Tim Oren's Due Diligence

Cruel, But Fair: Some Questions For Ben Bernanke

At Zero Hedge, some proposals for what Fed Chair Bernanke should be asked at his reconfirmation hearings. Some are quite technical, some understandable to all. A sample:

6. An important factor in the financial crisis (and a large part of the ultimate cost to taxpayers) was the implicit government guarantee of the GSEs. In part because of decisions you made, there is now an explicit government guarantee of every large firm on Wall Street. Has moral hazard increased or decreased over the past year?

You don't have to be a financial wizard to tell something's amiss. Gold headed for the sky, banks sitting on piles of cash, and the double ready to dip. There are a lot of avoided questions and evaded responsibilities that need to come home to roost. This might be a good place to start. RTWT.

Silicon Valley's Dirty Little Secret

Over nine years ago I wrote the following in a short piece for an Asian colleague who was interested in the 'Silicon Valley culture':

" The Valley is really an aggressive, colonizing culture that grows by importing immigrants, and has overspread and occupied part of California. By immigrant I mean anyone who moved from outside into the Valley, whether from another region of the US or from outside it."

It was therefore interesting to come across this recent post from a population geographer, who had arrived at a similar evaluation from his own direction. For instance:

"...in these global cities [including the SF Bay], two economic geographies share the same physical geography – and those economic geographies are in conflict. One set requires catering to high skill, highly paid workers and firms where cost is a secondary concern. The other involves occupations and industries where cost is very much a concern. The occupants of these two geographies have very different public policy priorities.... In a global city, particularly a mature and expensive one, the elite geography wins. "

"And where do these elite come from?

"This explains why, for example, not only have taxes gone up, but things like schools and other basic services have declined so badly in places like California. Traditional primary and secondary education is not important to industries where California is betting its future. Silicon Valley, Hollywood, and biotech draw their workers from the best and brightest of the world. They source globally, not locally. Their labor force is largely educated elsewhere. Basic education and investments in poorer neighborhoods has no ROI for those industries."

This is one half of the poorly hidden secret. While industry leaders will express pious support for local education and improvement, their actual exposure is limited: Immigrating employees with children will ask for salaries that can cover the costs of private schooling or locating in one of the high priced areas with decent schools. But since being an engineer, scientist, or manager of same doesn't necessarily breed true in the next generation, it's always assumed that most of the next wave of talent must be imported from elsewhere. Even if they are nominally Stanford or Berkeley grads, their birth certificates usually don't read 'California'. As far as the other population:

"If you are just an average middle class guy, why live in one of those global cities anyway? ... And frankly, the folks on the global city side prefer it if you leave anyway. Immigrants are unlikely to start trouble, but a middle class facing an economic squeeze and threat to its way of life might raise a ruckus. That won't happen if enough of them move to Dallas and rob the rest of critical mass and resulting political clout."

If this is sounding familiar, I suggest you read the whole article, which draws some worrisome conclusions for long term social and political impacts on the region and the US generally.

The other half of the secret? The post gives a hint:

"...an attractive environment draws diverse uses, then one becomes economically dominant and, through superior purchasing power, displaces other uses over time. The story ends when that dominant economic activity exhausts itself..."

Due to rising costs and regulations, and the effect of the Internet in reducing geographic specificity, Silicon Valley has been progressively moving its lower valued functions offshore: chip fabs, customer support, QA, documentation and lower-level code and data creation and maintenance. With them has gone a good chunk of the immigrant inflow, both American and international, which has shifted to ever more highly educated and experienced people. And it now appears that this generation of more senior offshore immigrants is more ready to return home, rather than making the Valley their permanent station in the global network.

This, along with a recession unprecedented in Valley history, and a government with little understanding of business, may be why Michael Malone has said that the area is now a 'sandwich missing its meat':

"...the big pull [of innovation] has always come from the thousands of fast-moving, risk-taking new start-up companies who find unexpected (and sometimes vast) new applications for those technologies.... Those companies aren’t there anymore. The crucial center of the tech world – new and fast-moving companies – the meat in the technology sandwich – is gone. Under the press of an economic slowdown, government regulations that have handcuffed entrepreneurs and venture capitalists – and perhaps most of all, an Administration that increasingly seems actively hostile to entrepreneurship and small business – high tech is hollowing out. "

It took decades to build up the human, financial and technological capital that has made the Valley what it is - for better and worse. It will likely take as long to dissipate that capital, so there is time for a correction. But the trends are in the wrong direction.

High Beta Personalities?

An interesting article in The Atlantic describes studies of a so-called 'orchid' gene, believed to indirectly code for a tendency to ADHD as well as anti-social behavior, violence and 'externalizing' (what we'd have called 'acting up' back in the day). The relevant evolutionary question is: If humans as both as groups and individuals generally enhance their survival chances by social cohesion, why haven't these negative alleles been selected out? Noting in passing that studies in which phenotypes are evaluated by necessarily subjective questionnaires make me twitchy, the studies cited in the article put forward a hypothesis with some experimental support: The same gene that creates the downside behavior is highly responsive, in a positive sense, to more supportive environments during childhood. It can apparently lead to either a problem child, or a super-achiever, depending.

Roughly 20% of the population have the 'orchid' allele in question. Leading me to wonder: What's the proportion of carriers in Silicon Valley in general, or in the entrepreneurial or venture capital contingents in particular? What kind of selection might be going on right under our noses?

“I’m not going to hire anybody in the United States....

...I’m moving. They are doing everything possible to destroy jobs.” So says Emerson Electric CEO David Farr, who was promptly attacked by administration officials.

He's right. Whether through incompetence or ideologically based intent, our government is damaging the economy and discouraging job formation during the worst downturn since the Great Depression. Take for instance, the misnamed 'stimulus'. Financed entirely by deficit spending, it's taking over a million dollars to create one 'job', often a public employee position that should have been cut to balance a state or local budget. From the same article, the private sector puts just over $300,000 of capital to work to create a job, capital less available because it's been diverted to government debt.

That's assuming business is willing to risk capital in the current environment, where one now must assess political as well as market risk. From the point of view of one small businessman, it looks like this:

Over the last year the Congress and Administration have:

• Printed trillions of dollars of new money, raising the risk of future inflation


• Borrowed trillions of dollars, sucking capital out of private lending markets


• Run up deficits that pretty much guarantee future tax increases


• Toyed with health care bills that will substantially increase the cost of labor
• Toyed with climate bills that will substantially increase the cost of fuel and electricity


• Demagogued industries with average to below-average profitability for making obscene profits that must be reduced (e.g. health insurance companies who make 3-4% of sales)


• Taken over whole industries (autos, banks) and run them to the benefit of favored political constituencies, even when it violates the law (e.g. trashing for secured creditors of auto companies in favor of the UAW).


• Demonstrated a disdain for money-making by imposing populist compensation limits on executives of out-of-favor companies and industries.


• Spent money in the stimulus mainly to add government jobs, every one of which is generally focused on making my life running a business harder. If you do not understand or believe this, you have not run a business that employs people.


• Shown a general philosophic hostility towards markets and capitalism

What sane person will put up risk capital, with a potential payoff years in the future, in an environment like this? Is it any wonder that analysts now think umemployment will reach 12 percent or higher? (More likely 20% if you count those who have dropped out entirely from discouragement.)

Mr. President, you're not helping. You're making things worse.

A Message From A Biotech Entrepreneur

This was originally sent to the Instapundit reagrding his posts on biotech innovation. Since I found it as a comment here, I'm going to take it as being an open letter. I'd be pleased to credit the author if he or she will e-mail me:

"I read with interest your links today on pharmaceutical and medical device innovation, including an article of your which I had not seen before. While what both said is true, it overlooks perhaps *the* major source of innovation in this segment: venture financing of start-ups.

By way of introduction, I run a young biological tools company. Our products will contribute directly to creation of a new generation of pharmaceuticals and of diagnostic tests. At the moment we are funded entirely by NIH, as the venture capital market is moribund. I also serve as a frequent reviewer at both NIH and NSF, on both academic and small business panels, and for a dozen technical journals where research results are disseminated.

These days big pharma does very little research. The innovation comes from the small companies, and those that succeed often acquired by big pharma, or license their drug candidates to them so that the enormous costs of clinical trials are absorbed by the much larger partner.

These small companies live on what can be substantial investment (hundreds of millions of dollars each) by venture capital firms. So the ability of a company to raise money will depend on the VCs being able to generate enough after-tax income for their few successes to fund their failures. Obamacare is squeezing this on both ends. First, the capital gains rate is slated to increase substantially. Second, the revenue potential for the putative new products under whatever form Obamacare takes will undoubtedly decrease. This also affects company value for any potential IPO.

That makes this space a much less attractive investment. Of course companies will still be funded, but they will be far fewer in number and the pressure on them to produce will increase from what is already obnoxious. Since success is partially a numbers game, there will be fewer products that come to market.

No, a company cannot live on grants. A $2 million grant award is a large one, but this is typically the amount that a company raises from venture sources for its *first* funding round (of many). And winning grants these days is really, really challenging: success rates are on the order of 15%. It is nearly impossible to fund a company of any size from grants alone -- only the academics can live on grants since their salary and lab overhead is heavily subsidized by their institution.

I should also note that there are many overhead categories that government grants will not cover, such as intellectual property prosecution. The agency funds the work, and expects you to publish the results, but will not fund obtaining patents. There is a commitment to commercializing new products!

That to me is the major threat to innovation under Obamacare: draining the life blood out of the small-business corpus. That's where the innovation resides, and that's what appears will be hit the hardest."

"Smart Money" Indeed

This is both a gross privacy violation and a fascinating result. Seems some Finnish researchers managed to get their hands on that country's records of IQ tests of its soldiers. They then joined that data with several public databases to correlate the intelligence tests with not only income, but stock market participation and portfolio structure. Multiple regression and factors analysis ensued. The punchline:

...the consumption of smarter individuals, rather than the wealthy, may be what drives the pricing kernel. This latter conclusion is not currently featured in formal neoclassical models of asset pricing. However, it is consistent with neoclassical folk wisdom—that economic behavior, divorced from utility optimization, is irrelevant for market efficiency because savvy investors determine asset prices.

How politically incorrect. How fascinating. Read the whole thing. (Hattip: Tyler Cowen.)

The Consumer and Recovery: This Time It's Different

An excellent analytic piece on consumer credit and spending at Zero Hedge.

Good reading for anyone investing in consumer sector stocks, or consumer-facing startups. Not only is it a tough analysis of what lies ahead, but it assumes a recovery started in Q3. If, like myself, you see that less than one percent GDP growth as a self-serving number put out by a government that has largely p***ed away the stimulus money in unsustainable and unproductive directions, you may need to slide everything right by a few quarters as well.

A Well-Deserved Nobel

No, not that one. It's the economics Nobel awarded to Oliver Williamson and Elinor Ostrom. I don't know Ostrom's work first hand, but Williamson's bridges between Coase's concept of transaction costs and an analysis of the various ways of organizing economics activity through markets, contracting and firms. The guys at Marginal Revolution have a more complete take on his work. For many years, Williamson's Economic Institutions of Capitalism has been my go-to reference to stimulate thinking about economic reorganizations precipitated by the net and other technology innovations. (Copyright 1985, so it's safely pre-net, forcing you to think it through yourself.) So I'm glad to see the good professor get his recognition, and I will hoist a drink in his honor this evening.

Rocky Mountain Retrospective

Here are some useful reflections from the editor of the deceased Rocky Mountain News on how and why it died. (Via the InstaProf). Very likely too late to do any good for other newspapers, but John Temple's lessons learned apply to most any established company that finds its market changing rapidly due to forces beyond its control.

Of all the sins in his list, the most deadly is the mental habit of evaluating every move by its impact on the former core business. Not only does it cripple the formation and success of internal ventures, but it forms an obvious constraint that the entrepreneurial minding can alleviate by leaving and setting up in competition. Temple talks about the Rocky's difficulty in retaining its Web staff against recruiting from 'pure plays', the lesson transfer to other industries and markets.

The Roving Eye: Green Bubble Sighting, 24 Hours vs. 22 Minutes, Big Iron of Yesteryear

It's not really about energy. How late in silly season does it have to be before you get stories like this? A treadle to borrow a few ergs from autos passing by. Somehow the writer involved (and some franchise owners who let their brands be used) completely missed the back-of-the-envelope analysis that you'll find in the fourth comment to the story, which makes it obvious that this placement is about gullibility, not greenery. Do I have to be a cynic to guess it has more to do with this chart than it does the environment?

And that's the news tonight. Jeff Nolan nails an unwittingly self-revelatory comment from ABC Nightly News' executive producer, John Banner. Banner is mentally stuck in the constraints of his legacy distribution platform, and won't stand back to realize that 24 hour availability is not a problem from the point of view of his former audience, it's a feature. I can't put Jeff's summation any better:

What the traditional news business can’t seem to stomach is that their profession isn’t that complex after all and their historical barrier for entry was not access but distribution, which in our age is not a steep barrier to overcome at all.

Check your six, JB. Regardless of your politics, you've got to respect the launch of Breitbart's Big Government site. From rumor to legislation mover in a week. And talk about 'afflcting the comfortable'. This is going to end up a textbook example for new media launches, up there with the canonical Blair Witch viral campaign.

Speaking of legacies. A blast from 50 years in the past as IIHC crashes a current model car with a '59 Chevy.

Did they get their clunker credit? At least it wasn't a '57, which would be a mortal sin. (Via the Insta-guy. Go back 50 more years, and there's this:

That's the S. S. Keewatin, dating to 1907, the oldest surviving Great Lakes steamer, moored at Douglas, Michigan where we're vacationing and visiting family.