Merry Banker
Finance & Culture in Subversive Brogue
The Camorra
Apr 16th
Fascinating piece over at Vanity Fair about the Camorra – the Neapolitan Mob – which controls large sections of the city and is generally tolerated by the government. Like any business, the Camorra has shown a highly sophisticated operating structure:
[Di Lauro's] greatest defense was the business structure he built, arranged as a pyramid of independent entrepreneurs, acting as franchisees under his guidance, and respected by him as largely autonomous associates. There were about 20 at that level, each with the exclusive rights to a major drug piazza. They bought a minimum of narcotics from Di Lauro each week, and paid a significant rent, but beyond that they were free to earn as much from their piazzas as they could. This included going to outside vendors for additional supplies if they could find them at a better price than Di Lauro offered. He would even finance them, and at low interest rates, if they required it. In return, Di Lauro expected a certain code of behavior: within the clan, people would be treated fairly, down to the lowest level of associates; they would not quarrel stupidly with one another; they would recognize Di Lauro as an arbiter in cases where the quarrel was real; in other ways, also, they would recognize Di Lauro’s authority at all times; they would not take independent action against any other group in the city; and, finally, they would never—never!—speak Di Lauro’s name.
Even the judges and police recognize how useful the Camorra is for preserving stability and social norms in Naples:
An anti-Mafia judge told me that some of the police—even those who have not been corrupted—would rather not see the government prevail, because they fear the even greater disorder that would result. Another judge pointed out to me that the government needs the Camorra for social control. He said, “For a political leader, it’s easier to speak to a Camorra boss than to 100,000 people to get a message across.” More than that, he said: the Camorra sets standards, enforces laws, keeps police power itself in check, fends off aggressive tax collectors, employs a huge percentage of the population, creates and distributes wealth more efficiently than any other sector of society, and stands in to keep things going, especially in times like these, when the national economy has failed and the currency itself is at risk.
In some ways, Italy still retains vestiges of its Renaissance past… powerful clans and city states battling for resources and autonomy from erstwhile conquerers / political consolidators. This is a long article, but well worth the read.
9 Point Plan for becoming an Indie Rocker
Apr 16th
- Get a dingy LA apartment using your trust fund. Just to keep up appearances, get a job waiting tables in the kind of place a record producer would never visit.
- Embrace poverty and chastity. Spin as either a rejection of capitalist norms or some sort of religious thing.
- Assemble a band whose quirky cuteness masks their lack of talent. No prior musical training required… the important thing is that they feel it soooo deeply.
- If you have an interesting name – like Terrance or Juliet – use the [your name] and the ____s formula. If not, drop your name and just be the _____s. Example: “The Tricks”, “The Treats”, “The Oblongs” etc. If you want to be really innovative, drop the plural ending: “The Oblong.”
- Do no drugs at all… or way too many. If the latter, choose odd or unfashionable ones. Either way, you’ll seem unique and unsullied by modern temptation.
- Build all your songs around 2 or 3 easy-to-play chords in 4/4 time. Forget about complex harmonies, key changes or syncopation. Those are the tools the record/radio complex uses to seduce you… and the band can’t play them anyway.
- Don’t worry about tone, pitch or annunciation when singing. Just decide whether to be REALLY LOUD or really soft all the time. It’s OK to whisper your lyrics… the fans will hear you in their hearts.
- Remember your audience: sing about the trials and heartaches of overprivileged, hyperemotional white kids. Unrequited love, defeat on the lacrosse pitch, Ivy League rejection etc. Conceal in elaborate, anachronistic metaphor just to keep’em guessing. When those resources are exhausted, consider picking an obscure literary figure and sing from his/her perspective (Raskolnikov, Captain Cuttle, Lady Macbeth etc.)
- Pick a vague political cause to get behind. Nothing too heavy or controversial, just something to get your name out there (endangered rattlesnakes, the plight of Turkmeni peasants, etc.). Mention at every gig and pass around a collections jar. If your trust fund is big enough, go ahead and donate your ticket revenues to the cause.
Drug Economics and Violent Crime
Dec 8th
I read a fantastic profile of the late Pablo Escobar at Mental Floss. It’s fascinating to track his evolution from small-time street dealer to the billionaire kingpin he later became. Apart from the violence and corruption, Escobar was no different from any modern-day entrepreneur, identifying an underserved market and meeting the demand with evolving sophistication:
[In the early 80s], he bought a Learjet to fly cash out of the U.S., and the Cartel’s expenses included $2,500 per month for rubber bands for bricks of cash.
Escobar employed a team of 10 full-time accountants to keep track of it all, but could also be surprisingly relaxed: he shrugged when $5 million was loaded on the wrong boat — “you win some, you lose some” — and accepted the regular loss of 10% of his income to “spoilage,” as up to $500 million per year was eaten by rats or rotted due to improper storage.
Escobar’s personal fortune was estimated at $7-$10 billion in 1985, of which perhaps $3 billion was in Colombia, with the rest spread out in countless foreign bank accounts and investments, including apartments in Miami, hotels in Venezuela, and up to one million hectares of land in Colombia (about 3,900 square miles, or 1% of the country’s land area).
Enormous financial incentives (and cocaine’s illegality) drove Escobar to use increasingly bloody means of sustaining his empire. He famously offered people the choice of “Plata o Plomo” – money or bullets – when they stood in his way. His murderous reputation and gruesome death led many to believe that the drug trade was inherently violent, and would continue driving violent crime until entirely stamped out. Hence the DEA’s wide and ever-growing powers. From the Atlantic:
Cocaine was the driving force behind the majority of drug-related violence throughout the 1980s and into the early 1990s. It was the main target of the federal War on Drugs and was the highest profit drug trade overall. In 1988, the American cocaine market was valued at almost $140 billion dollars, over 2 percent of U.S. GDP. The violence that surrounded its distribution and sale pushed the murder rate to its highest point in America’s history (between 8-10 per 100,000 residents from 1981-1991), turned economically impoverished cities like Baltimore, Detroit, Trenton and Gary, Indiana, into international murder capitals, and made America the most violent industrialized nation in the world.
Happily, violent crime has been on a long decline in the US since the days of Pablo Escobar – but not because the DEA is winning the War on Drugs. On the contrary, drug dealers have been just as successful at circumventing government agencies as “legitimate” businessmen like bankers and oil drillers. Old-fashioned competition caused cocaine prices to plummet in the 1990s, dramatically reducing incentives to kill over drug profits:
Then in 1994, the crime rate dropped off a cliff. The number of homicides would plummet drastically, dropping almost 50 percent in less than ten years. The same would go for every garden variety of violent crime on down to petty theft. The same year as the sharp decline in crime, cocaine prices hit an all-time low. According to the DEA’s System to Retrieve Information on Drug Evidence (STRIDE) data, the price per gram of cocaine bottomed out in 1994 at around $147 (calculated in 2003 dollars), the lowest it had been since statistics became available.
Something was wrong. If anything, cocaine prices should have been skyrocketing. One of the DEA’s stated objectives for the War on Drugs was to make drugs more expensive and therefore harder to access for the individual user…
But despite drug busts and stricter regulations, cocaine prices kept declining. In fact, prices have been declining since before the War on Drugs even began. An Atlantic story from 2007 noted that the price per gram for cocaine had gone from an average of around $600 in the early 1980s to less than $200 in the mid 1990s, and was down to as little as $20 per gram with ever-increasing purity. In some instances, illegal drug prices spiked in the wake of a large drug bust or the dismantling of a cartel, but the larger trend has been markedly downward. That’s due in large part to the ingenuity of drug importers, who only got more sophisticated in their ability to bypass border security and avoid arrest following a significant bust, ultimately bringing in more product with time. That growing supply resulted in more competition between dealers who started supplying a higher purity product, at a lower cost, to win over consumers.
But it’s not only a growing supply of product that led to the collapse of the cocaine market. Newfound competition in the form of locally-produced methamphetamines and prescription narcotics would continue to drive business away from cocaine and the inner city to the suburbs and exurbs…
Once the margin of profit for dealing small amounts of crack cocaine disappeared, being part of the drug trade was no longer worth the persistent threat of violence or the stiff criminal penalties. A 70 percent drop in cocaine prices like the one that occurred in the mid 1990s combined with competition from decentralized sources for methamphetamines and prescription narcotics would completely eliminate the minimum wage drug dealer as a viable profession.
The lesson here is that no enterprise (even apparent monopolies like the Medellin Cartel) can withstand competitive pressures forever. The cocaine business has followed the same growth curve drawn by countless other industries – 1) widespread adoption leads to huge profits for early providers; 2) new entrants challenge incumbents for a slice of the pie – competitive battles and product evolution boost sophistication while compressing returns; 3) market erosion and commoditization push the industry toward maturity, thus shaking loose all but the most efficient providers. That doesn’t mean US-based dealers can’t still make money at stage 3 – but they’re probably not making enough to justify violent crime anymore. Unfortunately this isn’t the case in Mexico, where average incomes are lower and drug profits fuel the border economy…
Game Theory & Theft Prevention
Dec 8th
Interesting post over at the Economist about signaling and property theft. The premise is that stickers on trucks saying “no valuables/tools left inside” encourage thieves to break in – quite the opposite of their intended effect:
Most if not all sticker owners are tool owners, and nervous ones (which suggests their tools may be valuable) at that. The sign may have the added effect of lulling those displaying it into a false sense of security. On any one night a decent percentage of them may have forgotten to remove their tools or chosen not to out of laziness. A good strategy might therefore be to target only vans with deterrent stickers as the success rate will be higher amongst this group.
In other words, the fact that a truck has such a sticker confirms that valuable tools are often on board. Breaking into said truck probably has a higher payoff to the thief than breaking into a similar vehicle with no such marker. The effect is compounded when the sticker gives the owner false comfort that thieves will actually be deterred… they’ll be more likely to leave the tools.
The Risk Premium is risen! It is risen indeed.
Aug 19th
More thoughts from the Atlantic on the Equity Risk Premium.
…once everyone believes that the stock market offers high returns for relatively little risk, that notion stops being true. And everyone apparently does believe just that—even after the 2008 crisis, the price-to- earnings ratio of the S&P 500 remains near the top of its average historical range. Paradoxically, the current high price may be supported in part by a belief that the old equity premium still obtains. A survey done by ING Direct in March of this year found that, even after a decade of lousy returns and a spectacular market crash, more than a quarter of Americans expect annual returns in the stock market to average 10 to 20 percent.
If the return on equities really has fallen, this decline poses a big problem for the average investor who planned to stick 5 to 10 percent of his or her annual income into stock funds and retire comfortably. At an annual inflation-adjusted growth rate of 8 percent, savings of just 5 percent of your income for 30 years will leave you with a nest egg big enough to replace almost half your income when you retire. Saving 10 percent will make you really comfortable.
But if the return is 2 to 3 percent, you’ll need to save close to 40 percent to replace almost half of your income. And a 2 percent return seems to be a real possibility—in fact, it’s a hair above the 1.8 percent that Smithers & Co., an asset-allocation consultancy, forecast for U.S. equities over the next decade.
What alarmist hogwash. Is Megan really claiming the equity risk premium is 2-3%? It doesn’t take a Harvard MBA to deconstruct that assertion (which is good because I don’t have one – stay tuned for a post on pretentious businesspeople & their MBAs).
Consider market PE ratios. The S&P 500 forward earnings multiple is 13x – or a 7.7% earnings yield. In other words, for every $100.00 you put in the S&P500, the companies you’ve invested in are earning annual net profits of $7.70, which they either pay out to the shareholders or reinvest in the business.
10-yr US treasuries are yielding 2.6%. So on a flat, no-growth-ever basis, we’re already up to 5.1% for the Equity Risk Premium – which stacks up well against the 4-6% commonly assumed by managers and investment bankers in the USA.
But we’re not done! Profits grow over time as the economy grows – meaning the $7.70 will go up over the long term. We account for this using the old Gordon Growth Formula: c/(r-g), where “c” is the coupon/profit, “g” the annual rate of growth and “r” the all-in cost of capital, including growth. “R” is the variable we want to solve for. So if 7.7% = (r-g), and we assume average economic growth of 3% (over 10+ yr time period), that takes us to 10.7% for the equity cost of capital. That means the ERP is around 8.1%, well in excess of historical levels.
That’s just my cocktail-napkin estimate, and should accompanied by a margarita and several grains of salt. But if I’m in the ballpark, stocks looks like a solid buy, at least compared to all the other risky assets out there. With bond spreads thinning, people are going to start reaching for yield elsewhere. When that happens, there could be a nice run-up in stock prices as the ERP gets compressed to historical levels. So it may be that our retiree will be OK after all.
Traffic Jams & Predictive Models
Jun 10th
How great would it be to know about traffic jams an hour before they happen? IBM has developed a system to do just that.
During pilot tests in Singapore, forecasts made across 500 urban locations accurately predicted traffic volume 85 to 93 percent of the time and vehicle speed 87 to 95 percent of the time. Similar results were achieved in Finland and on the New Jersey Turnpike.
The key to success is predictive modeling—software that combines real-time data from road sensors and cameras, as well as GPS transponders in taxis, with historical traffic information, roadwork conditions and weather forecasts. Each week the model recalibrates based on statistics from the most recent six weeks. It broadcasts advisories to electronic road signs and car navigation displays. The system also predicts when a congested road will return to normal flow.
The end-goal here is to notify drivers of problems in advance, thus steering traffic along lower-volume routes to reduce stress on the most congested roadways. If the system sees a traffic snarl building along Piedmont Rd., road signs and mobile apps will recommend taking I-85 to Buckhead instead. The idea is to lower the citywide opportunity cost of transportation by increasing average speed and decreasing average time spent in the car. If you can re-route the right number of cars at the right time, you reach a Nash Equilibrium with traffic spread among multiple routes, with no route materially faster than another.
Yet I doubt this will work as well as it’s supposed to. Heisenberg’s Uncertainty Principle comes to mind: sometimes the act of observing changes the nature of the thing being observed. Because people are aware a traffic jam may form, they alter their behavior (say, by taking another route). But everyone has access to the same information, and everyone is trying to out-guess each other. So the prediction model creates a snarl-up on the alternate route instead (exactly the opposite of what was predicted). Fortunately, IBM has considered this problem:
In each location, ongoing work will optimize the advisories. If, for example, Highway 1 is clogged and too many drivers who receive messages flock to Highway 2, it will become clogged; engineers will customize the model so it can determine whether sending the messages to only 25 or 40 percent of drivers, say, would best balance the two roads. And because a high percentage of drivers now carry cell phones, IBM is working with several telecom companies to be able to track the continually changing density of their phones along roadways, which could provide finer-grained modeling.
Seems problematic to send the messages to some people but not others. People would either object on fairness grounds, or they’d find a way to hack the system and get up-to-the-minute messages regardless. If they do, the system wouldn’t work and we’d be no better off.
Actually, the best use for such predictive modeling is probably in road planning & construction. IBM could partner with cities & states to target infrastructure improvements (lane expansion, light timing, mass transit etc.) that will have the biggest impact on transportation efficiency. This prioritization function would be especially beneficial for cities with tight budgets i.e. most of them. Officials could also run population scenarios and thus plan appropriately for growth (would have been useful in Atlanta 10-15 years ago).
I’m encouraged that the technology has progressed this far and that agent-based models are coming into the mainstream. I do dream of the day when traffic jams are a thing of the past.
Commercial Space Flight Economics
Jun 8th
A guy is spending $500 million of his own money to launch two private space stations. He’s planning to rent space to small/developing nations, giving them cheap access to the orbital research environment without the expense of running a full space program. It sounds crazy, yet I figure this venture could make him a billionaire many times over. Let’s run some numbers.
The stations will hold 36 people in total, housed in 6-person modules.
For a country or company willing to sign up for a four-year commitment, the lease for an entire six-person module would cost just under $395 million a year, and that would include transportation for a dozen people each year… prices are good through 2018, and Mr. Bigelow said the prices would drop by then if, [as expected], rocket prices drop.
That works out to a revenue run rate of $2.4 billion / year. And that’s the discounted rate.
A 1-month stay will set you back $25 million /person – including transportation to/from the station. That works out to $800 million per month, or $9.6 billion / year.
Assuming demand is there (and I suspect it is), the stations would probably take in annual revenue of $4.0 – $6.0 billion. Based on the figures quoted in the article and some very rough guesses, I think operating costs could run as follows:
$1.0 billion – launch purchases
$1.3 billion – space station operating costs
$500 million – capital expenditures to the stations
$150 million – corporate overhead
$2.95 billion Annual Operating Costs
$1.05 billion – 3.05 billion Annual Free Cash Flow (beginning 2017)
I figure the stations might last 12-15 years before they’re obsolete and have to be retired. With a total personal investment of $500 million, founder Robert Bigelow (of Budget Suites tycoondom) is looking at 46% – 69% Real Internal Rate of Return over the next 20 years. Put more simply, he’ll get all his money back within 6 years and still net $1.0 – 3.0 billion / year for himself for 15 years or so.
Much work stands between today’s dream and tomorrow’s reality. But it’s clear that commercial space flight has a bright future and could create some galactic-size fortunes for the early pioneers.
Count me in.
Call all you want, but there’s no one home…
Jun 7th
After writing 3 words in this post, I got distracted and checked Facebook, then email, then Twitter in succession. 10 seconds later, no wiser or better in touch, I returned to the real task at hand – writing this paragraph. And so it goes pretty much all day – rolling waves of digital distraction, punctuated by brief periods of focus. And so it goes for more people than ever. I’m *shocked* to hear this kind of Internet ADD can have consequences beyond carpal tunnel syndrome:
The lower-brain functions alert humans to danger, like a nearby lion, overriding goals like building a hut. In the modern world, the chime of incoming e-mail can override the goal of writing a business plan or playing catch with the children.
“Throughout evolutionary history, a big surprise would get everyone’s brain thinking,” said Clifford Nass, a communications professor at Stanford. “But we’ve got a large and growing group of people who think the slightest hint that something interesting might be going on is like catnip. They can’t ignore it.”
NYT goes on to say that multitasking actually decreases productivity and the creative impulse. Phone calls, text messaging, email, Facebook, etc. bombard the brain’s receptors with visual and aural stimuli – all day long. You can’t ignore it, any more than a cat can ignore a roach scurrying across the linoleum floor. And once you’re hooked on the flow of information, it’s hard to go back. After all, you don’t want to miss anything important!
Except that you do miss things – even the really important stuff. That’s because your brain becomes less adept at filtering irrelevant information. So you may be able to quote Lady Gaga’s Twitter feed word for word, but you probably forgot to pay Comcast on time and got your cable shut off. Oh wait, that’s me…
The rise of the internet and cheap computing drove the 1990s productivity boom – and helped fuel one of the highest-growth episodes in economic history. I wonder whether Web2.0+ will have as great an impact on productivity. When does technology begin to outstrip our ability to process the resulting flow of information? When do the gains from instant communication create more distraction and giga-garbage than we can reasonably handle?
Sometimes it seems like we’re already there. Whether you’re in a business meeting or a smoky bar on Saturday night, at least half the room is messing with their smartphones at all times – casting a little blue glow that makes faces and hands seem otherworldly. Appropriate, because such people are in their own electronic world, and not the one they happen to be standing in. They might as well not be there at all.
I’m not suggesting we should put down our phones or give up the internet. We’re in an information arms race, and whoever knows more sooner wins. But if we’re always plugged in – even when we’re physically with other people – our ability to communicate suffers and we lose a little bit of our humanity. And oddly, we sometimes react to information overload by shutting down entirely – closing ourselves off even from the people and things most important to us.
It’s possible that we may evolve to better handle multitasking – particularly as technology/biology converge in the next 100 years and we all become cyborgs. For now, though, all we can do is hold on for dear life and hope we don’t drown trying to drink from the information fire hose.
The Disappearing Equity Risk Premium
Jun 3rd
Megan McArdle wonders whether stocks measure up to bonds in prospective future returns:
So what you get is a market where expected future growth is fully priced in, and there’s no substantial premium for holding equity over debt. So all that’s left is volatility–stocks bouncing around in a mostly uncorrelated fashion that evens out over time, marked by a few unhappy moments when there’s some major market event and everything heads in the same direction at the same time.
It’s hard to imagine there’s much upside in the stock market these days.
Real interest rates are already very low, causing assets to remain richly priced relative to the income they generate. Should the real interest rate climb again (i.e. if China reorients toward domestic consumption and the Feds keep borrowing money), asset markets will decline relative to what they would have done otherwise.
If, the Equity Risk Premium (“ERP”) really is at an historic low, we’re unlikely to profit much by taking equity risk going forward (unless you think the economy will grow a lot faster than projected). So while we’ve had a nice run-up coming out of the recession, stocks don’t seem to offer much of a bargain anymore on a risk/reward basis. This may explain some of the recent weakness in global stock indices, and could be evidence of a longer-term shift away from equities and toward fixed-value investments like high-yield bonds and US Treasuries:
If the equity premium is substantially diminished, or even gone entirely, then there’s no reason to favor stocks as much as most people do, other than as a way to hedge the inflation risk of your bond investments. If that’s true, then it really might be time to sell.
I’m not going to make a habit of prognosticating here – but I have some real concerns about the price of risk and what it means for asset prices going forward. The economic crisis doesn’t seem to have caused much upward movement in the ERP as you would expect. But I anticipate this will change as 1) the rich world ages and 2) Chinese savings rates decline and their bubble pops. Hold on to your potato.
Welcome and Call to Action
Jun 2nd
Merry Banker is hereby christened. The purpose of this site is to share timely and relevant commentary on business & current events. I’ll try to stay on target with the finance angle – but you may find me veering off topic here and there as it suits me. I’ll also post finance case studies and how-to’s for investment decision making.
But this is not a one-way conversation. In sharing my thoughts, I hope to inspire discussion and debate. I want to hear what you have to say. Please comment liberally, especially if you disagree. Just keep it civil, please.
Enjoy yourself!