Cardiff de Alejo Garcia

Thoughts on the future of finance blogging

This post first appeared on 15 April 2013 at FT Alphaville.

I spoke on a panel with Allison Schrager of The Economist and Joe Weisenthal of Business Insider at the Kauffman Economics Bloggers Forum. Below is a revised draft of my prepared notes, and many thanks to Brad DeLong for the invitation.

New podcast at FT Alphaville

Please have a look at a podcast we launched over on FT Alphaville a couple of weeks ago.  Hosted by yours truly, it's a long interview about the Chinese economic model with Peking University finance professor (and indie record-label owner) Michael Pettis.

Mallaby's defense of hedge funds

Another long finance post that I'm sticking beneath the fold.

Kling, Reinhart, and capital inflows

What follows is long and consists entirely of finance geekery, so it goes beneath the fold. 

Obliquity

Psy-Fi Blog reviews the new book by FT columnist John Kay:

Many of the great mistakes of history, including the problems financial markets have continualy re-experienced, have been caused by a basic error of judgement – the idea that it’s possible to define, plan and control the outcomes of the world around us despite the rampant uncertainty we daily take in our strides. So instead of relying on expert judgement and feeling our way carefully towards outcomes we’ve found ourselves traduced by people with tunnel vision and a strong but unjustified confidence in their ability to navigate unerringly to a correct solution, whatever that might be. ...

At the centre of Obliquity is the idea that we mostly don’t make decisions through some careful process of analysis – maximisation, or whatever term you want to apply to it – because the world is too complex to permit of such an approach in real life. This theory of direct decision making is not just wrong, but is also at the heart of some of the worst decisions in history, invariably made by people who thought that they knew what was right for everyone else.

Instead we end up with reasonable outcomes when we approach decision making obliquely – by using judgement and skill and, frankly, muddling our way through making the best of the situation as we find it on a day by day basis. The book gives example after example of corporations that have succeeded in making their shareholders very rich by setting themselves objectives that are nothing directly to do with wealth creation – and also shows how often direct attempts to generate wealth lead to the exact opposite outcome.

Much more here.  This adds to the welcome proliferation of books in the last decade that challenge our understanding of how much control we have over outcomes in our lives. 

People are inconsistent in how they view their own lives versus the lives of others.  We tend to look upon another person's lot in life and, whether it's that of a celebrity or a destitute bum, assume it is mostly deserved.  And we treat him that way.  But when we look at the outcomes in our own lives, we're more likely to see them as a combination that, along with talent and effort, includes factors beyond our control.  I don't know if books that make us aware of these biases lead to any actual changes in behavior, but it doesn't hurt to be reminded of them now and again.

Sovereign wealth funds and technology transfer

John Kemp of Reuters posted a concise, helpful overview of the issues facing sovereign wealth funds last week, writing:

There is no evidence SWFs have wielded their non-traditional assets for political or military purposes, or to achieve technology transfer, according to the IMF. But the fact that they might do so in future has made investments by funds with a “sovereign” label much more controversial than those by institutions which are notionally private.

This is one of the topics covered in The End of Influence: What Happens When Other Countries Have the Money, the excellent recent book by economists Stephen Cohen and Brad DeLong.  The authors aren't much worried about governments using these funds to advance military aims, but they do think attempts to transfer technology and innovation are a possibility.  What exactly does this mean?  Here's a relevant passage in the book:

In the real world, scale and especially technological knowledge were key causes of wealth—and the acquisition of your technological knowledge by others might well diminish your terms of trade and standard of living.  Recall that at least half of American economic growth comes from technological and organizational progress in the form of innovation.  These gains from better knowledge of technology and organization are not all seized by those who pioneer the innovations that turn out to be most useful, but rather spill over into the broader economy usually quite nearby.

It is here that sovereign wealth funds may threaten to become a serpent in the garden.  Governments would pursue objectives—for technology transfer, for strategic political advantage, for the redistribution of rents, for the differential acquisition of markets—that would lead them to different decisions that would have been made by profit-oriented market agents. ...

Here is another:

And what will happen when governments with ownership stakes in [foreign] firms think that it would be nice if they would tune things so that the spillovers happen not where the operations are currently located, but rather where the government would prefer the spillovers to be?  And this growth can be shifted.  Money helps.  It can try to shift many things, including the generators of yet more  money.  It can take totally new technologies out of the start-up companies that create them and attempt to shift them back home for next stage development into yet newer products and processes.  Some such efforts will succeed.  Most will probably fail.  But when they fail, they will still have inflicted damage on the innovating economy. 

Of course, it's possible that nothing like this will come to pass, or perhaps it will but not on such a scale that we'll notice.  Maybe sovereign wealth funds will simply continue to invest passively and look for good investment opportunities.

The only additional point I'll make is that there's nothing especially pernicious about a country that uses its money to buy foreign companies seeking to capture for itself any new innovations—even if most such attempts are bad ideas and likely to fail.  Americans would probably treat such efforts with suspicion of evil motives, but in reality it's exactly what you'd expect from an investor who just wants to get maximum value out of its investment.

Regardless, there's probably not much we can do about this.  As Cohen and DeLong explain, for the government to vet every foreign investment in an American company would be an inappropriate reaction.  Our government just isn't very well suited for that kind of role and would be as likely to filter out the kinds of benign investments we should encourage as anything that would threaten our prosperity.

Taleb, debt, young people, and entrepreneurship

We currently learn in business schools to engage in borrowing (by the same professors who teach the Gaussian bell curve, that Great Intellectual Fraud, among other pseudosciences), against all historical traditions, when all Mediterranean cultures developed through time a dogma against debt. Felix qui nihil debet goes the Roman proverb: “Happy is he who owes nothing.” Grandmothers who survived the Great Depression would have advised the exact opposite of debt: redundancy; they would urge us to have several years of income in cash before taking any personal risk—exactly my barbell idea of Chapter 11, in which one keeps high cash reserves while taking more aggressive risks but with a small portion of the portfolio. Had banks done that, there would have been no bank crises in history. ...

Debt implies a strong statement about the future, and a high degree of reliance on forecasts. If you borrow a hundred dollars and invest in a project, you still owe a hundred dollars even if you fail in the project (but you do a lot better in the event you succeed). So debt is dangerous if you have some overconfidence about the future and are Black Swan blind, which we all tend to be. And forecasting is harmful since people (especially governments) borrow in response to a forecast (or use the forecast as a cognitive excuse to borrow). My Scandal of Prediction (i.e., bogus predictions that seem to be there to satisfy psychological needs) is compounded by the Scandal of Debt: borrowing makes you more vulnerable to forecast errors.

That's from a new essay in the second edition of Nassim Taleb's The Black Swan. 

Provocative stuff, and Taleb's rationale against debt at the macroeconomic level is interesting.  Globalization---the increased flow of goods, capital, and people across borders---has already levered up the world economy in a sense, by making it vastly more efficient.  But this interconnectedness has also made it highly susceptible to the kinds of acute, negative shocks that would be contained locally in a less connected world.  So, for instance, a sovereign debt crisis in Greece might contribute meaningfully to a double-dip recession in the US (maybe). 

Fine. He takes this a bit too far, but his basic point about the systemic dangers of excess leverage seems correct---and it's an old lesson we keep forgetting.

But I think Taleb's advice that individuals should have big savings before taking personal risk has to be qualified.  Specifically, young people with an entrepreneurial bent should ignore it completely, as that kind of caution leads to worse outcomes both for them and for society.

Taleb is no fool: he's a proponent of experimentation and entrepreneurship, which is similar to book publishing in that it's impossible (or nearly impossible) to predict either which idea will be a big hit or the extent of its impact.  In other words, the whole point is to make it possible to capitalize on a positive Black Swan.  It's just that Taleb wants this kind of personal risk to be taken with a small part of an individual's portfolio so that he or she is "robust" to failure.  

Unfortunately, this would eliminate most people in their early twenties from the pool of potential entrepreneurs.  These are people who tend to finish college without a whole lot in the bank.  They can't take personal risk with only a small part of their portfolio because they have no portfolio.

But look.  If a bunch of 23-year-olds with few personal assets choose to max out their credit cards while starting a company in their garage, the worst thing that happens if the project fails is they get wiped out and declare bankruptcy.  In the meantime, they've picked up some valuable skills and remain young enough to bounce back from whatever damage was done to their credit rating, reputation, etc..

This kind of risk-taking, even when it involves debt, is good for young people, especially in an ideas-based economy where the commodified jobs of the past are less safe than they used to be.  As Paul Graham, who invests in companies founded by twenty-somethings for a living, writes:

Your early twenties are exactly the time to take insane career risks...it's not necessarily a mistake to try something that has a 90% chance of failing, if you can afford the risk. Failing at 40, when you have a family to support, could be serious. But if you fail at 22, so what? If you try to start a startup right out of college and it tanks, you'll end up at 23 broke and a lot smarter. Which, if you think about it, is roughly what you hope to get from a graduate program.   

More often than not, starting a company means incurring debt.  And a society that fosters this kind of risk-taking, for instance through lenient bankruptcy laws, makes for a more dynamic economy.  Nor does it increase the "fragility" of the young people who borrow the money, as Teleb worries; in many cases, quite the opposite. 

So for these kinds of ventures, I think the primary responsibility to diversify and be cautious belongs to the institutions doing the lending and investing, as they would be wise not to expose too much of their portfolio to any single risky project.  Which is something they already know anyway, or should know.

Some thoughts about private equity in emerging markets

This one's for the finance geeks, so it goes below the fold.

Gotham to become more interesting, but at what cost?

I'm about halfway through Richard Florida's The Great Reset, which includes this passage:

The extraordinary tranches of cash pulled in by investment bankers, traders, and hedge fund managers over the past two decades skewed [New York City's] economy in some very unhealthy ways.  In 2005, I asked a top-ranking official at a major investment bank whether the city's rising real estate prices were affecting his company's ability to attract global talent.  He responded simply, "We are the cause, not the effect, of the real estate bubble." ...

Still, stratospheric real estate prices have made New York less diverse over time and arguably less stimulating.  When I asked [Jane] Jacobs some years ago about the effects of escalating real estate prices on creativity, she told me, "When a place gets boring, even the rich people leave."  With the end of the hegemony of the investment bankers, New York now stands a better chance of avoiding that sterile fate.

The trend described in the book, whereby a permanent decline in financial sector dominance leads to a more interesting and vibrant New York in the long run, seems to have begun.  Hiring has recovered in the last couple of months, but it's coming from outside of Wall Street.  The city has lost about 35,000 finance jobs, and although it's too early to know what the net effect of the crisis will be on Wall Street employment, it's likely that many of those jobs won't return or be replaced for a long time.

Some stories, based mostly on anecdotal evidence and sentiment indicators, say that Wall Street is hiring again, and certainly it's possible that job losses in the sector overshot.  But this new hiring has yet to show up in the official numbers.  City Room:

All told, the city’s private sector added almost 25,000 jobs in March, significantly more than the normal gain in the month, said James Brown, an economist with the Labor Department.

Hiring was especially strong in professional and business services, like advertising, and in management of computer systems, a large part of the city’s economy that usually expands early in a recovery, Mr. Brown said. ...

One continuing cause for worry is the persistent loss of jobs in the city’s most lucrative fields, investment banking and securities trading. Companies in those businesses shed a few thousand more jobs in March, according to the state’s numbers.

I don't know if New York was headed for a "sterile fate" before the crisis struck, but it's easy to understand how the escalating cost of living had been pricing out a lot of artists and creative types, especially within Manhattan.  (Seven of the top ten in Nate Silver's ranking of the city's most livable neighborhoods are in Brooklyn.)

Whether or not this was unhealthy for the city depends, I suppose, on how you look at it and who you are.  A higher concentration of lucrative-but-boring occupations probably did make the city a blander place, but the tax dollars generated by such jobs also made it a richer one, providing generous funding for public services.

Time's Barbara Kiviat wrote last week that New York's economic base is already impressively wide, and less reliance on "such an alcoholic boyfriend of an industry" as finance would be no bad thing: New York's economy would become less volatile and inequality would decline. 

And for people like me, it's obvious that an even more artistic, fashionable, entrepreneurial, techie, publish-y, media-ish, cheaper New York City would be wonderful.  If a decline in finance sector employment is needed to get us there, then great.

Even so, the process of getting from here to there is still something to worry about.  The city isn't inhabited only by young and relatively unattached media types.  It seems to follow that a protracted decline in the city's tax revenues will have an adverse impact on a lot of residents (on public sector workers most of all, of course) for at least a while.  That isn't exactly an original point and I could be missing something, but there's a reason the city's loss of finance jobs is described above as a "continuing cause for worry" rather than, say, as a bridge to a better New York.  I wonder how wrenching and disruptive this shift, worthwhile though it is, will turn out to be.

******

Richard Florida's blog is here.

This is a multimedia project about New York's startup scene, which includes a good interview with Fred Wilson of Union Square Ventures.

Here is Dave Winer's speech about returning home to New York, about which he says:

New York is, among other things, the center of the media industry. I think it will be that for a long time to come. And that industry must make the transition to the new communication technology. And it must do so with abandon -- without knowing in advance what the business models are. ...

That's why the startups of New York are so precious. Tumblr, Foursquare, bit.ly, gdgt, drop.io, Gawker, Boxee, Blogtalkradio, Etsy, Hot Potato, Bug Labs, Hunch, Kickstarter. These companies are not only incubating ideas that may turn into businesses, they are also developing New York-based human capital. Experience has shown that the next generation of startups will be born in the previous-generation startups. So by concentrating inteligence here, the network can develop and new ideas can develop, around the realities of a changing media business, which is a very different perspective from that of Silicon Valley.

Here is Doree Shafrir's article in NYMag about the companies listed above.

Here is Ed Glaeser on how Manhattan's "historic districts" keep real estate prices artificially high.

Two types of startups

From Paul Graham, whose irregularly published columns are always worth reading:

There are two types of startup ideas: those that grow organically out of your own life, and those that you decide, from afar, are going to be necessary to some class of users other than you. Apple was the first type. Apple happened because Steve Wozniak wanted a computer. Unlike most people who wanted computers, he could design one, so he did. And since lots of other people wanted the same thing, Apple was able to sell enough of them to get the company rolling. They still rely on this principle today, incidentally. The iPhone is the phone Steve Jobs wants.

Our own startup, Viaweb, was of the second type. We made software for building online stores. We didn't need this software ourselves. We weren't direct marketers...

There is no sharp line between the two types of ideas, but the most successful startups seem to be closer to the Apple type than the Viaweb type. ...

So if you want to come up with organic startup ideas, I'd encourage you to focus more on the idea part and less on the startup part. Just fix things that seem broken, regardless of whether it seems like the problem is important enough to build a company on. ...

Don't be discouraged if what you produce initially is something other people dismiss as a toy. In fact, that's a good sign. That's probably why everyone else has been overlooking the idea. ...

Read the whole thing here.