Airs – Ian Lance Taylor

The stock market gyrations last Thursday may be a nice example of the issue of complexity I’ve discussed in the past. When the financial markets are too hard to understand, failure modes become unpredictable.

Because there is profit in complexity, or at least the chance of profit, we can expect more of this going forward. History suggests that there will be a slow and intermittent increase in complexity and volatility, up to some limit where ordinary investors are no longer willing to tolerate it. The government will increasingly try to guarantee the behaviour of the financial instruments used by ordinary people: bank accounts and 401k plans. High finance will increasingly separate from ordinary finance, as indeed was the case in the past.

My guess is that we’re headed for a cycle of booms and busts more like the ones in the last 19th century. The money that comes from complexity has a lot of influence over the political system, and people are working hard to avoid regulations which smooth things out while lowering profits. At the same time the government may increasingly intervene to keep finances stable for most people. E.g., although Fannie Mae and Freddie Mac will most likely disappear, there will be some new mechanism for controlling home mortgage interest rates.

Hard to say how it will all work out, but whatever happens you heard it here first.

A friend (I’ll call him John) recently told me about a con that was run on his parents. The con artist called his parents home and pretended to be John. This was apparently done with a little social engineering: “Hello?” “Hi, Mom?” “Is this John?” “Yes, it’s John.” The caller excused the fact that he sounded different by saying that he had just been in a car crash, that he had been drinking at a bachelor party or something like that, and that he was now at the police station. He said he had not been able to reach his wife. He asked them to wire him some money.

Described coldly like that it doesn’t sound very plausible. But from John’s parent’s point of view, they got a call late at night, so they probably aren’t thinking completely straight, and their son is in trouble right now. You have to help your son; you don’t spend time thinking that your son might be scamming you, and you don’t think that somebody would claim to be your son when they are not. The con artist said he hadn’t been able to reach his wife, so they didn’t bother calling his house. They wired $3000 to a location in Toronto with a code word to pick it up. That money is gone.

The con artist, having succeed once, went back for a second try. He called again, saying he was now out of the police station, and needed more money to get the car fixed. This time he asked for $9000. My friend’s father dropped the money off at the wire transfer place, but on his way home realized that this didn’t sound right. He called my friend’s home, discovered the scam, and was able to get the $9000 back. The con artist made a third try a few days later, this time posing as an investigator for the money wiring company, asking for some financial details. No luck there either.

This kind of scan is particularly targeted at elderly people. As we get older we don’t think as quickly, but of course we always want to help our children. I assume that the con artist just calls numbers out of a phone book until they get a hit. On the web I found news article about the scam (my friend’s parents do not live in Tennessee).

To you, dear reader, this is just be a friend-of-a-friend story, but for me it’s just one link away. It does happen. Not only does it cost money, it makes my friend’s parents feel like idiots. You may want to mention this to your parents. The FBI has a web page listing cons aimed at elderly people, although it doesn’t seem to mention this particular one.

I have no idea whether the recent SEC lawsuit against Goldman Sachs will prevail in the courts. Goldman’s defense sounds pretty good to me: the investors were presumed to be sophisticated, and they should have been able to figure out what was going on.

What ought to collapse, though, is Goldman’s reputation for putting their clients first. In this case, they permitted a hedge fund manager to select the mortgage bundles which went into the CDO, and then sold the CDO to investors, Goldman’s clients, without telling them how the mortgages were selected. That would be fine except that the hedge fund manager was betting against the clients. I can’t see any way you can spin that into saying that Goldman was looking out for their clients.

Goldman’s first business principle says “Our clients’ interests always come first.” Not in this case they didn’t.

My blog used to have just two readers, and I wrote a lot of random stuff. These days I seem to have acquired some 30 readers or so, and I feel a bit of pressure to make these posts actually interesting. That tends to reduce the number of postings, which of course is not a bad thing for readers, but isn’t really what I want to do with the blog. So I’m going to continue trying to write more posts, even if they aren’t interesting. My apologize to those who prefer quality.

Anyhow, recently in Berkeley there were a lot of protests about cuts in the California university system. In the 1960’s California provided a free university education to state residents who met the entrance qualifications (as of course many European countries do). Tuition in the University of California system is now over $12,000 a year. That’s quite a change.

This change is due to the broken California budget process. Raising taxes in California requires a 2/3 majority vote in the legislature. To get around that, many politically desirable projects are implemented using ballot questions which call for issuing bonds to raise the necessary money. The money raised from the bonds can only be used for the specified purpose. The interest on the bonds is paid out of general tax receipts. The effect is that the general fund is split up more and more into specific projects, draining funds from other projects. The specific projects which are funded are the ones which can get a ballot measure passed. Votes on those ballot measures are weighing a specific good—whatever the measure is about—against a general harm—future restrictions on budgeting. There is very little thought given to weighing different choices. In effect the process short-circuits the point of a representative democracy, which is to vote for people who can take the time to make good decisions on these difficult choices.

Back in Berkeley, the protests generally argued that the tuition increases were unacceptable because of the harm to the education and to the student body. I can understand their anger and frustration. But I don’t understand their tactics. If there is not enough money for education, then you have to raise more money or you have to spend less money. At the state level there aren’t really any other options. The citizens of California have made choices over the years, through a series of ballot measures, which ensure that the amount of money available for education will fall over time. This was hidden for some years by the economic boom in Silicon Valley, and the revenue shortfall has been exaggerated by the recession, but I tend to think that the effect is real in the long run. Of course few people consciously thought that, e.g., restricting fuel taxes to only be used for transportation would have the effect of reducing spending on education, but it does.

It seems to me that a rational protest would have involved some attempt to adjust the way that the state handles funding. Instead, what I see on, e.g., campusactivism.org, is a quote like “if there’s money for wars, bank bailouts, and prisons, why is there no money for public education?” Setting aside the fact that no California state money is being used to pay for wars or bank bailouts, there is no money for public education because that is what the voters have chosen. It seems to me that useful protests should try to draw these connections for people, rather than just relying on unfocused resistance to the cuts.

I think it’s a shame that the University of California system is moving out of reach of many families. It’s a shame because everybody deserves access to a good education. It’s also a shame because U.S. economic success these days depends upon a well educated work force. But I don’t see any way to fix the problem without fixing a great deal more about how the state runs. I don’t think the state is going to get fixed short of a real crisis, and we’re not there yet. For now I think it’s inevitable that the University of California system is going to shrink, and I expect that the state will be paying for that indirectly for many years to come.

The merger between AOL and Time Warner, the biggest merger in U.S. history, happened ten years ago. It is now generally considered to have been the worst merger of all time.

Hindsight is 20/20, but I clearly remember that when I first read it I thought it was a joke. I was working in Silicon Valley, as I still do today, and it was obvious that the Valley was in the boom part of its regular boom/bust cycle. Money was pouring into Internet companies, but it was obvious that it was a bubble headed for a crash. That’s not hindsight either, it’s what I and plenty of other people thought at the time.

So AOL’s stock price was obvious vapor, especially considering that cable modems were starting to spread and AOL had no obvious plans to get out of the cheap dialup world that it lived in. AOL’s walled garden had already disappeared into the wider Internet.

Time Warner, on the other hand, was a serious company with real products and real continuing customers. Actually they turned out to be heading into a terrible decade along with the rest of the media, but I didn’t see that coming. The notion that they would merge with AOL—actually AOL’s market cap was higher so it was more of an acquisition of Time Warner by AOL—seemed completely laughable to me.

A friend of mine suggested that the real goal was for Steve Case to put real grounding under AOL’s absurd market cap, by using it to buy a real company. I’m not sure I agree—I think Case may have really believed that AOL somehow deserved its market cap. I have no idea how he convinced everybody else involved. It just seems so obviously crazy on the face of it.

Of course, one thing arguing in favor of the merger is that our form of capitalism requires companies to always grow, which is very hard for very large companies to do. At some point, the personal incentives for executives are such they will do better if they do something even if it looks crazy, because doing nothing will certainly not lead to growth. I haven’t checked I’m sure the executives who agreed to the merger did fine out of it.

There have been mergers which I thought would fail but turned out to more-or-less succeed, such as HP/Compaq. But I always thought AOL/Time Warner one would fail, and on that one I was right.