Start with a Large One

There’s an old, old joke about how to make a small fortune on speculative investments: start with a large fortune. We’ve seen a lot of examples of this principle over the years, but I have to admit that the recent rise and fall of the parent company behind the “Movie Pass” subscription service is so extreme that it is genuinely hard to believe it is really happening. And the fact that apparently there are still investors out there who are holding on to the company’s stock in hopes of it making a comeback takes us well past the point where the whole things sounds like satire…

If you’re not familiar with Helios and Matheson Analytics, don’t worry about it; their business is almost entirely built around Movie Pass. If you’re not familiar with Movie Pass, the basic idea was that users would agree to pay a monthly fee for a specified period, in return for which they would be able to go to an unlimited number of movies. The number of movies per month was later lowered to a specific number, but regardless of how often you were allowed to use it, the business model was clearly based on having more subscribers who pay for the service and never use it than subscribers who go to the movies all of the time…

Now, we should probably concede that there have been many other subscription businesses based on this same model that have succeeded very well over the years. A familiar example would be “health clubs” – private gyms – that offer memberships at somewhat less than the actual cost of providing service to an additional customer. Since a certain number of their customers will sign a two-year contract and then use the facility less than a dozen times – in some cases the number of customers actually going to the gym has been recorded at less than 25% of those paying for the privilege – this model can be highly lucrative. Unfortunately, it is much easier to go to the movies than it is to go to the gym, and attendance was correspondingly higher…

Without auditing their books I can’t tell you how much of the resulting operations failure was predictable, but one fact that stands out in the Market Insider article and other accounts of the company’s failure is that Helios never managed to negotiate a discounted high-volume rate for the movie tickets it was providing to its subscribers. If the company had obtained such a rate – say $5 per movie – and then offered customers five movies per month for a subscription of $30 per month they would have made $60 on every customer who attended all 60 movies over the 12 months, and more than that on anyone who attended fewer than that. Meanwhile, if movie tickets cost from $10 to $15 each, the service is still a good deal for the customer, since they will break even if they go to two shows a month, and save money after three…

Marketing a service that provides a finite number of movies, even at a remarkably good price, would have been much more difficult than just advertising “unlimited” movies and hoping that the majority of your customers don’t attend more than a few movies each year, of course. By the same token, it would probably have been a good idea to get the bulk discounts on movie tickets before you started offering the service to the public, and it probably would have been an even better idea to figure out what would make movie studios want to offer you bulk discounts in the first place…

Given all of these issues, I’m not sure why investors are continuing to hold onto the stock when Helios has seen its stock value drop from somewhere over $100 a share to somewhere under 10 cents a share, but then I can’t explain why people would keep buying more shares as the company was leaning further and further into its death spiral, either. It’s possible that people don’t really understand how sunk costs work, or what escalation of commitment means…

But that’s a discussion for another day…

Two Tribes Go to War

I read with great interest the story on Fox Business this week about the falling out between Kroger and Visa. It’s a classic example of two parties each believing that they have the upper hand in a dispute, and refusing to budge because they expect their opponent to blink first. But as American author David Drake points out, wars generally start when both sides believe they can win, and more than half of the time they're wrong. In this case, Kroger believes that VISA needs them more than they need the credit card company, while Visa believes the same thing about the supermarket. There’s a chance that both of them are wrong, and an even bigger chance that the dispute will cost both of them more than it ought to…

At the heart of this dispute is the fact that all credit card companies charge merchants a set amount for processing sales made using their cards – that’s how the credit card companies make their money, along with the interest they hope to collect from consumers who happen to be bad at math. For years, American Express had the highest fee structure, which is what led to a number of businesses refusing to take American Express cards. Master Card and Visa have traditionally had some of the lowest transaction fees, but apparently Kroger believes that it should be given a better rate than Visa wants to give them, based on the number of transactions Kroger sends in each day…

Visa, in turn, apparently believes that Kroger should be satisfied with paying the same rate that all of its competitors get. Every business wants to gain some competitive advantage over the other companies in their industry, but Visa does not see any reason why they should make less money per transaction in order to give Kroger a better bottom line. As a result, Kroger is threatening to stop taking credit cards with the Visa logo, and Visa is telling them to go ahead and refuse to accept payment and see what effect that has on their business…

Now, we should probably acknowledge that no business has any obligation to accept any particular form of payment. There are still a number of cash-only businesses operating in every community, and others who won’t take checks, vouchers, or Bitcoins. Kroger is only accepting the various credit cards as a convenience to its customers, and if it has enough loyal customers – or, at least, enough customers with more than one method of payment who still want to shop at Kroger if they can’t use their Visa cards – then this dispute shouldn’t affect them. Likewise, Visa has thousands (or millions) of other merchants who are still accepting their cards and paying their fees. What I think both companies are ignoring in this case is the competition…

The grocery industry normally operates on insanely low margins; food products can have as low as 0.8% margin, which makes it understandable that Kroger would want to save money on their merchant’s fees. Unfortunately, that also means that even a very small number of lost customers will impact their business. Visa doesn’t have the same problem – margin isn’t usually an issue for financial services firms. But Visa makes most of its money from the interest it charges cardholders, which means that the only thing that would be worse for them than not receiving merchant fees for transactions would be if people stop using their Visa cards for transactions on which they will end up paying interest…

It should be interesting to see which company blinks first. From where I’m sitting, each of them needs the other badly enough that they should really stop butting heads and work something out, but once again, I’m not the CEO of a major grocery or financial services company, and I don’t have access to their books anyway. Let’s just hope they figure this out before one or the other company fails and throws thousands of people who want no part of this feud out of work…

Still Hard to Believe

I was reading an article in Barron’s this week about how companies are using the increases in revenue from the recent changes in the corporate income tax laws to buy back their own stocks, and provide larger rewards to shareholders in record amounts, and wondering how anyone watching this could possibly be surprised by it. I realize that this blog is starting to sound more and more like The Grumpy Old Man blog and less like a business blog, but the fact is that I’ve generally been in a bad mood since roughly 1977, I’m certainly not young anymore, and I’m absolutely a male human being of adult age for all that I don’t behave that way. And this latest reaction by business to our changing financial climate is the sort of thing that could have been predicted by a particularly dim six-year-old – or anybody else with no grasp of how money works…

It’s important to remember, I think, that stock shares aren’t just representative of an ownership position in the company; they are also sold by the company to raise money. Buying them back does cost money; potentially a lot of money. But as a result, the remaining stockholders effectively end up owning a larger share of the company, because the repurchased shares are now owned by the company, which is to say, by them. Even in the case of an overvalued stock, the share price is likely to rise because the shares themselves are now actually worth more than they were before. Naturally, this will make the stockholders happy, which will in turn make them more likely to retain (continue employing) the current board and management team, who can in term continue to collect their (sometimes ridiculously) large salaries…

This isn’t really a difficult concept. In fact, it’s somewhat simpler than a normal stock price increase. Most of the time, when the market price of a stock rises, it is because the people buying it believe that the company is or shortly will be worth more than the total value of the stock price indicates. This may have no connection to reality whatsoever, particularly in the cases where investors are speculating about things that haven’t happened yet. This is one of the factors that makes picking stocks that will increase in value so maddening; in addition to all of the economic, financial, political, and social factors involved, you’re also trying to predict buying decisions that may be completely irrational. Even people who are very good at picking stocks are only correct a relatively small percentage of the time…

From where I’m sitting, the question here is really why anybody would expect the companies who were in a position to do this to do anything else. The people responsible for the changes in the tax codes keep insisting that businesses will use the extra funds made available by the lower tax rates to expand their operations and create additional new jobs, but why should they? If any of those corporations want to use their own money to expand they probably could, but their stronger stock position means (among other things) that they can borrow money at a much better rate, and they can use the repurchased stock shares as collateral if they need to. And if a company is already profitable, and they have just become considerably more profitable, why would they or their ownership group want to mess with a good thing?

Now, I would be the first to admit that finance can be intimidating if you’ve never studied it. But this isn’t really a question of finance, or even of economics. Anybody who can grasp the idea of making the people who own your company happy being a good way to keep your job can understand why repurchase programs would happen, and anybody who can imagine that a time when people who are clearly driven by political advantage over any practical concern are making irresponsible changes to both our tax codes and our international trade status would make people cautious about expanding their operations can understand why these companies aren’t, in fact, expanding their operations…

I’ve heard a lot of people insisting that finance and/or money is too complicated for them to understand over the years – and I’ve annoyed a number of them by replying that the subject is entirely within their abilities, and refusing to learn about it means turning control of every part of our civilization that runs on money over to people who have no particular reason to act in the public interest. Let’s hope that somebody starts paying attention – to the economy, if not to me – before things get any worse…

Release the Vultures!

By now you’ve probably heard about Toys-R-Us shutting down, either on the news or by seeing someone standing on a street corner holding one of those black-and-yellow “Store Closing” signs. You may also have seen video footage, online or on the news, about long-service employees, in some cases people who have been with the company for 30 or 40 years, being let go with no severance pay. But if you’ve been tempted to blame the failure of the company on Amazon or Wal-Mart, or showrooming, or any of the other scourges of retail businesses these days, I regret to tell you that the answer is much, much, worse – and far sadder…

You can find any number of stories and files online that go into detail about this, but I thought the article on Boing Boing did a good job of summing up the situation. I don’t have much to add to Cory Doctorow’s excellent reporting, but I thought the point ought to be made (again) about who is responsible for this travesty. Basically, what happened to Toys-R-Us was that a cabal of venture capital firms bought it, used the company’s assets to borrow a huge amount of money, took out a reported $200 million for their personal enrichment, and then defaulted on all of the loans. In addition to announcing that they wouldn’t be honoring the loans, the VC firms also revealed that they wouldn’t be keeping any of the commitments them made to their employees…

If you’re wondering how they got away with this, I regret to tell you that as far as I can tell none of the venture capital firms have broken any laws. It’s possible that one or more of their creditors may choose to sue them for defaulting on their loans, but if they’ve worked this out right there should be enough proceeds from the bankruptcy sales to cover most of it, and the lenders can write off whatever is left on their taxes. It’s also possible that the employees might be able to recover something through their own legal efforts, but in any case all of these are civil matters; no one has been charged with a crime – or is likely to be…

This class of financial banditry is sometimes called “Vulture Capital” and the firms involved are referred to as “Vulture Capitalists,” although I have to say I think that the nickname is unfair to actual vultures, who (as previously noted) never bother anything that is still alive. There are no laws to prevent this sort of thing, partly because it would be difficult to prove the difference between somebody doing this in order to extract money and then crash the company and somebody who just borrowed too much money and then failed in their attempt to run the company. You can’t realistically make it a crime to be bad at management (or finance, one assumes), nor would you want to throw people who were actually trying to do the right thing in jail because they overestimated their abilities…

Unfortunately, that means that people like the vultures in this story can abuse the system for their own ends. The other reason no one has been able to establish a standard for distinguishing vulture capitalists from garden-variety incompetents, or implement a law to stop them, is because (as you might expect) a lot of very wealthy people have spent a lot of time and money to prevent it. It might be possible for more progressive political forces to combat this, assuming that there were any and that anyone in the general public cared about this issue before their employer of thirty years was purchased and carved up by vultures. But until such time as the American people start demanding greater accountability, from their political leaders if not from their business leaders, this sort of thing will probably just keep happening…

So the sad truth is, that the people responsible for this travesty, and all of the others like it, are us…

The Other Bernie

In the movies, and in most other narrative art forms, once the bad guy is convicted and sent to jail that’s usually the end of the story. Occasionally there will be a follow-up or a coda that talks about the character’s experiences in prison, but for the most part there isn’t a lot to say about sitting in a small room with bars on the windows for fifty years without the possibility of parole. But sometimes the conviction and jail sentence is the beginning of the story, or more correctly the end of one story and the start of a new adventure. As such, I really wasn’t all that surprised to find our old friend Bernie Madoff back in the news…

You can take a look at the Quartz Media page if you want to, but it’s a fairly simple tale. Apparently, while in Federal prison in North Carolina (at Butner Prison, one of the infamous “Club Fed” facilities), Madoff managed to buy up all of the instant hot coca packages available in the commissary and started reselling them at a profit in the prison yard. According to this report, things have gotten to the point where if you want to purchase any of the stuff you have to “go through Bernie”. Since he’s already considered a prison-house celebrity – other prisoners come to him for financial advice and stock market tips – no one seems to mind, and given some of the things that a criminal mastermind can get up to while in prison, I doubt the prison officials are worried about it, either. What struck me as funny was that this actually makes the previous Madoff story somewhat more credible…

Back in 2011 I brought you the story about Madoff claiming to be working with Harvard Business School to develop content for a new course offering in investments – and how to detect fraudulent ones, I would assume. You can look up my original post here, if you want to, but at the time I used this as an example of not believing everything you read on the Internet, a topic which has now become all too common on business blogs and related sources. But if this story is true – and so far it appears to check out – then it would appear that Madoff has, once again, proven himself to be sharper and more ruthless than the majority of the people living in his environment, which suggests that he really might have some lessons worth listening to. What struck me as most unfortunate was that he didn’t figure all of this out ten or twenty years earlier…

You see, none of the activities described in the Quartz article are illegal, or even against prison regulations, apparently. Yet, despite the obvious handicaps of operating inside a Federal prison with limited funds while surrounded by thieves, fraudsters, and con artists, he still managed to pull off a financial (commodities trading) coup like this one. That, combined with some of his earlier success before he turned to running a Ponzi scheme, makes me wonder what Madoff might have accomplished if he’d actually stayed on the straight and narrow. Granted, it probably wouldn’t have been anything as lucrative as stealing $50 billion, but it probably wouldn’t have involved a 50-year prison sentence, either…

Please understand me when I say that I’m not trying to excuse any of Madoff’s behavior; quite the contrary. I consider this story to be the final evidence, if any was actually needed, that Bernie could have achieved almost any conceivable level of success without ever committing a crime, which leaves arrogance and narcissism as the only possible motivations for his offenses. And while it doesn’t seem likely that anyone will risk letting him loose on the public again, particularly in light of his most recent activities, I would still advise my readers (assuming I have readers) not to bet against hearing from Bernie Madoff again in the future…

Some Call It Justice

You may have heard the term “schadenfreude” before – it comes up in popular culture every so often, as in the case of the Avenue Q song by that title – but if you’re not familiar with it, the definition is “pleasure at the misfortune of others.” In this increasingly cynical world we’re seeing more and more cases of it, probably best demonstrated by things like the homeowners who had been wrongfully foreclosed on by Bank of America (they didn’t have a mortgage with B of A or anyone else) getting a court order to seize all of the company property from their local branch. Call it karma, cosmic retribution, or evildoers finally getting their comeuppance, these reports have become seen as feel-good happy-ending stories to lighten up our news. And in the case of the debt collection agency that just got nailed for $83 million in punitive damages it’s hard not to agree…

You can find the original story on the New York Daily News site if you want to, but what it comes down to is an outfit called Portfolio Recovery went after a woman in Kansas City for a debt that they knew was not her own – it was owed by somebody with a similar name. The jury in the case ruled that the company knew perfectly well what it was doing, but figured to make an easy buck off the victim, and decided to slap the firm with these amazing damages for violating the Fair Debt and Collection Practices Act. Apparently, the fact that the company knew it was in the wrong and continued to pursue the fraudulent claim for over a year annoyed members of the jury…

Interestingly, the company’s statement about the case (also available on the Daily News site if you want it) calls the amount outrageous and says that Portfolio Recovery is going to appeal the award based on its size – but does not protest that the company did nothing wrong, as you would probably expect. Apparently, the court case established not only that they actually did the things of which they were accused, but also that they knew the collection attempts were fraudulent and continued with them anyway – which would seem to be an even more spectacular failure than the original ill-advised collections effort…

Now, no one is really saying that a year of the plaintiff’s time was actually worth $83 million, or even that the emotional distress caused by the proceedings is worth whatever portion of the award she gets to keep after paying her legal fees. The jury’s point is clearly that unless the company is slapped down good and hard, with an award of damages that is just too massive to ignore, they will probably do the same things again next time. And I’m sure that everyone involved expects the company to appeal the award and try to spend years or decades tying the whole thing up in court, until the plaintiff either gives up or dies. In this case, however, that’s probably a really bad idea…

From a strategic standpoint, what the company needs to do is settle the case as quickly as possible, and with as little fanfare as possible. It’s not unheard of to have settlement agreements that include all parties involved not speaking about the case ever again, and Portfolio Recovery can probably get such an agreement into the deal if they make a large enough offer. Once they settle the case the whole story will drop out of the news cycle, and the company can quickly audit its books to eliminate any similar cases (ones it knows are bogus) and make good-faith efforts to resolve any similar cases before the next lawsuit comes up…

Because every day this story stays in the headlines it will come to the attention of more people, and eventually one of them is going to decide that he or she can win an identical lawsuit, even if they were not wronged by the company. And if that happens, schadenfreude is going to be the least of their problems…

Predators on Parade

Over the years I have written in this space a number of times on the subject of predatory lending, and the occasional feedback I’ve gotten about it usually ranges from confused to skeptical. People in general are reluctant to believe that a financial company would simply ignore state and Federal banking laws in order to offer loans with unscrupulous terms to the desperate; people in the Internet age find it hard to believe that anyone would accept a loan at four or eight (or 20) times credit card interest when they could almost certainly obtain something better online. Unfortunately, neither of these beliefs is necessarily true – as an article on the Detroit Free Press website last week makes all too clear…

According to the story by Susan Tompor, Michigan’s Attorney General has just announced a settlement following legal action against two out-of-state lenders who had been offering short-term loans at rates ranging from 89% to 169% interest, or between 12 and 24 times the State limit for unlicensed lenders of 7%. The story notes that under such a loan a consumer who borrowed $1,000 for a two year period would end up paying over four times what they borrowed. Even worse, however, was a much shorter (six-month) loan program with an effective APR of over 350% - effectively, paying $1.75 for each dollar you borrowed in addition to repaying the full amount…

It’s not always clear why people agree to loan terms like these. In some cases it really is desperation – the need to pay off some expense that can’t be financed any other way, and for which default (or foreclosure) isn’t an option. In other cases it’s a matter of speculation – the belief that the customer can take the money, buy something, sell it quickly for more money, and pay back the original loan before the interest has a chance to add up. You will see this kind of thing happen any time there’s an investment bubble in play – we saw it in 2005-2008 in the Real Estate Bubble, around the turn of the Century with the Dot-Com Crash, even during the Beany Baby craze in the late 1990s. But the sad truth is that many of these loans result from the fact that most people don’t really understand how finance actually works…

Now, we should probably acknowledge that loans of this type do represent a large risk for the lender. Generally unsecured by anything, and frequently take out by people who lack either the assets or the income that would make it worth taking them to court, a disproportionately large number of these loans will end up in default, and the company will never recover any of the money. Consequently, the interest rate on these loans has to be high enough to make up for the increased risk, or no one would ever offer them in the first place. Unfortunately, that’s also where and why the whole topic moves into the grey area…

If the state imposes a hard limit on the interest that can be charged for unsecured loans (in Michigan that limit is currently 7%) then there is also a hard limit on how risky the individual loans can be. If the lender can only make 7% on its money, and more than 7% of its funds are never repaid at all, it will quickly go out of business. Such a policy will prevent people from being charged 169% interest on a loan, but it will also keep someone with an 8% chance of defaulting from getting a loan. Predatory lending appears in the first place because there are people with a (real or perceived) desperate need for funds who can’t qualify for an ordinary loan – and as long as that need exists, there will always be unscrupulous companies who will be willing to risk state and Federal sanctions to make a fast buck…

Unless we can manage to educate the public about how finance works, or at least about how consumer loans do, this situation is probably going to continue. Alternately, I suppose, we could try teaching people about saving money, living on a budget, and not blowing money on get-rich-quick schemes or inappropriate purchases. In either case, however, I would not recommend holding your breath…

Financial Aid Starts Early

You may have heard the jokes – they go all of the way back to the Murphy Brown television series in the early 1990s – about how competitive preschools are, and how choosing the wrong one could start a fall of dominoes that will prevent your child from getting into the right grade school, middle school, high school, college and graduate school. Exactly how many people actually believe in such a sequence is unclear, but there are still news stories every few years about preschool programs that cost as much in tuition as most public universities, and the massive competition that occurs each year to get into the best. An offshoot of these jokes involves parents taking out student loans on behalf of children who are not yet able to dress themselves, or in the case of less wealthy families, seeking financial aid in order to achieve the same results. Unfortunately, this may be less of a joke than you’d think…

According to a story that ran last week in the New York Times, the problem with preschool is that it isn’t affordable for a very large range of families, especially in the case of single parents who also need after-school daycare. The example given is in Chicago, where even the public school system’s Preschool program runs in excess of $13,000 per year – over a thousand dollars per child per month – and private programs range upwards from there. There are low-income programs like Head Start, for families that qualify, but most people living above the poverty line can’t get their children into those programs, which only leaves student loans, personal loans, and the aforementioned financial aid programs. Programs which, it turns out, also leave large numbers of parents and their children out in the cold…

Now, we should probably acknowledge that the Daycare issue isn’t a new concept. For at least the last twenty years, and possibly more like fifty, many working-class families have had to decide between working a second (or third) job in order to pay for daycare, or just having one parent quit their jobs and stay home with the children. Indeed, if your monthly take-home pay is $1,000, and cost for childcare is going to be $1,120 per month, you probably couldn’t afford to go back to work if you wanted to. A single parent does not have that option in the first place, of course, and once we start considering child support and spousal support issues the whole matter of who actually qualifies for financial aid becomes even more complicated. The real question is what to do about it…

Greater funding for financial aid programs would seem to be one obvious approach, except for the fact that all of the existing financial aid systems are overtaxed, not just the ones available to preschool students – and the fact that funding for public education is already in crisis. As appealing as the idea of pumping additional money into local school districts in an attempt to increase the number of places available in public preschool facilities might be, it does not appear that throwing additional resources into traditional methods is going to help. The question that comes to my mind is whether there might be a private-sector approach that would help…

We have already seen examples of companies offering subsidized preschool programs as a benefit for their employees – offering the services at cost makes them effectively resource-neutral on the balance sheet, while at the same time helping to retain valued employees and raising morale. There can even be an operational efficiency improvement, in that employees who have children in daycare in the same building in which they work do not have to leave the premises and travel across town in order to look in on their children. Public support for such programs could be very cost-effective, since every child placed in private or corporate daycare would be one less individual competing for finite resources in public schools or from financial aid programs. But there might be an even more direct approach to the problem…

As of the last time I checked, there was no specific program available to fund new daycare businesses – but there is no reason that the Federal government couldn’t establish one, either through the Small Business Administration (SBA) directly or through the entrepreneurship programs that all of the Federal agencies are required to support. By doing so, they would be able to relieve pressure on both the financial aid system and the public daycare system, not to mention creating jobs for all of the caregivers who would then be employed by the private-sector daycare centers. You would need additional social services personnel to regulate such businesses, and some additional infrastructure to administrate the SBA programs, but you would also be creating profit-making businesses and gainfully-employed citizens, all of who would (in theory) also contribute to the tax base and put additional funds into the local economy…

I’m not saying any of this would be easy. On the contrary, any such program would require a great deal of resources to start and to run, as well as considerable intestinal fortitude on the part of the public officials that launched it. But at least we could get rid of some of these competitive preschool jokes…

The Cost of Space

There was an interesting article on the Vox website a week or so ago about the relative costs of exploring and colonizing space relative to the amounts our government spends on other things. It’s no secret that I have been in favor of space exploration for as long as anyone can remember, going back to early childhood when I watched Neil Armstrong step out onto the surface of the Moon for the first time and “helped” (to the extent that a six-year-old can help) my father build a plastic model of the Apollo spacecraft. But over the years since Apollo space travel has lost a lot of its popular support and interest, and increasingly people seem convinced that moving beyond Low Earth Orbit is prohibitively expensive under any conditions short of a full-blown Cold War pissing contest. It turns out that this isn’t exactly the case…

For example, the cost of building and deploying the F-35 Joint Strike Fighter, everybody’s favorite high-tech boondoggle, is running about $29 billion per year (projected) over the course of its 50 year service life. The cost of a manned mission to Mars is estimated at about $5 billion per year over 20 years – about $100 billion compared to $1.5 trillion, if you prefer. Granted that no one has ever built the equipment to go to Mars, the price differential might not be quite as high as it appears; my point here is that a Mars project could run 100% over budget and still leave $19 billion a year over for F-35 units…

If that is too speculative – and I can see how it might be, given the currently unknown issues involved in interplanetary travel – how about something more down to Earth? Ask anyone you like which the US spends more money on, NASA or the Post Office, and see what they say. Most people would tell you that the USPS is supposed to make money, or at least break even; there are years where it loses money, but not that much. According to the USPS and NASA websites, however, our government lost $5.5 billion on the Post Office last year, while NASA’s Planetary Science program (that’s everything they’re working on that relates to the planets, moons and asteroids) received just $1.35 billion. To be fair, the whole of NASA’s budget is bigger than what we lost on the Post Office – it’s about $16 billion according to the agency’s own 2015 projections. But we should also note that this is still only a third of what we lost on Medicare fraud according to the GAO – not what we spent on actually providing Medicare benefits to the people who qualify for them, but what the Federal government lost on overpayments, benefits sent in error, and outright fraud…

If that’s not crazy enough for you, consider that according to the GAO, in 2013 the Federal government’s Office of Personnel Management spent just under $85 million on payments to Federal retirees who were, at that time, already dead. Again, that’s not counting death benefits or payments made to spouses or dependents; that’s the money literally thrown away. By contrast, the New Horizons spacecraft, which is due to reach Pluto later this year, costs about $78 million per year. And that’s not even counting silly things, like the fact that the U.S. Mint loses $105 million per year on pennies and nickels – pennies cost more than 1 cent to make, and nickels cost more than 5 cents to produce…

Why does he tell us this? I hear some of you asking. After all, it’s not as though I can tell you what we stand to make on our investment; I can’t even tell you for certain what the benefits of commercial utilization of space are likely to be. My point here is that the income from things as simple as communications satellites, memory foam, advances in electronics and the so-called “space metals” is already incredible, and all of the commercial space flight thus far is just barely scratching the surface of that potential waiting a few thousand miles overhead. There may be good reasons why we should not go to space; there may be more important or more immediate uses for the necessary resources here on Earth. I’m just saying that whatever those arguments might be, cost isn’t one of them…

You’ve Got to be Kidding…

It was one of those moments when you just assume that someone on the Internet is having a joke, either on you or on the world in general. On one of the news aggregation sites I like to visit was a headline about a guy starting a crowdfunding appeal to raise money to follow his girlfriend to Miami for Spring Break – on the grounds that she would dump him if he doesn’t rush to her side. I hit the link hoping to find the legend “April Fools!” somewhere on the other side…

Unfortunately, there was no such comforting word. You can pick up the original story from the Washington Post site if you want to, but I’m afraid the headline was correct: “Boyfriend to crowdfunders: ‘Girlfriend will dump me unless you send me to Miami spring break.’” It turns out that the young man in our story is convinced that “the sun just melts all the morals in Miami,” and unless he is there to “overseeing all parties and fun activity for the duration of the trip” his relationship will be over. Post reporter Peter Holley (whose article provided all of the above quotes) recounts these events with a remarkably straight face, not even stooping to humor when the modest amount requested ($300 USD) falls short by more than two-thirds of the total ($91 out of $300 requested), which is definitely better than I could have managed in his place. But as humorous as this story appears, I do believe it is covering a more serious issue…

Done correctly, crowdsourcing is one of those very rare new ideas that really can change the world for the better. Just over the past few years we’ve seen dozens, or possibly hundreds, of business ventures that would never have been able to obtain finding through traditional channels assemble the capital needed to launch successful ventures. Audio, video and publishing projects that no one would ever have gotten to see have been produced; new technologies that could improve the quality of millions of lives have been developed, charitable projects have gotten the support to serve people who would otherwise have been neglected, and deserving companies have been able to go on providing jobs to their employees, goods and services to their communities, and an honest living to their owners. Unfortunately, not all of these stories have ended well…

Last summer we heard the story of the young man who decided to request $10 on Kickstarter to make potato salad – not thousands of dollars to feed the hungry, or even money for groceries until payday, but just enough money to make a bowl of potato salad to see if he could. He ended up with well over $50,000 and a vast chorus of critics, all denouncing the stunt and bemoaning the fact that crowdsourcing projects asking for money to pay medical bills or feed the hungry were being ignored in favor of a bowl of potato salad. If you look around any of the major crowdsourcing sites you will find dozens of projects just as silly as this one, and dozens more posted by people who really do need help and have nowhere else to turn, nearly all of which remain unfunded or even ignored. And every day, the number of people asking for your support increases, until eventually finding even one worthwhile project will take longer than anyone has to spend surfing the Web…

It makes you wonder how many worthwhile projects are never going to be heard of at all because someone is trying to convince people to help him follow a woman who may or may not actually be his significant other around on a vacation that she apparently took without him. Or, for that matter, because of any number of other cute, funny, silly, satiric, sarcastic, naïve, inappropriate or delusional projects that collectively make this wonderful new form of capital development that much harder to use for people who actually need help…

Repurposing

Here’s another interesting case for you: Suppose you are the general manager of an airport that no one is using, and nobody particularly wants to move into. It’s not a far-fetched situation, either; a lot of the smaller and less well-traveled US airports are falling on difficult times following the consolidation of the industry. Thirty years ago there were over 70 major airlines in the United States, and at least four dozen of them that flew coast-to-coast, all competing for passengers and guarding air routes to which only they had access. Getting permission to use a gate in an airport outside your normal system wasn’t possible, at least not at anything like an affordable price, and customers in a given city were limited to whoever was already entrenched there. Then Congress deregulated the airline industry and everything changed…

Today there are fewer than a dozen carriers with nation-wide operations left in the US, and most of the survivors have been moving away from direct, non-stop flights in favor of a hub-and-spoke system. There was a time when if you wanted to fly from Los Angeles nonstop to Des Moines or Pittsburgh you could just get on a flight and go, but this is no longer the case. Today you’d probably have to fly to Dallas or Chicago (on American) or Denver (on United) or possibly Phoenix (Southwest) and catch a connecting flight – and some of the minor airports aren’t even that lucky. Increasingly in the US you will need to get on a regional carrier that can connect you to a major airport and change airlines there…

The difficulty here is that an airport is (usually) a large, sprawling installation, and it requires a lot of expensive maintenance to remain operational, regardless of how many flights are landing there. And while it might be possible to use some of the airport grounds to launch other businesses, both the EPA and the FAA will probably take a dim view of that, not to mention what Homeland Security and the TSA are going to think. Unless you can find some form of revenue stream that can be generated using the existing facilities, or whatever resources are located in, around, or under those installations, a lot of the lesser airports are going to have to close…

Fortunately for the folks in Pittsburgh, they’ve just discovered one such resource: natural gas. It turns out that the runways at the Pittsburgh airport are sitting over a large, and previously undiscovered, natural gas field – and that modern horizontal drilling techniques can get at the gas without disrupting operations at the airport or weakening the integrity of the structures. Dallas and Denver both have working oil fields on their grounds, and have operated them for years without any ill effects. This is especially important in Pittsburgh, where the Economist is reporting around half of the airport’s current revenue is being taken up just paying the interest on various debts. Hopefully, this will be enough to keep the airport out of the sort of death spiral where it can’t afford to keep up its facilities, so fewer airlines want to go there, which lowers revenue still further and the cycle repeats…

It isn’t being reported at this time just how long the natural gas deposits might last. We can only hope that the people running the airport will use the time during which the gas is flowing to figure out their next move – because eventually the gas field is going to run out, and when it does they’re going to be right back to where they are now, trying to find some other financially viable use for a dying airport…

The Ethics of Co-Signers

Let’s try this one as a hypothetical: Let’s suppose that somebody wants to borrow money from you. It’s not a large sum by your standards – losing it won’t bankrupt you – but if you just gave that amount away to anyone who asked for it you’d be broke in short order. Let’s also suppose that the person who is asking is a decent human being and you have no particular reason believe that they won’t pay you back, but they’re not currently working and won’t be for the foreseeable future. You might be reluctant to make the loan under those conditions, but let’s further suppose that the person asking for money finds a responsible third party (a parent, for example) who agrees to pay you back if the borrower can’t for some reason. Suppose you made that loan…

Now let’s suppose that a few months later your borrower dies in a tragic accident that is in no way his or her fault. What are you going to do? We will assume that you are neither heartless nor insensitive, but at the same time you can’t afford to just give money away at will – and your borrower’s parents co-signed on the loan, promising to pay you back if something like this happened. Would you go to the co-signer and ask them to honor the commitment they gave you and repay the loan? Does our answer change if the borrower’s parents are devastated by the loss? Does it change if they are approaching retirement age? How about if they have taken in the borrower’s (now orphaned) children and are working hard just to get by?

This sort of thing happens a lot more often that you would hope; there was a story about a case just like this that appeared this past week on CNN online. It’s not exactly a case of biased reporting, but it’s clear that both the reporter and most of the people who have written in the Comments think that it is terrible of the finance companies involved to be attempting to recover their money from these excellent grandparents who are already expending their savings and giving up any real chance of retirement in order to raise their grandchildren. The fact that the loans in question were student loans, and therefore can’t be discharged in bankruptcy or otherwise legally evaded undoubtedly make this even worse, but the basic issue remains: what are the loan companies’ ethical responsibilities in this case?

It’s easy to say that the lenders should just forgive all of the debt – reduce the loan amounts to zero, take a credit on this year’s taxes, and move on. And if this was the only such case that would ever happen I’m sure that all of the companies would just write this off. Unfortunately, there are thousands of such cases every year, and if the companies forgive all of them they will go out of business, throwing all of their employees out of work and doing potentially catastrophic damage to their stockholders – none of whom have done anything wrong either, we should probably note. It might actually be heartless to collect on debts like these, but it’s hard to imagine how it would be fair to destroy one group of innocent people in order to help another group of innocent people – especially when the group that will benefit really did bring the crisis on themselves…

Which brings me to the inevitable question: does a financial institution have an ethical responsibility to forgive loans – effectively throwing away money – because either the original borrower or their co-signer have suffered a personal or family tragedy? Does our answer change if the original borrower could easily have obtained life insurance (at a reasonable price) to cover the loan – which a healthy 27-year-old probably could have – that would have prevented the whole situation? Does our responsibility to be kindly and good people override our fiduciary responsibility to our stockholders or our professional responsibility to our employees and other stakeholders? Or should we just offer our loans and financial products at fair rates with clearly-written contracts and assume that our customers are grown adults who can make their own choices and accept the consequences of their actions?

It’s worth thinking about…

Define Success

I can’t really take credit for this one – I was directed to the idea from the What If site, which was created by the genius behind the XKCD web comic – but as I followed up across the related sites a question popped up in my rather idiosyncratic thought process: When can you reasonably describe a crowdfunding exercise that brings in over $1.4 million as a failure? Just as important, though, is the counterpoint question: When can you reasonably describe a project that receives just 0.0000025% of the necessary funding (that’s one dollar for every 40,000,000 you actually need) as a success? Well, it depends on the how you define success – and on how big the project really is, I suppose…

If you haven’t seen any of the Solar Roadways video or text presentations you can find a good selection of them on You Tube, but the basic idea is to replace the asphalt and concrete surfaces of all of the roads (and highways and parking lots and so on) in America with solar panels. Since that’s somewhere around 29,000 square miles, we could conceivably generate three times our current total energy requirements just using current solar cell technologies, with more to come as the state of the art improves. There are a number of technical issues involved, which you can read about on the Jalopnik site here, but there are also some offsetting advantages, such as using the same roadway-mounted solar panels to house programmable LEDs, making the roads reconfigurable in real time. Unfortunately, when we look at the business side of the concept the whole thing gets murky with amazing speed…

Project estimates provided by the Extreme Tech website put the total cost of conversion for 29,000 square miles of roads at around $56 trillion USD – or about four times our current National Debt – using the cost figures provided by the Solar Roadways company’s own projections. And that doesn’t even consider the costs involved in developing the clear outer layer of the roadway – there isn’t currently any form of super-glass that can handle all of the operational requirements for such a substance. There are also issues like the proposed LED lane marker system costing more than the solar cells themselves, the cost of transmitting the generated energy to customers who can use it (which dwarfs the rest of the project), and operational concerns like cleaning the glass tiles (roadways get dirty a lot), replacing broken elements while traffic swirls around you at highway speeds, and hackers getting into the LED lane markers and configuring the roads into one giant death trap…

Now, we should probably acknowledge that there is nothing inherently wrong with the idea of widely dispersed solar collectors, assuming there is some economical and technically feasible way of connecting them to the power grid. For that matter, even if a continental-scale project isn’t possible, there’s no reason you couldn’t have single streets or individual parking lots built this way that can power their surrounding buildings. If creating a self-cleaning glass strong enough to stand up to truck traffic while still collecting sunlight isn’t feasible, then what about roof tiles made the same way? Or simple parking-space carports, which are common in the sunny parts of our country, that use the same technology to turn entire parking lots into giant solar arrays? Of course, that would require further research and development, since the current solar cells are still a bit too expensive for this sort of mass use. If only somebody were to come up with seed money for such a program – say, using crowdfunding…

It remains to be seen if the Solar Roadways people will get anywhere with their more advanced designs; as previously noted, they still need 40,000,000 times more money to complete the project. But between crowdfunding and Department of Transportation grants they now have around $2.2 million USD in research funds, which isn’t exactly small change. I don’t know if we will ever drive on continuous bands of solar collectors, but it’s possible that we might park under them, work under them, or live under them sometime soon. Even with a funding percentage of 0.0000025%, it’s hard to call that a failure…

The Ethics of Bootstraps

In the past few weeks we’ve been hearing more and more about the deepening crisis regarding student loans and payments that can’t be reduced, discharged through bankruptcy, or even written off on your taxes, and how the estimated $1 trillion is contributing to our nation’s ongoing fiscal crisis. Since this is an election year, people have been lining up to use this as a partisan issue, with people on the right claiming that this is just another example of people feeling entitled (and proclaiming that THEY never took out any loans to fund their education), while people on the left attack the idea of student loans that must be repaid as being anti-education, anti-intellectual, repressive measures used by the ruling classes (or plutocracy, if they think to use the term) to keep people down. As always, I’m going to leave the political and social issues to those better qualified to discuss them, but there’s an obvious business issue regarding whether people should be required to pull themselves up by their bootstraps – and whether that’s even possible anymore…

First off, there’s the issue of how college tuition and related expenses have climbed while the relative value of college degrees has fallen. Minimum wage has risen by a factor of slightly more than twice since I was in school, while tuition for my relatively cheap public university has risen by a factor of more than ten. When considered in the light of the devaluation of the bachelor’s degree, the disappearance of affordable consumer credit and the crashing economy, it seems clear that present conditions are not comparable to those of even one generation ago; suggestions that the undergraduates of 2012 can do things the way those of 1982 (let alone 1952) are at best disingenuous, and at worst, self-serving nonsense. But even if we accept that obtaining a college education is more expensive (and therefore more difficult) than in previous decades, the issue of how much assistance should be made available to students remains unclear…

Consider, for example, the scenario so beloved of right-wing politicians where a student has assumed $100,000 worth of debt in order to a bachelor’s degree for which no career track exists. In previous generations such a debt load (even adjusted for inflation) would not have been required, and the graduate would likely have been able to obtain a suitable (if not ideal) job on the strength of the degree alone. Under present conditions the graduate may well have no realistic hope of ever being able to pay off the loans – leading to crushing poverty, career failure and the aforementioned trillion-dollar drain on our economy. Moreover, it is now relatively simple to determine the expected income of any career track, as well as the number of such jobs currently available. With this information it should be possible for a student to calculate the probability that he or she will be able to manage (and pay back) a student loan, just as they would with any other debt. Or, I suppose, a compassionate lender could do it for him or her…

Now, I don’t want to suggest that everyone who wants to get an education shouldn’t have the opportunity to do that; I’m just pointing out that it isn’t economically possible to provide financial assistance to everyone, just as it would not be possible to extend $100,000 worth of credit for car loans or credit cards to unemployed 20-year-olds with no job prospects either. The difficulty is that some of our most successful people did not have any idea what career they would follow or how their college degree would (or wouldn’t) help them in the future – and we can’t expect loan providers or their personnel to know such things either…

So the question is, do we have an ethical responsibility to provide every potential student with the resources to go to college, knowing that some of them will gain no benefit from doing so and that the continued failure to repay student loans contributes to the destruction of our economy? Or do we have an ethical obligation to our society, our taxpayers, and the employees and stockholders of our financial institutions to require them to make only those loans that have a reasonable chance of being repaid, even though we know that this will deny some students who would otherwise be wildly successful the opportunity to go to college and gain the tools they will need?

It’s worth thinking about…

Good Fundraising, Bad PR

I noted with great interest a story on the Washington Post website this week about the University of Maryland’s plans to build a new official residence for their President. This is projected to cost somewhere in the range of $7.2 million US, including the cost of knocking down the old official residence and preparing the site. This probably wouldn’t draw much attention, if not for the fact that the University is undergoing some rather heavy budget cuts at the moment, and they’re talking about cutting a number of very popular programs – including as many as eight NCAA sports. The new residence will be paid for out of donations from alumni and friends, not State or University funds, but people associated with the school are asking why those same donations couldn’t be used to save the sports programs – or, you know, for academics, if it comes to that. Right away, I was transported back to thirty years ago, in a place called Santa Barbara…

For those of you joining us late, the University of California has ten campus locations, one of which is in Santa Barbara, about 100 miles northwest of Los Angeles. I went there for my undergraduate degree from 1982 to 1986, and while I was there the Chancellor decided to upgrade the kitchen in his house. As I remember the story, our Chancellor was living in a house that he and his wife had purchased for themselves, partly because the official on-campus residence was not really suited to full-time living quarters, and partly because it was located in the swamp, next door to a dining commons and the dorm I lived in. The remodel was to be paid for from University funds, and every student group on campus was protesting because student services had just been cut for the hundredth time. Unfortunately, while the Chancellor was a world-class scholar and a fairly good administrator, he wasn’t all that great at public relations. Telling the student groups that he wasn’t answerable to them wasn’t a good tactic (he was answerable to the President of the University, who was answerable to the Governor, who was answerable to the taxpayers – many of whom send their children to the University of California), and telling them they didn’t understand the financial complexities of the situation wasn’t a good idea – although it was probably the truth…

Now, we should probably note that one of any university president or chancellor’s primary duties is raising money for the school, and that this includes throwing a variety of parties and receptions, ranging from dinners for a dozen or so guests to gala events of a hundred or more. This can be difficult to accomplish in a single-family home built before 1960 and never intended for such duty; in Maryland if the President wants to host more than two dozen current or potential donors at a time, some of them will be eating in a converted garage, and the off-campus residence in Santa Barbara in the mid-80s wouldn’t have done that well. In the current case, less than a third of the project is actually going towards the President’s living quarters anyway; of the total some $5.2 million is going to create the meeting, banquet and conference space that the President’s office will use for fundraisers in addition to other official functions. But that isn’t stopping people from raising cane at the costs involved…

I don’t know off hand how much money the President raises for the University of Maryland every year, or how much more effective those fundraising efforts would be if he had a better facility in which to hold those events. But traditionally, fundraising events have been more effective if the President invites people to his or her official residence (development officers call it the “house effect”), and the higher up the scale one goes, the more likely donors are to respond to such factors. I can’t tell you for a certainty that the University will make its money back; only that this is the way to bet. And I can’t tell you if the current President will deal with the inevitable backlash correctly as the project goes forward, but he would be well advised to look up the events in Santa Barbara thirty years ago – and then try anything else…

PayPal Strikes Again

I don’t have a lot to add to the story that is now sweeping the Internet about PayPal’s latest atrocity, but I’m going to pass it along anyway because it demonstrates how a company goes from screwing up the small details to screwing up the big details and eventually moves into legal and social problems it can’t get out of (or just ignore). Please feel free to pass these comments – and the associated story – along to anyone you know who still isn’t clear on why it is important to give your first- and second-level customer service personnel the power to handle problems, and the training to do so. And to anyone who isn’t clear on why stupidity is a problem in a business setting…

The story, originally from the Consumerist website, but now spreading out across the Internet, is that a PayPal user sold a vintage violin on EBay, the buyer then claimed it was a forgery, and PayPal told the buyer that he could have his money back if he destroyed the instrument. The buyer did so, and sent pictures of the wreckage to the seller and PayPal; PayPal then deducted the money from the seller’s account and gave it back to him. The seller is now out a vintage instrument and/or $2500 (it depends on your point of view), and is seriously considering legal action against all of the offending parties, as well as planning to avoid PayPal for the rest of her days…

Now, if this story doesn’t make any sense to you, that’s because the procedure followed in this case was the wrong one. There are laws against selling forged goods (over the Internet or otherwise), and if someone does sell you something over EBay that turns out to be a forgery, you can request that the company freeze the seller’s account and return your purchase price to you, assuming the seller didn’t empty out the account as soon as they got your money. But you can’t just declare that you think the thing is a forgery and demand your money back; you will need to find some evidence to support your claim. You also have a duty to report the crime (forgery is a crime; so is fraud) to the appropriate authorities. But apparently the people at PayPal who handled the case didn’t know that…

By the same token, forged goods are often ordered destroyed once the criminal proceedings are over, in order to prevent anyone else from being defrauded in the same manner. But that determination will be made by the court, once the time comes. If all forgeries were destroyed at once no one would ever be prosecuted for that crime due to the complete lack of evidence. For that matter, if the only authority you need to declare something a forgery is to say you think it’s a forgery, what would keep anyone from buying something, declaring it a forgery, putting together a fake picture of the wreckage, getting a refund, and then selling the item at 100% profit?

I feel quite certain that PayPal has a corporate policy about forgeries; I am even more convinced that this isn’t it, or the company would already be out of business. If the violin in our story was authentic then the company is accessory to theft, destruction of private property, fraud, and possibly liable for the value of the instrument (not the selling price; the actual value); if the violin is actually a forgery (although it’s not clear of what) then the company is guilty of obstruction of justice, destruction of evidence, and possibly tampering with a Federal investigation. Even a few such charges would be enough to shut down the company; if we consider that as many as 5% of all EBay purchases are believed to be fraudulent, and that EBay has around 500,000 auctions going at any one time, that would mean that PayPal could be involved with as many as 25,000 fraud cases A DAY. And if even a tiny fraction of them are mishandled this badly, every employee they have would be in jail long ago…

I don’t know where the breakdown happened in this case. It’s possible that PayPal doesn’t train its Level One personnel on how to handle this kind of thing; it’s also possible that the actual procedure takes work, and the PayPal personnel just figured this would keep them from having to do it. But I do know that the more common these stories become, the less likely anyone is to buy or sell anything of particular value this way. Eventually, people may come to believe that you’d be better off buying something off the back of a truck for cash than you would for buying something off of EBay using PayPal – and it is stories like this one that will build such a belief…