Felix Salmon

Be happy that Stan Fischer worked at Citi

Felix Salmon
Feb 10, 2014 18:30 UTC

Last week, Justin Fox had a great post entitled “How Economics PhDs Took Over the Federal Reserve”. The first Fed chairman of the modern era was a banker, Marriner Eccles; he was succeeded by Thomas McCabe, who had a bachelor’s degree in economics but whose main qualification was having been the CEO of Scott Paper. Then William McChesney Martin moved over to the Fed from Treasury; he was a former stockbroker and New York Stock Exchange president, and ushered in a new era:

Under Martin, regulating the economy through monetary policy pushed aside bank regulation to become the central bank’s No. 1 job. So hiring economists, and bringing people with serious economics backgrounds onto the FOMC, became a priority…

The new Fed Board of Governors (assuming the Senate confirms the latest nominees) will include veteran economics professors Yellen, Stanley Fischer, and Jeremy Stein, plus Lael Brainard, an economics PhD who has spent most of her career in Washington but did teach at MIT for a few years early in her career. The other three members are lawyers who have spent much or most of their careers in government. As for the Federal Reserve Bank presidents, eight of the 12 have economics PhDs and seven of those have spent much or all of their careers at the Fed. Two of the non-PhDs have spent their careers at the banks they lead, while only two bank presidents — Atlanta’s Dennis Lockhart and Richard Fisher of the Dallas Fed — fit the pre-1950 Fed mold of successful bankers/businessmen doing a stint as central bankers.

The ascendancy of the professoriat didn’t serve the Fed particularly well: without real-world business or banking experience, the FOMC ignored the problems of growing leverage, particularly in the financial sector, for far too long. Alan Greenspan’s Fed was run on laissez-faire principles: the market is a self-correcting mechanism which doesn’t allow banks and shadow banks to become too leveraged. Or, to put it another way, if investors are happy buying structured credit products at razor-tight spreads over Treasuries, then who are we at the Fed to spoil their party.

When the credit crisis first hit, in 2007, worries spread out from Wall Street: mortgage bankers first, then banks more generally, then the New York Fed, which is very plugged in to real-world concerns in the financial sector. The problem was the final leg, from the New York Fed to the Federal Reserve Board: for all that there might be a problem in practice, the economists in Washington couldn’t see how it would be a big problem in theory. And so they convinced themselves, in the notorious words of Ben Bernanke, that the subprime problem was going to be “contained”.

It’s therefore a real problem that the American central bank — which is, after all, a bank, and an incredibly profitable one, at that — has precious few actual bankers on its governing board. I’m all in favor of having a significant number of monetary economists who can think deeply about the effect of short-term interest rates on employment and inflation. But at the same time, it would be nice to have a few people who understand financial markets, and the pass-through mechanisms which define them. Not to mention a relatively sophisticated understanding of what banks actually do, on a day-to-day basis. After all, the Fed is the main prudential regulator of the banking system, and its board needs to understand where the stresses are.

All of which serves to underscore what an excellent nominee Stanley Fischer is as vice-chair of the Federal Reserve. Yes, he’s a professor — indeed, he wrote the definitive macroeconomics textbook, which is now in its twelfth edition and still going strong. He’s also a deeply experienced central banker and international policymaker. But he also has some real-world banking experience, having worked in a senior level at Citigroup from 2002 to 2005.

According to Pedro da Costa, however, Fischer’s years at Citi will count against him when he appears at his confirmation hearing:

The nominee for Fed vice chairman is likely to face questions at his confirmation hearing about whether he would be a tough regulator of big banks after earning several million dollars at one.

This is, let’s say, unhelpful. Yes, Fischer earned good money when he was at Citi. But the reports about his financial disclosure form I think draw too much of a causal connection between his Citi tenure and his wealth. Here, for instance, is Bloomberg’s Joshua Zumbrun:

While Fischer has spent much of his career as an academic and government official, he served as vice chairman of Citigroup Inc. from 2002 to 2005 and amassed a personal fortune of between $14.6 million and $56.3 million, a sum that would make him one of the wealthiest Fed officials.

The implication here is that Fischer had a modestly-remunerated public-service career before he joined Citi and cashed in. Which really isn’t true. Fischer’s tax-free income at the World Bank and IMF was substantial, and he surely made just as much money when he was at MIT. But the real money, I’m quite sure, came from that textbook, which he co-wrote with Rudi Dornbusch. It was the macroeconomics textbook of the late 1970s, and, like all standard textbooks, became something of a license to print money. (The trick is to keep on updating the textbook with new editions, making old second-hand versions useless and forcing students to pay three-digit sums for the version being used in class.) If Fischer took his textbook proceeds and invested them conservatively into the great bull market of the 1980s and 1990s, that alone would make him a very wealthy man today.

Fischer left Citi before it imploded, but he was there while it was manufacturing many of the toxic subprime products which ended up proving all but fatal. Mortgage products weren’t Fischer’s area, but he did work very closely with Robert Rubin, who was blithely unconcerned about the risks being built up. That’s an incredibly important and valuable lesson to learn: you can’t trust wise men like Rubin to see what’s going on in front of their face. And when bank CEOs tell the Fed board that they have everything under control, Fischer will know better than most just how little those statements can be trusted.

I doubt that Fischer will have any real problems being confirmed. Any senators who want to cause mischief can certainly do so — they can point to his private-sector experience, or they can bellyache about how he has various different nationalities rather than being “100% American”. But Fischer is probably the best central banker in the world; it would be completely insane for the Senate to block him. Especially given that he brings some of the actual banking experience that the Fed so desperately needs.


LOL Felix ascribes to the “Great Man” theory of history, which is largely not true and anachronistic after-the-fact rationalizing. Does Felix really think that the Fed has influence over the economy? Another Fischer, Fischer Black, who won the Nobel in 1997, thought not. And the Fed has staff that does the hard work behind the scenes; the chair is largely a figurehead. As for voting, it’s been found that most of the players follow the lead of the head, that would be Yellen. I doubt therefore that nixing Fischer would be so bad, and, like the posters say before me, might send a message that rich fat cats from Citi are not to be rewarded.

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Those noisy payrolls figures

Felix Salmon
Feb 7, 2014 16:13 UTC


The chart of the day comes from Betsey Stevenson, and helps to show just how noisy the payrolls data really are. The big headline figures of the day, 113,000 is ostensibly the increase that we saw, in January, in the number of people on American payrolls. It’s a disappointing number, while a print of say 200,000 would have been decidedly encouraging.

But just look at how we got to that 113,000 figure. We took January’s workforce, of 135,396,000 people, and then subtracted December’s workforce, of 138,266,000 people — for a total decrease of 2,870,000 jobs. But we know that the number of jobs in America always decreases in January — even when the economy is surging. It’s cold out, making outdoor jobs very difficult to do, and the Christmas seasonal jobs are all in the past. So the BLS institutes some seasonal adjustments. In this case, it subtracted 880,000 jobs from the December number, and it added 2,103,000 jobs to the January figure.

All of which means that the 113,000 headline figure is, in fact, 135,396,000 + 2,103,000 – 138,266,000 – 880,000.

You want to trade on that being 70,000 jobs lower than you thought it would be?

But wait: we’re not even close to being done. This month’s payrolls release is much longer than normal — 2,465 words — because it has to explain a lot of changes. As it says in a big box at the very top of the page:

Changes to the Employment Situation Data

Establishment survey data have been revised as a result of the annual benchmarking process and the updating of seasonal adjustment factors. Also, household survey data for January 2014 reflect updated population estimates.

These changes are not small: last month’s preliminary number, for instance, was revised up — on a seasonally adjusted basis — to 137,386,000 workers from 136,877,000. That’s a difference of more than half a million people.

The noisiness of the payrolls report is good news, truth be told. Now that the taper is well under way, there’s very little doubt about the direction of monetary policy for the next year or so. We’ll taper all the way to zero, QE will be over, and then we’ll look at where we are and start wondering whether and when rates might actually start rising. The employment situation when QE is finally over will have almost nothing to do with what happened this month, or next month, or the month after that. Most importantly, it will have to do with the number of people actively looking for work: as the unemployment rate comes down, and the economy continues to grow, will discouraged workers start returning to the workforce, or at least start looking for work again?

There are a lot of unemployed and underemployed workers on the sidelines of the economy, who would work much more if work was available. The Fed’s full-employment mandate means that it’s Janet Yellen’s job to find work for those people. How she’s going to interpret that mandate is something we’re not going to get a real hint of for a long time yet. But one thing’s for sure: we’re not going to be able to guess anything useful by looking at today’s payrolls report.


Felix, great that you’re pointing this out. The press release also discloses the margin of error which tells the same story. It’s sad that the mainstream press is ignoring this.
We really shouldn’t be dumbfounded by why Wall Street trades on the “noise”, it isn’t that surprising. You need variability (i.e. “noise”) to make money. If it’s easy to predict what the number is, then the profits would disappear.

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Why bitcoin won’t disrupt digital transactions

Felix Salmon
Feb 7, 2014 04:12 UTC

I like to keep my feet warm, and so I’m very glad that in five years’ time, Ben Horowitz, the co-founder of Andreessen Horowitz, is going to be sending me a pair of luxurious alpaca socks. The bet, which originated on RapGenius, is now a reality, thanks to Planet Money. And while NPR has written the broadcast up as a story, it falls to RapGenius, again, to annotate it. And it’s in the RapGenius annotations where things start getting interesting.

Horowitz expands on his statement that bitcoin is a “computer science breakthrough” by saying this:

Bitcoin is the first scaled network where you can transfer (not copy, transfer) a piece of digital property from one person to another with no central authority. This paves the way for a dizzying number of super high value applications such as a fee free stock exchanges, smart contracts that can programmatically be executed and enforced, and many other awesome things.

Horowitz, here, is looking forward to a world where bitcoin provides the rails upon which all manner of commercial transactions can run: potentially, it’s much larger than payments alone. In recent columns, both Dan Primack and John Gapper have also made this point.

There’s something else that the Primack and Gapper columns have in common: they’re both behind a paywall. Essentially, they’re digital goods which are non-rivalrous (if you read Gapper’s column, that doesn’t prevent me from reading it too), but also excludable (the FT can prevent certain people from reading the column, on the grounds that they haven’t paid enough money).

The incredible growth of the internet can be attributed in large part to the fact that most of the content on the web is both non-rivalrous and non-excludable: this blog post, for instance, can be read by any number of people, and is freely accessible to all. But now Horowitz is looking forward to expanding the web to include what he calls “digital property”: essentially, digital goods which are not only excludable but are rivalrous as well.

A good example might be shares of a company’s stock: such things haven’t existed in physical form for many years, but they’re still highly rivalrous. After all, the entire basis of the stock market would fall apart if I could somehow give you a copy of my stock while holding onto that same stock myself. A large part of the technology underpinning stock exchanges is the way in which they have to ensure that once you sell a share, you no longer own it, and you can’t sell it a second time. That’s also the technology which underpins bitcoin, except bitcoin transactions take many orders of magnitude more time to clear than stock transactions do.

In theory, there are all manner of clever things which can be traded in a distributed manner, using the open-source bitcoin protocol; most of them involve “coloring” coins in some manner, so that a bitcoin serves as a token of ownership of something else. There is a lot of valuable rivalrous digital property out there, and a lot of companies, including Thomson Reuters, make a lot of money by helping to manage it. The technology involved tends to be tried and tested (to the point at which any failures are very big news), and the players involved tend to be extremely conservative. On top of that, the costs are often extremely low: the simple transaction costs involved in trading stocks, or large quantities of foreign exchange, are very close to zero these days.

So while in theory there is the possibility of disruption in this space, I’m not holding my breath. The Race to Topple Bloomberg, as the headline of Aaron Timms’s recent Institutional Investor article puts it, has been going on for the best part of 20 years now, with no visible success. (I first asked Mike Bloomberg whether he was worried about competition from the open internet for an article I wrote back in 1996.) I’m happy that Satoshi Nakamoto managed to solve the Byzantine Generals Problem — but while that might be a necessary condition for these particular walls to start falling, it’s far from a sufficient one.

The internet has been an amazing and revolutionary force, which has brought entire industries to their knees, and which has created a huge amount of wealth for Silicon Valley venture capitalists. But what Horowitz and Primack and Gapper are talking about here is the hope that a whole new protocol — bitcoin — will essentially do for digital transactions what the internet did for communications, just by dint of being cheap and open-source. I wish it luck, but it’s going to need it. Because it’s up against formidable incumbents, in the form of both huge corporations and entrenched government interests. My bet is on Goliath, not David.


Bitcoins stolen from Silk Road. Site manager is “really, really sorry”.

There are good reasons why most people use cash only for trivial transactions that are too small to be worth the bookkeeping required for other forms of payment.

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Puerto Rico needs to prepare for its default

Felix Salmon
Feb 5, 2014 23:40 UTC

Ryan McCarthy has a good round-up of Puerto Rico’s debt problems, which have now been exacerbated by S&P downgrading the island’s bonds to junk status. (Moody’s and Fitch are certain to do so as well, in short order.) For a good one-stop overview of most of the big issues, I can recommend Nuveen Asset Management’s note, which includes this chart:

Screen Shot 2014-02-05 at 5.21.10 PM.png

What you’re seeing here is a vicious cycle: as debt problems pile up, economic activity decreases, which causes even bigger debt problems, even lower economic activity, and so on. Puerto Rico is now shrinking at a 6% annual pace, and that number is probably going to get worse before it gets better. The chances of the island’s economy actually growing at any point in the foreseeable future seem remote: indeed, the country has essentially been in one long and nasty continuous recession since 2006.

Puerto Rico has $70 billion in debt outstanding, all of it needing to be repaid with interest — and the simple fact is that there’s no way it’s going to be able to do that, if its economy continues to shrink and its most talented nationals continue to decamp for the mainland, where their prospects are much brighter. Labor mobility from Puerto Rico to the rest of the US, and particularly to Florida, has never been higher, while most of the migration in the other direction comes in the form of retirees, who are not exactly going to kick-start the economy. In fact, in terms of the labor force participation rate, they’re just going to make matters worse, on an island where only 1.2 million of the 3.4 million inhabitants are employed.

In many ways, Puerto Rico is similar to those other tourist destinations, Portugal and Greece — it’s highly indebted; it’s not particularly well educated (only half of Puerto Ricans over 25 have graduated from high school, and only a quarter of high-school graduates go on to get a bachelor’s degree); and it is hobbled by being unable to devalue its currency.

All of this is a clear recipe for default: if Puerto Rico can’t repay that $70 billion in debt, then it won’t. The only alternative is a bailout — but as Martin Sullivan explains, the US government has already extended a back-door tax-code bailout worth some $2 billion per year, and even that is both insufficient and constitutionally dubious. A more explicit bailout is not going to happen — not when Detroit is being left to deal with the ravages of bankruptcy on its own.

The good news is that the increasingly-inevitable default is not hugely harmful in itself. It’s not fully priced in: the funds owning Puerto Rican debt are going to take more losses, if they don’t sell now. And the insurers who have wrapped some $15 billion in Puerto Rican debt are going to have to get used to making a lot of coupon payments for quite a long time. But that’s their job. This is the way debt markets should work: if you lend money at high rates of interest to someone who can’t pay it back, then you have to understand there’s a pretty good probability of default.

The default will be messy, however, since there’s no chapter of the US bankruptcy code which encompasses Puerto Rico. A lot of different court cases will be held in a passel of different jurisdictions, and a lot of lawyers will get rich. In the end, everybody is going to have to take a nasty hit — including the island’s retirees, whose pension fund is woefully underfunded. From a legal perspective, there will be some fascinating arguments about sovereign immunity, and whether (and how) bondholders can attempt to enforce their contractual rights, absent any kind of overarching bankruptcy regime. In the end, restructuring terms could end up simply being dictated by Congress.

Still, the important thing is not the process, it’s the final outcome. If Puerto Rico manages to emerge from default freed of its massive debt burden, it will finally have a chance to start growing again. If it doesn’t, it won’t. The problem is that there’s no easy way of herding the bondholders and bond insurers, all of whom are going to want to maximize their financial recovery, thereby making Puerto Rico’s real recovery that much more difficult.

My advice to the Puerto Rican government, then, is this: start having quiet conversations in Washington about a piece of legislation which would give the island the legal freedom and ability to restructure its debts in a clean, one-and-done manner. Such a law would not be a bailout: it would involve no money flowing from DC to PR. But it would allow Puerto Rico to default on its debt and come out the other side, without the risk of years of legal chaos. While bondholders would squeal, at least they would get certainty. And Puerto Rico would get something much more valuable still — an opportunity to finally drag itself out of its horrible recession.


Also: PR will prioritize its voters’ pensions over Yankee bondholders who don’t vote.

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The realistic and the optimal ways to overhaul energy taxes

Felix Salmon
Feb 4, 2014 16:15 UTC

Back in December, Max Baucus, the chairman of the Senate Finance Committee, came out with a pretty bold proposal to simplify America’s energy taxes, and to focus them on a simple goal: that the US should emit less carbon. That should be a pretty easy thing to do, in theory: you just raise taxes on the more carbon-intensive energy sources, while not raising them, or even cutting them, on sustainable energy sources. Except that’s not the way the US tax code works. America, it turns out, doesn’t really tax energy at all: instead, it subsidizes energy. And the amounts of money involved are very large:

Under current law, there are 42 different energy tax incentives, including more than a dozen preferences for fossil fuels, ten different incentives for renewable fuels and alternative vehicles, and six different credits for clean electricity. Of the 42 different energy incentives, 25 are temporary and expire every year or two, and the credits for clean electricity alone have been adjusted 14 times since 1978 – an average of every two and a half years. If Congress continues to extend current incentives, they will cost nearly $150 billion over 10 years.

As a result, Baucus can’t simply tweak energy taxes; instead, he has to tweak energy subsidies. His proposal is a good one: he essentially consolidates all those 42 existing subsidies into two new ones — one for electricity, and one for transportation fuel. In both cases, tax credits get handed out in direct proportion to how clean the facility is. Once carbon emissions have reached 75% of their current level, the subsidy phases out.

Charles Komanoff, of the Carbon Tax Center, responded to Baucus’s discussion draft last month, in testimony to his committee. Komanoff’s paper is conceptually simple: he asks what the outcome would be if instead of subsidizing clean energy, the government decided to go ahead and tax carbon emissions directly.

The first big difference, of course, would be fiscal. Komanoff takes 2024 as his base year, and reckons that under the Baucus plan, the government subsidies will cost taxpayers some $39 billion in per year, in ten years’ time. A carbon tax set at roughly the same level, on the other hand, would generate a whopping $450 billion per year in fresh government revenues. That’s enough money to make the system progressive, rather than regressive: checks could be sent out to lower- and middle-class households to cover any extra expenses they suffered as a result of the carbon tax. The Baucus proposal, by contrast, is regressive: most of the benefits would end up flowing to the highest-income households with the highest energy use.

The other big difference is in carbon emissions. Here’s Komanoff’s chart:

Screen Shot 2014-02-04 at 10.52.13 AM.png

A carbon tax, by its nature, affects everything: it’s applied equally to every sector of the economy, and encourages energy conservation (turning your thermostat up a little in the summer, for instance) just as much as it encourages cleaner energy creation. Komanoff’s model assumes a carbon tax which changes exactly as the Baucus subsidies do. Baucus’s tax credits work out at about $55 per ton for eliminated electricity-related carbon, and $102 per ton for eliminated carbon in the transportation sector. Komanoff’s carbon tax is set at just those levels for those industries, and at the average of the two everywhere else; overall it works out at a high $78 per ton. (Which serves to demonstrate how generous the Baucus proposal is.)

The problem is that there’s no easy way to get there from here. Fiscal policy is path-dependent, and Baucus knows full well that it’s hard enough to take one group of subsidies and replace them with two new subsidies which go to the same industries and cost roughly the same amount of money. In the current Congressional climate, it’s downright impossible to take an existing group of subsidies and replace them with a brand-new tax. Doing that would be wonderful in terms of reducing carbon emissions, but it would generate so many squeals of pain from the energy lobby (not to mention Republicans who hate all new taxes on principle) that it would never even get as far as a vote.

President Obama has said that addressing climate change will be a top priority of his second term — but he said that it would be a top priority of his first term, too, and he did exactly nothing on that front in his first four years. I doubt that Komanoff’s testimony came as any surprise to Baucus: it’s a well known fact in Washington that a carbon tax would be an extremely efficient way of raising much-needed revenues, reducing US carbon emissions, and helping America achieve energy independence. But Washington is not a town which tends to embrace efficient or logical solutions. If we’re going to reduce carbon emissions any time soon, we have a much higher chance of doing so with carrots than we do with sticks. Even when the sticks are much more effective.


“America, it turns out, doesn’t really tax energy at all: instead, it subsidizes energy.”

On net dollar terms this statement is clearly false. We subsidize the generation of energy via solar, wind, and the transformation of energy via ethanol. The subsidizes offered to these favored power sources are dwarfed by the taxes paid by fossil energy producers and consumers.

Europe offers the carbon lite sources even more generous breaks while on net taxing energy even more heavily than we do in the states… hard to see what they get for their money aside from crushing electric bills and $7-8/gallon gas… god bless them for getting the ball rolling though.

5 of the 7 billion people alive on this planet owe their very existence to the fossil fuel industry… THAT is the real inconvenient truth.

p.s. to BenE… those new CAFE standards are a paper tiger… they are back end loaded and when congress wises up to the fact that they cannot be met they will just be torn up like the renewal motor fuels mandates are being as we speak.

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Why the Post Office needs to compete with banks

Felix Salmon
Feb 3, 2014 23:32 UTC

Back in 2011, I said that “the only way to save the Post Office will be to allow it to move into financial services”, seeing as how “banks in the US are mistrusted and disliked and many people would love to be able to just bank at the Post Office instead”.

That’s still true, and has been given a lot more salience since the Post’s Office inspector general released a 33-page white paper, last week, saying that the Post Office should move into what it calls, in its headline, “Non-Bank Financial Services for the Underserved”.

The report has been warmly greeted by Elizabeth Warren, on its own terms:

If the Postal Service offered basic banking services — nothing fancy, just basic bill paying, check cashing and small dollar loans — then it could provide affordable financial services for underserved families, and, at the same time, shore up its own financial footing.

Warren also, however, praises David Dayen’s article about the white paper, which has an unambiguous headline: “The Post Office Should Just Become a Bank”. And Adam Levitin, who used to be Warren’s co-blogger at Credit Slips, also uses the paper to push the idea of postal banking.

So let’s be clear: there’s a very important difference between postal banking, on the one hand, and what the inspector general is proposing, on the other. And while postal banking is a good idea, the non-bank proposal from the inspector general is simply not going to fly.

Indeed, it’s rather worrying and disconcerting — not to mention disingenuous — that the inspector general goes out of its way to say that the Post Office should be a non-bank, rather than a bank:

The Postal Service is well positioned to provide non-bank financial services to those whose needs are not being met by the traditional financial sector. It could accomplish this largely by partnering with banks, who also could lend expertise as the Postal Service structures new offerings. The Office of Inspector General is not suggesting that the Postal Service become a bank or openly compete with banks. To the contrary, we are suggesting that the Postal Service could greatly complement banks’ offerings.

This is a bit weird, since the centerpiece of the inspector general’s proposal, the Postal Card, seems to do nearly all of the things that a bank account does:


Screen Shot 2014-02-03 at 5.05.30 PM.png

The inspector general, it seems, wants the Post Office to partner with a real bank, which would ensure that the funds on the Postal Card were FDIC insured: such a setup would be similar to the way in which Simple (which is technically a non-bank) partners with Bancorp for such things. But this is nit-picking, really: Simple explicitly sells itself as a bank replacement, and the Postal Card does pretty much everything that Simple does, plus — crucially — loans. (Which are the one big banking service Simple doesn’t offer right now.)

The inspector general — along with Elizabeth Warren — is at great pains to point out how useful the Postal Card would be to the “underserved” — that is, the millions of Americans without bank accounts. And they’re absolutely right about that: 38% of post offices are in ZIP codes with zero bank branches, and so such a card would bring banking services to lots of people who have no easy access to them right now.

But if the Postal Card is as attractive as the inspector general paints it, then why shouldn’t it also appeal to people who do have bank accounts? After all, the white paper explicitly says that the Post Office should offer “a diverse suite of financial services”: this is a much broader proposal than the basic savings account, capped at $2,500, which the Post Office offered between 1911 and 1967. And while it might well make sense to farm out back-end services to a bank rather than making the Post Office a bank itself, the fact remains that the Post Office would still be competing with banks. (Which explains why the banks are so opposed to the idea.)

If the Post Office was hobbled so that it would compete only with payday lenders and not with banks, then the whole Inspector General plan is, I’m sad to say, a non-starter — for exactly the same reasons why the Church of England can’t play a similar role in the UK. Non-banks compete on convenience, not on cost, and tend to be open very long hours; while the Post Office has the advantage that a lot of the underserved go there anyway, it’s still going to have real difficulty competing with Western Union, check-cashing stores, and all the other high-cost non-bank financial-services shops which do exist in the ZIP codes without banks.

In order to make a postal bank work, it needs to be a postal bank: it has to be able to take market share away from existing banks. That in turn means that the existing banks will fight tooth and nail to prevent such a thing from ever seeing the light of day.

The charitable view of the Inspector General’s report is that it’s essentially pushing a Trojan horse: that it will try to set the Post Office as a “non-bank”, on the grounds that doing so will help the underserved and not really compete with banks. That’s the only way Congress would ever allow such a thing to happen. But once the Postal Card is up and running, nothing’s going to stop the Post Office from competing directly with every bank in the country.

But if the Post Office is hobbled from day one in such a way as to prevent it from competing with banks, then the Inspector General’s idea is never going to work.


By the same token, the Postal Service should have been at the vanguard of email (specifically), but in providing Internet services as a ‘common good’.

Who wouldn’t have paid…say…$5/month for Internet access back in the mid-90s? And every post office could have been a digital hub.

C’est la vie.

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Viral math

Felix Salmon
Feb 2, 2014 15:23 UTC

This chart, from Newswhip via Derek Thompson, has been doing the rounds, and causing a bit of debate:


The question: What on earth is Upworthy doing so right? How is it that Upworthy’s articles shared a good order of magnitude more often than anybody else’s?

Part of the answer is that Upworthy simply doesn’t publish that many articles overall — a couple of hundred a month, each one carefully and laboriously optimized, through extensive A/B testing, to be as socially infectious as possible. But that doesn’t fully explain how Upworthy’s articles can be so much more viral. For that, Upworthy needs the help — either on purpose or inadvertent — of Facebook.

Facebook is the monster in the publishing room: a traffic firehose which can be turned on or off at Mark Zuckerberg’s whim. Right now, it’s turned on, and while a lot of sites are feeling the love none is doing so more than Upworthy. (Except, maybe, ViralNova.) So, how does Facebook give Upworthy such a big boost?

Let’s start with the basic mathematics of virality. Start with an article, any article; let’s stipulate that it gets 1,000 pageviews, naturally, just by dint of being published on a certain website. Now, let’s say that 1% of that article’s readers decide to share it with their friends, and that each reader has 100 friends. That means 10 people sharing, and 1,000 new people seeing the link. How many of those people will click the link? Let’s say it’s 10%. Which means that the article gets a boost of 100 new pageviews. Those extra pageviews cause their own viral loop, which generates an extra 10 pageviews, and that’s where the cycle pretty much peters out. Thanks to sharing, the article has been viewed 110 times, over and above the original 1,000 pageviews.

This requires a formula. Call the basic strength of the website PP, for publisher power: that’s the number of pageviews you can expect to get when you publish an article on your website. You then multiply that by S, or shareability: the likelihood that a reader will share your article on Facebook. That in turn gets multiplied by F, or the number of friends per reader, and then by C, which is the clickbaitiness of the headline.

The key number here is S·F·C, or shareability times friends times clickbaitiness. In our model, that’s 0.01 * 100 * 0.1 = 10%. If you increase any of those numbers — if you make people more likely to share your article, or more likely to click on the headline — then you’re going to increase the virality of the piece. For instance, if you double the proportion of people sharing the article and also double the probability that someone is going to click on the headline after seeing it, then S·F·C becomes 0.02 * 100 * 0.2 = 40%. If you start with 1,000 pageviews, then you’ll get another 400 viral views which in turn will generate another 160, and so on: your viral boost goes up from 110 views to 660 views.

You can see that a relatively small tweak to the variables in the S·F·C formula can make a very big difference to your total pageviews. Pretty soon you can double your initial pageviews, or treble them — and, then, when S·F·C exceeds 1, you achieve escape velocity: your article just keeps getting shared more and more and more. Getting S·F·C > 1, then, is the goal of all would-be viral content, and it’s by no means impossible: if 5% of an article’s readers share it, and those readers have 200 friends each, and 25% of people who see the headline click on it — well in that case, S·F·C is a whopping 2.5, or 250%.

At those levels, it almost doesn’t matter what PP is — how many pageviews you seed your article with before it goes viral. PP still matters, however — which is why so many viral sites have pop-up boxes which try to harvest your email address. It turns out that emailing lots of people with links to new content is a great way to start the ball rolling.

But there’s a fly in the ointment, here — something which makes achieving escape velocity much more difficult. Let’s call it FBT, for Facebook Throttle. If you share an article on Facebook, and you have 100 friends on Facebook, that does not mean that your 100 friends are all going to see that article in their newsfeed. Far from it. After you click “share”, Facebook then decides whether the article you just shared is going to appear in your friends’ feeds or not. (This is a very big difference between Facebook and Twitter, which shows you everything your friends are sharing.)

As a result, the important formula isn’t S·F·C; rather it’s S·F·FBT·C, where FBT is the probability that the article you’re sharing is going to actually appear in your friends’ feeds. In recent months, Facebook has been taking its foot off the throttle quite dramatically — but no one knows how long that’s going to last.

Which brings me to Upworthy. We know that Upworthy spends a lot of time optimizing for maximum S and maximum C. It more or less invented the “curiosity gap” headilne, for instance, which turns out to be a great way to boost C. In other words, Upworthy is maximizing the variables under its own control.

What’s less well understood is that there seems to be a direct correlation between C and FBT. While Facebook controls its own throttle, it does so in response to user behavior: it wants to show its users more of what they want to see, and less of what they don’t want to see. And it’s easy to tell what Facebook’s users want to see: just look at what they’re clicking on. As a result, there’s a direct feedback loop between C and FBT: the higher your clickbaitiness (C), the less that Facebook will throttle you, and the more likely that your articles will be seen by your readers’ friends.

To put it another way: at the moment, Facebook assumes that people click on exactly the material that they want to click on, and that if it serves up a lot of clickbaity curiosity-gap headlines, then it’s giving its users what they want. Whereas in reality, those headlines are annoying. Curiosity-gap headlines are a bit like German sentences: you don’t know what they mean until you get to the end, which means that the only way to find out what your friend is saying is to click on the headline and serve up another pageview to Upworthy. (Or ViralNova, or Distractify, or whomever.) It’s basically a way of hacking real-world friendships for profit, and there’s no way Facebook is going to allow it to continue indefinitely.

All of which is to say that the massive advantage which Upworthy has, as seen in the chart at the top of this post, is certain to go away. It’s a temporary phenomenon, a function of the fact that Upworthy is better than anybody else at turbocharging virality by using artificially-optimized curiosity-gap headlines as a way of sending a (false) message to Facebook that those headlines are the stories its users really want to read. Upworthy’s formula will work until it doesn’t. Which is why I think that Dennis Mortenson is going to win his bet against James Gross.


AbeB makes a good point. Computing the average for an extremely skewed distribution is next to worthless.
I just want to point one other thing out… the data is not for Facebook shares! If you read the paragraph before the chart, it clearly says they took the number of Facebook Likes divided by the number of articles published. I don’t know how correlated FB Likes and FB Shares are but I presume them different unless otherwise proven.

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Who’s to blame for the emerging-market crisis?

Felix Salmon
Feb 1, 2014 23:23 UTC

Paul Krugman and Dani Rodrik are out with dueling op-eds (the latter written with Arvind Subramanian) on the subject of the latest bout of financial-market craziness in places like Argentina and Turkey. Both men have been following emerging-market crises for decades; both indeed, are world-class experts on such episodes. What’s more, both economists have a broadly left-liberal worldview: there’s no deep ideological or philosophical rift here. And yet the two seem diametrically opposed.

Here’s Krugman:

Turkey isn’t really the problem; neither are South Africa, Russia, Hungary, India, and whoever else is getting hit right now. The real problem is that the world’s wealthy economies — the United States, the euro area, and smaller players, too — have failed to deal with their own underlying weaknesses.

And here’s Rodrik:

Emerging markets aren’t hapless and undeserved victims; for the most part they are simply reaping what they sowed…

The fact is that the emerging economies’ troubles are domestically generated problems and not the fault of foreigners. The complaint of emerging-market countries seems a classic case of blaming outsiders for choices and actions that have been predominantly domestic.

Take a step back, and you’ll find a certain amount of agreement: both Krugman and Rodrik would accept that a large part of the story here is that the Fed’s QE program caused enormous amounts of cash to flow into the world’s emerging markets, thereby helping to inflate the markets which are currently crashing. What goes down must have gone up — and it’s easy to see where the inflows came from.

That said, neither Krugman nor Rodrik is blaming the Fed for causing the emerging-market bubble in the first place. The Fed had a (domestic) job to do, and did it; QE was part of that job, and the Fed simply can’t worry too much about potential unintended consequences on the other side of the planet when it’s setting US monetary policy.

The stories being told by both Krugman and Rodrik are consistent, then, with the “taper tantrum” theory of the current emerging-market crisis. Basically, emerging-market economies have become reliant on the constant flow of very cheap dollars being printed by the Fed; now that QE is coming to an end, they’re finding themselves in a real pickle.

Here, however, the two narratives diverge. Krugman, if I’m reading him right, is saying that if only US economic policy had worked better, we would have a much more vibrant economy, throwing off enormous amounts of cash which would more than make up for the taper. Employed Americans, along with fast-growing US companies, would naturally look to invest their money abroad, and the flows to emerging markets would remain healthy, thereby avoiding a crisis. Instead, we have too few employed Americans, we have overly cautious US companies, and the markets have come to the collective (and self-fulfilling) decision that the end of QE will mean the end of substantially all capital flows to emerging markets. The result is a “sudden stop” — and all sudden stops are extremely painful.

Rodrik, on the other hand, says that the current crisis is the emerging markets’ own fault, for opening themselves up to fickle and volatile capital flows in the first place. Worse, whenever these economies run into difficulty, they tend to respond by becoming even more open to international capital flows. This is a story which is bound to end in tears, no matter what the Fed does.

The two narratives aren’t entirely contradictory, but ultimately Rodrik’s is more important, and more correct. Sure, a healthier US economy might well have kept the money flowing to emerging markets for a bit longer. But as Krugman himself demonstrates, sudden stops in emerging markets can happen in any number of US economic environments, and for any number of reasons. The trick to preventing sudden stops isn’t to keep the money flowing: the trick to preventing sudden stops is to not make yourself susceptible to them in the first place. Here’s Rodrik:

Over the last five years in India, every episode of rupee pressure has provoked a relaxation of regulations on foreign inflows, which has rendered the economy vulnerable to the next rupee shock, which, in turn, provokes the next liberalization and so on. In Turkey, policy makers spun a tale of invulnerability to shocks and contagion even as the economy’s growth was driven by a flood of short-term capital inflows. China provides an instructive contrast. China has chosen to insulate itself from foreign capital and has correspondingly been less affected by the vagaries of Fed actions and the fickleness of foreign finance. Chinese policies aren’t blameless, but their economic insulation has afforded them the luxury of being the recipient of complaints rather than the distributor.

With the taper ending, we’re beginning to see markets start to become rather more discerning than they have been in recent years. No longer will money simply flow to anything and everything, be it gold or Turkish lira; instead, we’re beginning to see the return of volatility. Sometimes, as in the case of this week’s Facebook earnings report, that volatility is welcome. And sometimes, as we’re seeing in emerging markets, it isn’t — especially when the volatility looks as though it’s more a self-fulfilling caprice than a rational reaction to economic fundamentals.

Still, as Rodrik knows better than anybody, Turkey has real political and economic problems of its own: you don’t need to look to the Fed to find reasons for the current sell-off. Sometimes, small open economies are the blameless victims of forces outside their own control. This is not one of those times. They knew what they were doing, when they allowed the Fed’s liquidity to flood their economies. One day, the tide was going to start going out. That day has now arrived.


Two morons duking it out without understanding the obvious trigger. A trigger that has been discussed a great deal in the financial media. It is the taper and reduction of cheap Fed liquidity that is pulling money out of these emerging markets. It was predicted this would happen and it is happening. That’s not to say the emerging markets wouldn’t be having problems anyway but we’re seeing concerted chaos in these emerging markets because of the Fed’s QE and zero interest rate policies. Policies that chumps like Krugman support.

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When disruption meets regulation

Felix Salmon
Jan 30, 2014 15:37 UTC

Nick Dunbar has a fantastic post today headlined “Disruptive Business Models, Uber and Plane Crashes”, talking about how “the latest flurry of innovation” is being concentrated in regulated industries. Dunbar concentrates on non-financial companies: his examples are Uber, Airbnb, and a small company called Manx2, which was an airline in much the same way that Uber is a taxi service or Airbnb is a hotel company. Manx2 no longer exists, in the wake of a plane crash which killed two pilots and four passengers.

What Manx2 actually did was sell tickets. For each particular route, Manx2 then contracted with a plane operating company to fly the passengers…

The Spanish regulator that oversaw Flightline had no clue that the crew who had trained and been accredited in sunny Spanish climes were working remotely for Manx2, flying to fogbound Irish airports. And the passengers who bought tickets from Manx2, which the report says was ‘portraying itself as an airline’ had no clue about the risks they were taking by flying in such a plane run by a freelance operator. Reading the report, it’s hard not to get the impression that the virtual airline business model of Manx2 was partly to blame for what happened.

All regulated industries are inefficient: regulation cannot help but add a layer of bureaucracy to any organization, and no one ever hired a compliance officer as a way of boosting productivity. This creates a natural inclination, on the part of entrepreneurial types, to want to disrupt the industry in question. They look at it, they see all that inefficiency, and they know they can produce 90% of the output with 10% of the overhead.

The problem is that from a societal perspective, sometimes 90% — or even 99% — just isn’t good enough. Airlines are a good example: thanks to regulation, they’re incredibly safe. And when a company like Manx2 manages to slip through the regulatory cracks, the consequences can be disastrous.

The anti-Uber lobby is making similar claims about taxicabs: that they’re licensed for a reason, and that Uber’s attempt at doing an end-run around taxicab regulations is going to endanger passengers and other road users. When you get in a cab, you’re placing your life in someone else’s hands, and you really don’t want that person to be a violent criminal, or have a history of nasty traffic accidents. What’s more, the government is generally better at checking on such things than private companies are.

The main reason why local governments mistrust Uber, however, has nothing to do with public safety: it’s simply a fiscal matter. Both hotels and taxis are important revenue sources for municipalities, which is why city governments tend to be unenthusiastic about Airbnb and Uber.

From the point of view of Silicon Valley libertarians, the idea that they’re disrupting a long-established flow of public monies is a feature, not a bug. If you threaten their disruptive business models, you’re threatening their freedom! That’s the message being sent quite explicitly by the mild-mannered Fred Wilson; his west-coast counterparts, like Balaji Srinivasan and Peter Thiel, have a tendency to go even further.

In finance, regulation is very important indeed — if you want to prevent everything from terrorist finance to global financial meltdown, central authorities need to be able to keep tabs on all financial flows. Finance startups generally operate in a lightly-regulated grey area, just because compliance costs tend to be prohibitively high if you want to, say, start a bank. That explains why Simple isn’t a bank; why most microfinance shops don’t accept deposits; why Apple didn’t storm into the payments space years ago; why it’s so difficult for startups to compete with PayPal, which has spent many years and hundreds of millions of dollars on global compliance; and so on and so forth.

And so when states like New York and California try to gently embrace bitcoin, bringing it into the regulatory fold while not stifling it entirely, the result is always going to be a little bit messy. Bitcoin is built on libertarian mistrust of regulations; indeed, much of the enthusiasm surrounding it comes precisely because it is such a powerful and elegant means of circumventing government control.

I can see the argument for lighter regulation of microfinance institutions: if your depositors have just a few dollars in their accounts, you can’t be expected to spend $50 per customer per year on know-your-customer operations. But in the case of bitcoin, the scoundrels have the head start, and the regulators are never going to be able to catch them. As a result, the entire bitcoin edifice is probably going to end up being shut down by the Feds at some point. It might well get replaced by some other cryptocurrency, but in the case of bitcoin, the regulatory arbitrage is already far too advanced. Which means that if the bitcoin economy continues to grow, the world’s financial regulators will eventually have no choice but to kill it.


The manx2 example sounds like a far more basic failing if Dunbar actually knows what he is talking about – which he may not.

The notion of pilots being trained only to fly in certain geographies sounds dramatically off vs. FAA practice, which I thought was similar in other countries. If the pilot and equipment are only qualified for VFR – Visual Flight Rules – then they only fly in VFR conditions, which would mean without fog. Full stop. If pilot and equipment are IFR – Instrument Flight Rules – then they can land based on instruments, and fog shouldn’t matter. It would be very unusual – maybe impossible – for any sort of commercial passenger or large-scale charter to operate VFR in the U.S.

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