story, Einhorn would surely have been annoyed, since he was taking great care to accumulate his stake in Micron as quietly as possible. But here’s the thing: Einhorn would never have dared take Regan and Bloomberg to court, trying to force them to reveal her sources. If a journalistic organization finds out a true fact and publishes it, that might inconvenience a hedge-fund manager, but it’s not going to result in a court case.

In the Micron case, however, Einhorn saw an outlet which was small enough to bully. If he wins, as Sorkin says, “the case could have a chilling effect on the free flow of information to traditional news outlets” — it would damage not only Seeking Alpha and its pseudonymous blogger, but also Trish Regan and all other journalists with confidential sources. Einhorn wants to be able to keep his own information confidential; he just doesn’t want Seeking Alpha to have a similar right.

If anybody deserves a lecture on journalism in this case, then, it’s not Siegel, it’s Einhorn. Meanwhile, Siegel is faced with a very hard decision. Einhorn is not the kind of person to back down from a fight: he has essentially bottomless resources, and will happily spend millions of dollars on lawyers just to make Seeking Alpha’s life miserable and expensive for the foreseeable future. Big media organizations are set up to fight such threats; smaller startups aren’t.

So the big question here is not whether Einhorn is right or wrong: of course Einhorn is wrong, Regan’s misplaced self-righteousness notwithstanding. Rather, the question is whether Seeking Alpha can and will be able to afford to fight him. That’s the big question which every non-enormous media company wants to know the answer to — and that’s exactly the question which Regan didn’t ask.

Ensconced as she is within the massive Bloomberg borg, Regan doesn’t need to worry about the cost of defending her journalistic operation against litigious hedge fund managers. But even Bloomberg benefits from a diverse media ecosystem. And so it’s rather worrying that Bloomberg TV should spend its energies defending Einhorn in this case, rather than finding out whether we’re facing a very real threat to media freedom.

Update: David Einhorn has dropped the suit, after finding out through other means who the blogger in question is. Trish Regan covered that development, too:

We’re in an interesting time in journalism, because bloggers are in the blogosphere, and there’s a lot of information out there that’s not always necessarily with someone’s name on it… Is that a danger, nowadays, that we’re in an environment where people can have a very big effect on securities, on the markets, and do so anonymously?

Yes, Trish, bloggers are in the blogosphere. And sometimes market moves happen in reaction to pseudonymous information sources. Or even to fully anonymous sources, in things like Bloomberg articles. I don’t see the problem with this. Unless you’re just upset that Valuable Insights has his own outlet, now, instead of having to bring his story to you.

COMMENT

SeekingAlpha published this statement about Greenlight dropping its suit:
http://seekingalpha.com/article/2106353- seeking-alpha-and-david-einhorn-the-real -story

Posted by Trollmes | Report as abusive

Janet Yellen didn’t gaffe

Felix Salmon
Mar 21, 2014 22:20 UTC

yellen.png

It’s become received opinion that Janet Yellen made a “rookie gaffe” in her first press conference as Fed chair, thereby “rattling markets”. She didn’t.

According to Peter Coy, Yellen made a “substantial blunder”. John Cassidy says she “got into trouble” when she told Reuters’ Ann Saphir that the Fed would wait “something on the order of around six months” after QE ends before starting to raise rates. Clive Crook was so perturbed by the presser that he is beginning to doubt the wisdom of the Fed having any kind of forward guidance at all. Mohamed El-Erian seems inclined to agree: the markets aren’t mature enough, he says, to internalize new information without over-extrapolating (i.e., freaking out).

But here’s the thing: the market didn’t freak out. The chart above shows the benchmark US interest rate — the yield on the 10-year note. The chart gives you a reasonably good idea of what normal volatility is: last Thursday, for instance, the yield fell by a good 10bp when John Kerry made noises about imposing sanctions on Russia. And overall, the yield has stayed comfortably in a range between 2.6% and 2.8%.

What’s more, the big FOMC-related move in the 10-year bond yield happened immediately at 2pm, when the statement was released. Yellen’s “gaffe” caused barely a wobble.

So why does everybody think that Yellen blundered? The answer is simple: they were looking at the stock market (which doesn’t matter), rather than the bond market (which does). Stocks fell, briefly; not a lot, and not for long, but enough that people noticed.

Which is good! In general, Yellen should be more transparent, not less, which means that she shouldn’t be overly cautious about what she does and doesn’t say in her press conferences. Her instinct to give a straight answer to a straight question is a good one. And if Yellen’s straight talk causes a very, very small uptick in stock-market volatility — well, that might not be such a bad thing, given that stock-market volatility is pretty low at the moment and that stocks should be pretty twitchy at these levels. What’s more, we don’t want to go back to the bad old days of Alan Greenspan, where the Fed was always assumed to have failed if it did anything which caused stock prices to fall. Yellen is going to oversee a series of interest-rate rises, and it’s entirely likely that stocks will pull back when that happens. That’s no reason to criticize her.

In fact, Yellen did more than just improve the transparency of the Fed with her remarks; she also helped prepare the markets for a wider range of possible outcomes. If the Fed does end up tightening six months after QE ends, the markets might be disappointed, but the Fed would be justified in taking a “don’t say we didn’t warn you” stance. That doesn’t mean it will happen, but it does mean that Yellen is helping to prepare the markets for the inevitable uptick in uncertainty.

As I explained back in October, transparency and predictability are incompatible goals; Yellen should go for the former, rather than the latter. The Fed’s future actions are unknown, and unknowable, and Yellen needs to be open about that fact. As central banker Adam Posen told Binyamin Appelbaum, there’s going to be increased fractiousness and unpredictability on the FOMC going forwards — and that’s a good thing, a sign that the economy is getting back to normal. If Yellen is keeping the market on its toes, she’s really just giving the markets an early taste of something they’re going to be seeing a lot more of. Traders, and the media, should — must — learn to embrace that, rather than criticizing it.

COMMENT

The recovery has been hollow and shaky. Congress is much more concerned with its own, disparate grasping than with the fiscal health of the nation. QE was elegant monetary engineering and it worked, but it has to be paid for and the easiest way to do that is future rate hikes. Money will move in from overseas, creating a mini-chain reaction. Travelers overseas with dollars can buy two of everything. The bankers get paid and domestic manufacture suffers. It’s all a package, folks.

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Annals of captured regulators, NY Fed edition

Felix Salmon
Mar 20, 2014 23:40 UTC

Peter Eavis has a worrying story today: the chairman of the New York Fed, William Dudley, has effectively, behind the scenes, managed to delay the implementation of an important new piece of bank regulation.

The first thing to remember here is that delaying regulations is an extremely profitable game for the financial industry. If a new regulation will cost a bank $100 million per year, and the bank gets that new regulation delayed by a year, then it’s just made $100 million in excess profit. What’s more, the further away you get from the crisis, the harder it becomes for new rules to grow teeth. So when the banking lobby doesn’t like a certain piece of regulation, its tool of choice is to bog it down and delay it to the point at which no one but the banking lobby cares any more. And then allow it to be implemented with so many loopholes and carve-outs that it’s effectively toothless.

In this game, the banks are on one side, and the regulators — primarily the Federal Reserve — are on the other. So it’s particularly worrying when a regulator ends up causing a delay and thereby helping the banks. And yet that’s exactly what seems to have happened:

Mr. Dudley’s concerns played a decisive role in holding up the final version of the rule, two of the people said. Some regulators, including officials at the Federal Deposit Insurance Corporation, were counting on the leverage regulation being completed by the end of last year. Strong supporters of the rule wanted it issued by then to reduce the chances that pressure from bank lobbyists would dilute it. The rule is now expected to come out in April at the earliest.

The optics here are not helped by the fact that Dudley made his millions at Goldman Sachs, a bank which would be directly affected by the rule in question, which forces big banks to increase the amount of capital that they hold against their assets. Neither are they helped by the fact that Dudley runs the New York Fed, which is generally seen as the arm of the Fed which is closest to, and friendliest with, America’s biggest banks. (Indeed, JP Morgan’s Jamie Dimon was a member of the board there for the six eventful years to 2013.)

Mostly, however, the problem is that Dudley’s objection is very silly.

Mr. Dudley raised the possibility that the rule could inhibit the Fed’s ability to conduct monetary policy…

The Fed officials in Washington assessed his concerns but did not think they were serious enough to warrant significant changes to the rule, the three people said.

In theory, Dudley is right. The way that the Fed conducts monetary policy is by instructing the traders at the New York Fed to buy and sell certain financial instruments so that a particular interest rate — the Fed funds rate — is very close to a certain target. Through a complex series of financial interlinkages, setting the Fed funds rate at a certain level then has a knock-on effect, and ultimately helps determine every interest rate in America, from the Treasury yield curve to the amount you pay for your credit card or your mortgage.

Those interlinkages are so complex that they’re impossible to model with any particular accuracy: all the Fed can do, really, is set the Fed funds rate and then see what happens to everything else. And directionally the causality is clear: if the Fed wants rates to rise, then it pushes the Fed funds rate upwards, and if it wants rates to fall, then it brings the Fed funds rate down. That doesn’t always work at the distant end of the yield curve, but it’s still most of what monetary policy can do.

Especially early on in the chain, a lot of the interlinkages take place at the level of big banks. And so it stands to reason that if you change the leverage requirements of big banks, that might change what happens to interest rates when you move the Fed funds rate. Or, on the other hand, it might not. In any case, if and when the Fed starts raising the Fed funds rate, it’ll rapidly become pretty obvious what’s happening to the rest of the interest-rate world, and the FOMC will react accordingly.

In the most extreme case, the FOMC might even change the way it sets interest rates, and start using interest rates other than the Fed funds rate to conduct monetary policy. After all, the Fed can intervene pretty much anywhere in the financial system it likes. Obviously, Dudley, as the head of the New York Fed, would be the person most closely consulted in terms of determining the most effective way for the Fed to intervene and move American interest rates. And in making his recommendations, he would have to take into account everything he knows about the architecture of the financial system, including the leverage ratios being demanded of the biggest banks.

But what doesn’t make sense is the idea that Dudley would try to throw a spanner in the works of an important piece of bank regulation, just because it might make his rate-setting job more difficult. The New York Fed is a highly profitable institution which employs a large number of extremely able traders and economists, all of whom are well versed in navigating the complexities of the interest-rate market. If a change to the leverage rule makes their job a bit more interesting or difficult, well, that’s part and parcel of what it means to work at the New York Fed. It’s no reason at all to delay a rule change and give New York’s banks a gift on a plate.

COMMENT

I think someone’s misunderstood something here. The delay has gone into the drafting of the final rule, after consultation based on the Notice of Proposed Rulemaking. That doesn’t mean that the date of implementation of the rule itself is necessarily going to change – in the NPR this rule was meant to be slowly phased in and to take effect on 1 January 2018. Given that, I think it’s pretty unlikely that a slight delay to get the rule drafted correctly – or even a full Quantitative Impact Study – is going to change the implementation schedule.

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