Lunch Talk: Robert Shiller on Innovation in Financial Markets

Recognized as one of the most far-seeing political economists of our time, Robert Shiller is known the world over for his brilliant forecasts of financial bubbles and his penetrating insight into market dynamics and how human psychology drives the economy. For his empirical analysis of asset prices, Robert was awarded the 2013 Nobel Prize in Economics.



tags: innovation, finance, lunchtalk, networking, money

BitCoin vs PayPal: a 100X+ difference

Both BitCoin and PayPal allow parties who don't trust each other's identity to exchange money electronically. The big difference is transaction costs. Because PayPal uses the existing system for electronic payments, it extracts high fees from the seller; the smaller the transaction, the larger the percentage of the fee. In short, PayPal doesn't scale down.

In contrast, BitCoin transactions are almost free. Moreover, they scale down as computing power (thanks to the Moore's law) becomes cheaper over time. The adoption of BitCoin or any similar monetary transaction system should stimulate development of businesses that involve high-volume payments. If posting on Twitter is free, BitCoin transactions should also be free.

Companies that will make Bitcoin payments reliable and secure are going to reap huge benefits in the mobile and financial markets.

tags: money, deontic, payload, control, machine1, machine2, finance, commerce, 10x, innovation

Trade-off of the day: Liquidity vs Growth

In "Corporate Finance" textbook I found this fundamental financial trade-off,

The more liquid a firm’s assets, the less likely the firm is to experience problems meeting short-term obligations. Thus, the probability that a firm will avoid financial distress can be linked to the firm’s liquidity. Unfortunately, liquid assets frequently have lower rates of return than fixed assets; for example, cash generates no investment income. To the extent a firm invests in liquid assets, it sacrifices an opportunity to invest in more profitable investment vehicles (p. 32. McGraw Hill, 2002).

The textbook treats the trade-off as a given, but from business practice we know that successful investors, such as Warren Buffet, break the trade-off by using insurance "float" and/or borrowing against fixed assets. Access to low- or negative cost credit seems to be the most creative way to deal with the problem.

tags: trade-off, constraint, finance, business, problem, solution

Cone of uncertainty in Financial and Patent Portfolios.

The picture above is a screenshot from a lecture on Financial Theory. It shows how one can hedge his bets when facing uncertainty and risk. In the example on the board, the professor shows how to win a favorable large bet by making a series of small side bets using backward induction.
Since the future is uncertain, he builds a tree of possible futures, with certain probabilities assigned to each branch of the tree. In theory the tree is infinite, but in reality its internal branches lead to equivalent results (recombining tree); therefore, we can consider the whole tree growing inside a limited cone of uncertainty.
Below is a slide from one of my Stanford lectures on the relationship between innovation strategy and patent portfolio. It also shows a cone of high-tech business uncertainty. The cone covers technology development options, which tend to move sideways (yellow spot) as the world develops. If you target your patent portfolio toward the "bull's eye" of today's implementation, you portfolio is likely to be of low value in the future. Therefore, you have to hedge your bets with patents that cover the entire cone.

1. Similar to a hedged financial portfolio, the innovator would be better off by building a patent portfolio using backward induction rather than patenting today's implementations.

2. The difference between financial and patent portfolio hedging would be in the timing aspect. That is, because with patents priority dates are of paramount importance, the innovator has to hedge by a) inventing the whole tree (within the cone); b) trimming the patent tree to reality as the time progresses, by divesting from the earlier patent assets.

Lunch Talk: (@Yale) History of the Mortgage Market

Professor Geanakoplos describes securitization and trenching of mortgage pools, the role of investment banks and hedge funds, and the evolution of the prime and subprime mortgage markets. He also discusses agent based models of prepayments in the mortgage market.

00:00 - Chapter 1. Fannie Mae, Freddie Mac, and the Mortgage Securities Market
17:01 - Chapter 2. Collateralized Mortgage Obligations
22:44 - Chapter 3. Modeling Prepayment Tendencies at Kidder Peabody
35:40 - Chapter 4. The Rise of Ellington Capital Management and the Role of Hedge Funds
52:52 - Chapter 5. The Leverage Cycle and the Subprime Mortgage Market
01:13:51 - Chapter 6. The Credit Default Swap
01:18:36 - Chapter 7. Conclusion


tags: lunchtalk, innovation, invention, finance, risk, growth

Lunch Talk: Technology, Innovation and Poverty Alleviation (@Google)

Kiva launched onto the scene six years ago disrupting the world of microfinance by leveraging technology. In doing so, Kiva pushed the boundaries of international development. Six years later over $300 million has been lent to over 780,000 borrowers, with an average repayment rate of 98.9%. Kiva continues to pursue its mission of connecting people to enable financial inclusion for underserved and isolated populations in 60 countries around the world, including the United States. Gary Briggs, VP of Consumer Marketing at Google, will be moderating this fireside chat. Attend this talk to learn about the new frontiers Kiva is pursuing!

Link

tags: lunchtalk, finance, business, innovation

Lunch Talk: Technology and Invention in Finance (Yale University).

In the beginning of the lecture, Professor Shiller reviews the probability theory concepts from the last class and extends these concepts by the central limit theorem. Afterwards, he turns his attention toward the role of financial technology and financial invention within society, in particular with regard to the management of big and important risks. He proceeds along the lines of a "framing" theme, referring to the context and the associations of inventions, and along the lines of a "device" theme, emphasizing the creation of complicated structures set up for a certain purpose, which require learning over time to be improved. His coverage of financial inventions spans limited liability for corporations and the framework of Township and Village Enterprises in China, as well as inflation indexation from its inception around the turn of the 19th century to its applications in Chile and Mexico in the 20th century. Professor Shiller concludes the lecture elaborating on swap contracts as financial inventions, and on the subsequent development of credit default swaps.

Link

Invention of wheeled luggage.

0:52 Fundamental financial problem: the value of money changes through time (and inflation risk).

tags: lunchtalk, finance, innovation, invention

Lunch Talk: An intro to financial theory (Yale University).

This lecture gives a brief history of the young field of financial theory, which began in business schools quite separate from economics, and of my growing interest in the field and in Wall Street. A cornerstone of standard financial theory is the efficient markets hypothesis, but that has been discredited by the financial crisis of 2007-09. This lecture describes the kinds of questions standard financial theory nevertheless answers well. It also introduces the leverage cycle as a critique of standard financial theory and as an explanation of the crisis. The lecture ends with a class experiment illustrating a situation in which the efficient markets hypothesis works surprisingly well.

Link 

tags: lunchtalk, finance, business, innovation, problem

Social heartbeat.

The chart below shows relative frequency of the word "present" in Google searches in the United States (category = shopping.) Since Google is an advertising, not technology, company, its marginal financial results depend on people searching for buyable items.

tags: pattern, finance, market, social

Reinventing stock market for startups.

Turmoil in the financial industry and continuing woes of the European banking system reduce investors' appetite for risk.  As a result, demand for stocks in the US is falling, which in turn prompts companies flash with cash prop up their own shares with buybacks (see Bloomberg quote below). In the current investment climate, startups and VCs are in a poor position because successful IPOs are few and far between. 
SecondMarket wants to solve the problem by providing a stock exchange for shares in small private companies that can't make it to IPO (see VBeat quote below).

Jan. 17, 2012. Bloomberg -- Stocks are getting scarcer in the U.S. for the first time since the bull market began as companies cut share sales to the lowest level since 2006 and buy back equity at the fastest pace in four years.


Jan 17, 2012. VBeat -- ...a re-invention of the small-cap IPO that might be music to the ears of venture capital funds backing tech companies. It now takes an average of 10 years to get a company to IPO, and there are fewer and fewer going public below the $1 billion mark. SecondMarket aims to be a third-route venture backed startups could pursue for an exit if IPO and M&A don’t make sense.
“We want to create a market where anyone who is a 20 percent holder of a company with a valuation of $150 million or more can get liquidity on their investment within two years,” replied Silbert.

The good news for SecondMarket is that NASDAQ used the same strategy to build a thriving exchange for small caps beginning in 1971. Maybe it's not a coincidence that creation of NASDAQ happened in between two recessions 1969-1970 and 73-75, when small companies faced liquidity issues similar to the today's situation.

tags: finance, problem, solution, economics, 10X

Medicare: Disaster 20 years in the making.

One of the reasons for Medicare going broke these days is an accounting rule adopted twenty years ago. It required corporations to account for post-retirement employee healthcare liabilities. Here's what Warren Buffet's wrote in his 1992 letter to shareholders:

Another major accounting change, whose implementation is required by January 1, 1993, mandates that businesses recognize their present-value liability for post-retirement health benefits.

A CEO didn't need to be a medical expert to know that lengthening life expectancies and soaring health costs would guarantee an insurer a financial battering from such a business.

In health-care, open-ended promises have created open-ended liabilities that in a few cases loom so large as to threaten the global competitiveness of major American industries.

Concerned with open-ended liabilities, CEOs began dropping healthcare retirement benefits for their employees. As a result Medicare got hit with a triple whammy: 1) the rising costs of healthcare; 2) the rising wave of retiring baby-boomers; 3) a drastic reduction in corporate healthcare available for the retirees.

Now twenty years after the accounting change, Medicare is struggling to sustain the demand. Reduced levels of reimbursements lead to doctor bankruptcies:

Jan 5, 2012. CNN -- Doctors in America are harboring an embarrassing secret: Many of them are going broke. This quiet reality, which is spreading nationwide, is claiming a wide range of casualties, including family physicians, cardiologists and oncologists.

Pentz said recent steep 35% to 40% cuts in Medicare reimbursements for key cardiovascular services, such as stress tests and echocardiograms, have taken a substantial toll on revenue. "Our total revenue was down about 9% last year compared to 2010," he said.

Unfortunately, we don't know the extent of the disaster because the federal and state governments are not required to account for unfunded liabilities. The rules of the game they imposed on private businesses in 1993 do not apply to them.

tags: problem, detection, trend, health, business, finance

Groupon timeline: from startup to IPO

Groupon infografic from www.sigfig.com (via VBeat). Note valuations:

early 2010. Series C financing. $1.3B
late 2010. Google offer to buy. $6B
early 2011. Series D financing. $4.75B
early 2011. Initial IPO discussions. $15B
mid 2011. IPO talks. $25B
late 2011. Release of earnings. $10B
late 2011. opening price $20 @IPO. $12.7B
late 2011. max market price @IPO. $25B
today. @market price. $XXXB.

Invention of the Day: Financial losses masked as acquisition fees.

Large financial losses are usually perceived by the markets as a major systematic problem within a company. At the same time, a large one-time payment is often seen as a legitimate business expense. Here's how Olympus exploited this psychological bias by hiding hundreds of millions of dollars in plain sight:

Nov. 8 (Bloomberg) -- Olympus Corp. said three executives helped conceal decades of losses by paying inflated fees to takeover advisers.

Olympus funneled more than $600 million in fees on the $2 billion Gyrus takeover to offshore funds to cancel impairments that the company had kept off its books.

Large acquisitions rarely work out to the benefit of the acquiring company. I wonder how much of it can be attributed to various losses recognized as a one-time non-systematic expense.

tags: finance, business, problem, solution, psychology

e-mail should die

In the age of social networking, e-mail has become a giant security hole. PC World reports:

George Bronk, 23, was arrested in late October after police found evidence that he'd hacked into more than 3,200 e-mail accounts. He used the same technique that Sarah Palin hacker David Kernell used to break into the former U.S. vice presidential candidate's Yahoo account: He scoured his victims' Facebook accounts for answers to the security questions used by Web-based e-mail services such as Gmail and Yahoo Mail.

Forget about pranksters and perverts. Now, that banks, brokerages, and other financial institutions switch from paper to electronic statements, hacking somebody's e-mail account is going to become an even more profitable enterprise.

tags: privacy, security, information, finance, control, payload, packaging, 10x

Evolution of the Hamburger.

I just finished reading The Hamburger, by Josh Ozersky, and wanted to capture key inventions and innovations in the evolution of this remarkable food item, which in many ways rhymes with the evolution of the Personal Computer.

- Ground meat on a bun instead of bread (fast food) - Walter Anderson, White Castle. p. 29
- Cooking process standardized across tens of restaurants to guarantee quality and sanitation of the food - Billy Ingram, White Castle. p. 30.

- Double-size burger ("Big Boy") - Bob Wian. p.46.

"...a bass player came in one night and asked for something different. Taking up the challenge, Wian took a sesame seed bun, sliced it in thirds, and proceeded to make the first designed double-decker hamburger. (This could never happen today, when all buns are presliced.)"

- Big Boy franchise - Bob Wian. p.48.

- US government gets into the burger picture, p. 91.

The U.S. Department of Agriculture in 1946 did an inestimable service to the beef industry, and its tireless lobby, by decreeing that hamburger could contain only beef and beef fat—that even the slightest bit of pork or pork fat disqualified it from the dignity of being called hamburger. This was a decisive blow for the beef men in the eternal war against the pork men, since it meant that they had an effective monopoly on the most popular meat product in America.

- Large-scale, limited menu, continuous high-speed burger cooking and service operation; drive-in restaurant (social networking) - McDonald brothers. p.53.
- McDonald's franchise, with uniform cooking and service process - Ray Croc. p.58.
: a combination of conformity and enterprise:

"...it was a franchisee who invented the Big Mac, a fran- chisee who invented the Egg McMuffin, a franchisee who invented the point-of-sale protocol (“May I have your order, please?”). A franchisee invented Ronald McDonald! Franchisees have conceived and developed most of the marketing and product innovations that have propelled McDonald’s to fast-food supremacy." p. 64.

- McDonald's financial model: lease restaurant from a real estate owner, sub-lease to the franchisee at 40% markup, use as a financial leverage to enforce process conformity - Harry Sonnenborn. p.78.

"McDonald’s became what it is for two reasons. One, because it was the first and the best hamburger franchise restaurant, with the most far-sighted senior management. And two, because Harry Sonneborn figured out a way to finance a multibillion-dollar empire without cash, collateral, or even a significant show of profitability.
Sonneborn would frequently go so far as to tell investors that McDonald’s was a real estate company, not a hamburger company."

- Hamburger University, rigorous training for McDonald's franchise managers - Ray Croc. p. 78.

"...the system was invaluable. It made McDonald’s predictable and productive, and a veritable moneymaking machine in the best franchises."

- Fully automated broiled burger cooking ("insta-burger") - Burger King, p.98.
- "Whopper" - a large burger - Burger King, p. 99.

- Meal combo of soda, fries, and burger for one price - Burger Chief. p. 100.
- Automated conveyor-belt broiled hamburgers - Burger Chief. p. 101.
- Giveaway toy with a meal; movie tie-in (Star Wars in 1977) - Burger Chief. p.101.

- Global expansion of the franchise - McDonald's, p. 118.

- Drive-through window - Wendy's, p. 121.
- Half-pounder, three-quarters pounder, salads, and baked potatoes - Wendy's, p. 121

- The gourmet burger - various NY restaurants. p. 130.
 
To add the most recent developments,
- McCafe - "gourmet" coffee to compete with Starbucks - McDonalds
- a "social networking" burger recipe restaurant - 4food.com

tags: health, payload, finance, evolution, system, infrastructure, brainstorming, social, control, 10x

How highly educated powerful clueless people run the financial world:

From June 2004 until June 2007, Wall Street underwrote $1.6 trillion of new subprime-mortgage loans and another $1.2 trillion of so-called Alt-A loans—loans which for some reason or another can be dicey, usually because the lender did not require the borrower to supply him with the information typically required before making a loan.

...when Park [one of AIG quants] decided to examine more closely the loans that A.I.G. F.P. had insured. He suspected Joe Cassano didn’t understand what he had done, but even so Park was shocked by the magnitude of the misunderstanding: these piles of consumer loans were now 95 percent U.S. subprime mortgages. Park then conducted a little survey, asking the people around A.I.G. F.P. most directly involved in insuring them how much subprime was in them. He asked Gary Gorton, a Yale professor who had helped build the model Cassano used to price the credit-default swaps. Gorton guessed that the piles were no more than 10 percent subprime. He asked a risk analyst in London, who guessed 20 percent. He asked Al Frost, who had no clue, but then, his job was to sell, not to trade. “None of them knew,” says one trader. Which sounds, in retrospect, incredible. But an entire financial system was premised on their not knowing—and paying them for their talent!

via marginalrevolution.com