September 26, 2008, 6PM PST: Presidential candidates debate both domestic policy and foreign relations at the University of Mississippi (details available from the commission of Presidential Debate). Many of us were not simply passive listeners, but rather involved in active discussions (backstory here).
Like many other web socialites, I was glued to Twitter’s election portal. The portal created a large chatroom-like environment which allowed the debate audience connect with each other as they watch the would-be Presidents perform for their benefit. It’s particularly fun to watch the wise-crack tweeters:
including those with a suspiciously familiar alter-ego:
Several bloggers suggested using Twitter to score the debate on an ongoing basis rather than just interacting. The idea is simple: watching a presidential debate over the span of 1-2 hours can be difficult, so score as you go using Twitter by adding 1, 2, or 3 points for meaningful contributions. Here’s an example of tweetscoring:
Adding up the points recorded during the debate yields an numerical score of admittedly subjective impressions:
What’s important here is not that Obama performed three times better (drawing that conclusion would be incontrovertibly misleading). While impressions are of course subjective, it’s important to note tweetscoring eliminates the tendency to more heavily weight the last few moments of debate over the already-forgotten beginning moments. I noticed McCain scored more points towards the end than Obama, which might have otherwise left me with the impression that both candidates performed well. Indeed my subjective feeling influenced by McCain’s strong ending performance was at odds with the tweetscoring result.
Tweetscoring turned out to be a fun (if not to be taken too seriously) exercise for me as a voter. For campaign managers, this a previously unthinkable paradigm shift to say the least.
About five decades ago, General Motors’ CEO Charles Wilson infamously uttered what’s become the anti-Rand rallying point: “What’s Good For GM is Good for America”. The legions of Youtube bailout refusniks might rightfully wonder if our monetary policy is being driven by such self-serving drivel. After all, any national bailout of the entire banking system is never going to be popular.
So Hank Paulson went to congress donning a metaphorical bulletproof vest knowing there’s plenty to dislike in his prescription. And let’s be honest here: there’s plenty to dislike on both sides of the political circus. Democrats kept wailing about welfare for guys in $5,000 suits while Republicans barked about a shameful slide into socialism. These folks are well aware that an election is only 5 weeks away, so I’m willing to bet they’ll all bemoan some nefarious arm twisting by the President as they cast a “yea” for the bailout. He’s been a political leper for a while now anyway, so they might as well slap him with the politically expedient scapegoat to save their own hides, right?
The whole notion of a bailout has to give any self-respecting capitalist heartburn. I absolutely hate the idea. However, we can’t sit idly by either – some kind of bailout is necessary.
How We Got Here
The empty talking heads predictably blame “predatory lenders” courting “subprime borrowers”, but what’s really driving the crisis is profligate use of credit derivatives. Here’s how this game works: banks previously made loans backed by a home asset and held them. In the brave new world of financial innovation, issuing banks hedged against risk through “insurance” or selling those loans to investment banks (or both). Many mortgage backed loans were “cleansed of risk” through credit default swaps where an insurer (*cough* AIG *cough*) agreed to pay the face value of a the debt in case of a homeowner default. Other home loans were bundled into “collateralized debt obligations” (CDOs), broken up into shares, and sold on Wall Street. Because that insurance policy or a CDO has a value, it’s sitting on someone’s balance sheet as an asset.
Basically MBAs take a real asset (the home), and create lots of paper assets deriving their value from that real asset – in effect we’ve created “wealth” out of thin air. Keep in mind those financial instruments are sitting on someone’s balance sheet at some calculated value, so the value of the home plus the financial asset on banks’ balance sheets exceeds (far exceeds) the value of the home itself. To put some actual numbers on this, the total value of mortgages in the U.S is roughly $14 trillion. The total “notational value” (or funny money value) of the an mortgages on the books? 168 trillion, or 12x in credit derivatives.
Now a highly leveraged position isn’t bad as long as the underlying assets keep growing. However..
The Ownership Society and the Big Gamble
President Bush walked into office championing something he called the “ownership society“. In essence, the idea involved promoting home ownership for everyone as a path to increased individual wealth. Noble but naive, he and the congress relaxed regulations and drove policies which lowered credit costs to make lending to the riskiest of home buyers financially feasible for banks. The result was a cheap-money fueled real estate boom which made many of us wealthy (at least on paper). I think you can see where this is headed: as attractive introductory rates gave way to higher market rates, risky borrowers defaulted bringing down the entire house of cards built on top of those mortgages.
Add together the cocktail of highly leveraged financial instruments and risky home loans they’re backed by, and you get the fiasco we’re now in.
We also from both liberals:
And free market types:
I Want Your Money
Hank Paulson’s prescription is best summed up by the economist’s lead story this week:
Mr Paulson’s plan relies on buying vast amounts of toxic securities. The theory is that in any auction a huge buyer like the federal government would end up paying more than today’s prices, temporarily depressed by the scarcity of buyers, and still buy the loans cheaply enough to reflect the high chance of a default….
Government support to the banking system can break the cycle of panic and pessimism that threatens to suck the economy into deep recession. Intervention may help taxpayers, because they are also employees and consumers. Although $700 billion is a lot—about 6% of GDP—some of it will be earned back…
In plain English, many of these financial instruments will be bought cheap by taxpayers, held for a while until the market hangover has run its course, then sold back to Wall Street. Investment bankers buying them on the cheap can ostensibly resell them at a profit, doubling down on commissions made from reselling the same securities the first time around.
The Catch-22
It seems like lunacy to throw our weight behind a bailout, but the alternatives are few and far between. One alternative is doing nothing, which we tried in 1929; That didn’t work out so well for most. Another alternative is direct government seizure and servicing of mortgages, which helps homeowners but does nothing to nurse a much needed credit market back to health. Two things are certain however. Firstly, passage of a bailout bill devoid of personal bankruptcy easement will be inerpreted as cronysm (and will meet with fierce rebuke during elections). I’d be surprised if bankruptcy isn’t easier to come by in the future. The other certainty is that if we want a continued healthy environment for startups and growth, we’ll need a liquid credit market in place. That means we’ll need to be proactive.
In a 1999 article that now looks absolutely insane, the New York Times reported on the easing of credit terms. Fannie Mae Chairman Franklin Raines, who’s quoted in the article, was all sunshine and roses as he threw away the financial future of millions of Americans. But at least one person. Peter Wallison, had a good idea of how this would all play out:
“In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.”
”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”
Like many of you reading this blog, I too have the attention span of your average hummingbird. The funny part my ADD-ness has become more acute over the last year or two, and I’ve discovered an odd side effect to it. Rather than sit in a zen state just thinking for an extended period of time, I tend to think in a packet-like state. That is, I tend to process information, then come back to it later and pick up where I left off last whenever I have a spare moment. This happens over and over again until I have completed “processing”, which is usually where I begin blogging. Like Susan Wu at CRV, I’m pretty bad about opening up my thought process and I usually blog about fully baked thinking, but I’m going to step out of my comfort zone here.
I Confess…
So, I’ve been mulling a confession for the past 2-3 months. Here it is: like Fred Wilson, I’ve grown restless with Web 2.0 startups. Now, Fred is a smart fellow with a high signal to noise ratio, but he’s bored for a different reason than I. He basically wants to change the world and feels Web 2.0 is not world changing. you can’t blame him, considering Supernova and TED have been all about energy and microfinance of late. I’m with you Fredster, but I’m bored because I believe the web is world changing but I’m not seeing jaw dropping innovation (or revenue for that matter). But this isn’t about Fred – his posts tend to spawn more than a fewcopycatblogposts anyway. Nor is this about me. It’s about what’s next in connecting us all.
Exhibit A
Case in point (and one of two catalysts for this post): Yammer wins the TechCrunch 50 competition. Now, we’ve been using Yammer internally for our company with some success, but frankly Yammer is more evolutionary than revolutionary. Most of us are still using Twitter and email primarily and no adoption methodology is in place. This isn’t a hate fest on Yammer, by the way, which is a good product with a real business model (where for art thou Twitter??). But the Yammer nod seems a bit of smarmy protest vote for the oft-errorprone microblog default Twitter, who’s been giving us the big fail whale far less of late. Also, Twhirl, the social software front end client, now supports any laconi.ca installation. In plain English, this means that any company can set up their own microblog and allow employees to send messages in one interface to the public Twitter and the private company microblog (Loic LeMeur, you are one uber-smart Frenchman). Let’s put this in big-picture-principle perspective: will Yammer earn even a footnote in a historian’s texts 100 years from now?
Exhibit B
I mentioned there were two catalysts for this post. The second was my chat with James, biz development dude for BigWorld games, who has developed a platform for massive multiplayer online games (MMOs) development. They’re doing some cool things with gaming performance which I won’t delve into here, but one of the things I will mention is they’ve extended the mashups idea into the virtual worlds space. Consider a gaming character interacting with an e-commerce site within a virtual world (sort of a virtual mall)..
Interacting with the Web in a Virtual Environment
Now consider a mashup with micro finance site Kiva, allowing small business owners in Bangladesh give investors in New York a virtual tour of their operation. Last stop: an in-world Kiva website where would-be investors can sign up. Another application: video gamers can get involved with each other via the web within a virtual world – and voila, instant e-commerce among players. Remember the old wild west days of Yahoo storefronts selling everything from lawn gnomes to dog biscuits? Lifting the poor out of poverty is going to be easier with virtual items – there’s virtually zero capital costs other than time involved, which the poorest unemployed have plenty of.
Where We Need to Go From Here
We need to start talking about measurable impact.
Not some hypothetical “ideas are currency” talk, but real quantifiable results. Once we do, we’ll start seeing Web 2.0 copycats merge just like the American automobile industry went from about 10 players to 3 from 1910 to 1940, since the network effect requires will natrually shrink the number of platforms out there. One great example of putting social tools to work to product measurable impact is Carticipate, which is pragmatic and location-aware way to combat high gas prices. Nothing sexy, fun, or lofty here. Just people reducing gas costs and carbon emissions to boot. Impact: less traffic, less money thrown at ExxonMobile, and more money socked away for Christmas gifts.
If you’re not sure where to begin, here’s a few questions to get started:
“How can social interactions lift the poor out of poverty? The Chinese have been turning World of Warcraft items into real dollars for years now. How do others in poverty enter the market without introducing so much competition that incomes collapse (ie supply far outweighs demand)?”
“How can microblog-accelerated serendipity create revenue-driving partnerships between entrepreneurs in 3rd world regions with otherwise poor connectivity?” (related thought by Marc Hustved here).
“How can we create a revenue stream from creating synergy between traditionally unrelated markets?” An example: Wall Street discovered a while back that engineers’ heat diffusion equations are surprisingly good formulas for stock option pricing. That’s what created the options trading market we have today.
That’s just for starters. Yes, I’m working on one of the above. No, I’m not dropping any hints here, but I might leak some of it if you and I strike up an interesting chat here.
I started to blog about things I’ve learned from the recent fiasco with Electronic Arts’ release of Spore, only to find the post started to look less like a timeline of events and learnings and more like a case study. So I figured I might as well try my hand at writing one…
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From Cheers to Jeers
As Tim reached over to pick up his ringing mobile phone, a quick glance at the caller ID info was all he needed to see. He had seen the reviews of Mark’s new production, and he knew exactly where to begin the conversation. “So, just how bad is it Mark?”, he spoke as he picked up the call. “I feel like I’m on one of those free-fall amusement park rides” replied Mark, not missing a beat. “I mean, what the heck is wrong with these fickle gamers – they better damn well understand we’re a business!”
Mark and Tim had been close friends since they bunked together in college, and often bounced ideas off one another. Now Mark needed someone to talk to as customers reacted overwhelmingly negative to his newest game release. As senior producer of the much anticipated game Spore, he was responsible for distribution of the most talked-about project in the gaming market all year. Mark worked for game publisher Electronic Arts (“EA”), who placed high hopes to extend a rebound from lackluster Q4 2008 results, after reporting a 400 million increase in sales in Q1 2009. There was still the nagging issue of a net loss for Q1 2009, but EA expected as high as an 80% margin on Spore, in an industry where 30% margins are more the norm.
Spore was also poised to capitalize off the two hottest trends in the market. Gameplay involved the creation of an alien species, which a player must guide through stages of evolution and social development – from single cell organism to complex society. Some called Spore a “god simulation”. The game concept lends itself to user generated content, which was accepted as a “must have” feature for any successful release. Spore also capitalized off the concept of Internet play, which had been the driver behind more than 50% of EA’s Q1 revenue increase. Players would be free to create a species and upload their creations to share with friends. Will Wright, the creator of Spore felt that the nexus of rich user-generated worlds which were sharable on the internet would lead to the next big hit. Most industry observers lauded the direction he’d taken.
High Expectations
Mark and his team carefully tied a limited release to the July 14th E3 show in Los Angeles; one of the big showcase events the industry. While Mark figured he would have to compete for attention share with other game titles debuting at the show, he knew no one has the kind of buzz Spore had going in. The Spore trailer debut at the show was welcomed with thunderous applause and only heightened the feeling that he was on to something big.
Mark and lead designer Will also carefully devised a timed release of the game to better forecast how well received the game would be. The game came in two parts: the first was a creature creator, where players could construct the look of their aliens, and the second is the game itself, where players could interact with the creatures of their own design. The first part of the game was thus a barometer for the second (and main) release of the game. The results were over 1 million new player creations by mid June, and the top selling game for the month, more than doubling the number of games shipped by anyone else.
The Piracy Tradeoff
“I still don’t understand why the game release has gone sour, Mark..”. Mark let out an audible sigh and then began to speak in hushed tones. “We knew buyers would distribute copies to their friends, Tim”, said Mark, “so we had to put something in place which would prevent gamers from sharing their game copies with their friends. We originally had the game connect to our systems every ten days to perform a validity check. A game copy deemed illegal would alert us as well as shut down the game.”
“Hold on Mark”, Tim interrupted. “What about people who don’t have internet access?”
“Well, we had to nix the plan after we realized it would report back too many false positives. We figured it would also spike our customer service calls with angry customers if game players weren’t connected to the Internet. Instead we opted to have the game install a maximum of three times, after which the game would not install anymore.”
The Release Date Crash
Mark knew something was wrong as he began to read the numerousreviews on the morning of Spore’s launch. To his surprise, the reviews mostly talked about the anti-copy measures taken as opposed to the actual game content. It appeared as though many game players were in full revolt, and were either refusing to buy the game, or were actively trying to return the game title for a refund. One game critic website in particular caught Mark’s attention:
“No matter what people think about the actual game play, the story now centers around the DRM scheme EA built into the title, and a grassroots movement has begun to tell gamers just how bad the DRM sucks.
The method? Bombing the comments on Amazon.com. Right now the game has 222 customer reviews, with 194 of them giving the game one star (out of a possible 5).”
Mark quickly navigated over to internet retailer Amazon’s Spore webpage, where he found an overwhelmingly negative rating on the game, followed by scores of buyers and would-be buyers complaining about the anti-piracy measures. Mark knew carpet-bombing Amazon would be particularly nasty way of protesting the anti-piracy measures, since casual gamers who aren’t aware of the “protest” may not bother to read the content of the reviews and only assume the game isn’t very good. A quick call to his team confirmed his worst fears: early revenues were not shaping up as expected.
Mark turned back to the Amazon website Spore page and began to read through the reviews to try to understand the uprising. Two feedback posts in particular seemed to sum up the mood:
“I upgrade my computer often, and still play some old favorite games. I wouldn’t be able to do this with Spore unless I stop upgrading to newer computers. This is more of a resell to paying customers package.”
“This basically means that you are actually RENTING the game, instead of owning it. The game WILL stop to function in the future. That’s inevitable, because even if EA keeps the activation servers going, there IS going to be a time when EA will simply cease to exist because of financial issues or federal laws (like most businesses eventually do). “
Turning it Around
Mark was becoming increasingly irritated the more he thought about it. “We never intended for this to get in the way of legitimate buyers, Tim. All we want is to make sure is that everyone pays for what they use. What’s worse still is that copies of the game are out on the Internet anyway. What a catastrophe.”
Mark picks up a drink and takes a sip, beginning to speak again after an uncomfortable pause: “I expected complaining to come from would-be pirates, but this is just irritating.. it’s affecting our bottom line. It’s not unreasonable to want to install the game after buying a new computer, I guess, but gamers will just have to compromise.”
Tim cleared his throat and replied “Well, maybe that’s the point Mark. Customers hate to be told what they can and can’t do with things they buy. You’ll need to find a better way, because it looks like they’re not just voting with their wallets anymore.”
Here’s a good discussion form CNBC which sums up the situation nicely:
You might be wondering why a blogger about startups, cleantech, and China is writing about the socialization of the mortgage market. The reason is this move will affect not only the value of the dollar (and hence the valuation of startup businesses to would be foreign investors), but also will contract the amount of credit available to new business owners.
As it stands, the current administration and White House have decided that bailing out homeowners assuming irresponsible levels of debt is unwise. I mostly concur, but I’m flummoxed that the congress and president don’t hold the inverse to be true. This nationalization move will bail out lenders assuming irresponsible levels of lending. The sham cover story to the American people will be something to the effect of “stabilizing Fannie Mae and Freddie Mac will cost taxpayers less because it will dampen the damage to our economy”. Rubbish, I say; the move will achieve the exact opposite effect. To see why, simply follow the process through to its conclusion. Nationalization of Freddie and Fannie will have to be followed specifically by a write off and pairing down of all outstanding debt held by both organizations (we wouldn’t want taxpayers to assume even higher risk). So we’ll rehabilitate the mortgage giants by shrinking the total amount of mortgages outstanding. That in turn will drop the valuations of current homeowners, who will be hard pressed to sell without deep discounting when the easy mortgage money is gone. That’s why commentators are calling this socialism for the rich: the only net effect of this is a direct transfer of funds to Fannie and Freddie supported by borrowing by the taxpayer.
I have a funny feeling I know where the borrowing will come from, at least in part. I suspect the Federal Reserve print out dollars as fast as possible to pump liquidity into an already over-stimulated credit market. Those dollars will eventually have to deflate in value accordingly, and houses will become even more expensive relative to the dollar. When houses sit on the market unsold, the discounting begins. And voila, we have both a devalued dollar and a devalued housing market – we’ll go from a sub-prime mortgage system to a sub-prime financial system.
We created this problem by pumping too much easy money into our economy to hold up an unsustainable growth rate, but markets of course correct themselves in time (this isn’t a downturn as much as it is a return to where we should have been). Unfortunately the current congress and president seem content to patch up the situation and pass the stink bomb to the next congress and president. We’re headed for a mortgage market contraction either way – the only difference here is that taxpayers assume the cost of investment risk, instead of the investors by bailing out Fannie and Freddie. All of this makes investment in start ups and innovators less attractive (and more expensive for entrepreneurs) if real estate is now a zero-risk proposition, and angel investors burned on asset holdings pull back.
Well, It’s a good thing Web 2.0 economics provides a pretty quick path to ramen profitability.
Update: Quint Cobb has a good play-by-play primer on the secondary mortgage market and why the cost of mortgages is about to go up for everyone, as well as some good investment principles to follow in the wake of everything that’s happening now.
