It’s this time of the year again when we have to vote for SXSW panels. Here’s a selection of panels related to the future of money/currency.
A comment I published on a skype group. I thought I’d publish here more widely:
I don’t want to try to defend the Fed, but I don’t think we should claim a false public and a real hidden purpose. I think the purpose of the Fed is simply to provide and manage the liquidity in a member-only fiat/credit network. I think the Fed’s role is – through its theoretical independence – to build confidence that the Treasury will not abuse its force to spend more than the economy can take. The Treasury doest not need the Fed to monetize spending: the Treasury has simply ageed to do so as a confidence-building trick, in exchange for the ability to provide stability backed by the full credit of the US to the banking system in times of crisis. All that said, I think what is legitimate to point out is that their mandate is difficult if not impossible, their power enormous, their independence … theoretical, and the unintended consequences of their actions enormous as well. Chief problem with the Fed is the belief and expectations by each and everyone on capital markets that they can and should try to solve every problem.
Thoughts Offerings blog has an interesting piece on how QE actually does not encourage traditional bank lending via deposit creation, but instead encourages lending through security issuance. I recommend the reading, it ties a lot of things together neatly.
If we take this post a little further, given that lending via security issuance is currently frozen on the consumer debt side, those benefiting from QE are those with access to capital markets: large corporations, financial intermediaries (who take fees on issuing, buying/selling securities), and the Government, but not the consumer or small business (except as recipient of Government welfare or subsidies). As a result, domestic demand is poor, which leads companies to invest and grow their revenues abroad (BRIC in particular), bringing rampant inflation in emerging economies and taking the dollar down. This is a self-reinforcing feedback loop.
Two things follow:
- the biggest risk to this growth is a slowdown in BRIC countries, China in particular. The reflation trade could easily morph into a vicious deflationary force as dollars are repatriated, assets sold, debts paid back, preference for safety over risk, short-term duration over long-term, returns.
- with consumer and small business loans still going down, paradoxically encouraged by QE as the Thoughts Offerings post expose, there is a major opportunity for peer-to-peer lending and crowdfunding. This is an area where lawmakers could have a huge impact with no dollar spent, just a regulation signed. Maybe they could even win an election with this one!
A currency is an attributable symbol whose meaning is common – consistently accepted, acknowledged – within a group of people, and over time.
The commonality, commonplace of a symbol is what distinguish a currency from other symbols. Currency is etymologically what runs, what is everywhere, not necessarily because it measures a flow, but rather because its meaning is everywhere. I would argue that the existence of currency precedes in time the flow of wealth it may at some point trigger. I would also argue that a currency can but does not have to be formal, agreed upon, well-defined, it can be instead informal, emergent.
For a symbol to become currency requires either (or combination of):
- force: this is the easiest. someone forces onto others the meaning of the symbol, such as is the case of the Government legal tender laws and monetary policy.
- emergence: this is the most fascinating, because it is uncontrollable and can result in very quick social changes. An example is: having a Web site, blog, LinkedIn profile, twitter stream is a currency, if you don’t have one, it will raise strong doubts from a hiring manager.
- agreement: this is probably the hardest. A group of people decide together that something will be used as currency.
Clearly, understanding how a currency emerges, and designing for a symbol to emerge as a currency seems to me to be a potentially very powerful piece of knowledge that I feel isn’t much written about in the Internet literature.
A Credit Union in France just announced the opening of a new online agency called Tookam. Besides a number of innovation related to social networks, the new agency provides a virtual currency that helps businesses engage their customers with charitable rewards, that is: rewards that can be turned into donation in government money to a charity chosen by both the business and the customer.
It’s an interesting variant on the “donate 1$ and our business will match it”, instead: “give us $x of your business and we will donate $1 to one of the charities we support”
It works as follows:
- The business establishes a rewards program in Tookets and pre-defines a number of charities that the tookets can be converted in Euros and donated to.
- Customer earns the tookets as they do transactions with the business.
- The customer can then turn some of the tookets into Euros and donate them to one of the charities pre-selected by the business.
What’s interesting here is the alignment of values that it creates between the business and the customer. By looking at the list of charities that the business’ rewards program support, the customer can decide whether to increase or stop shopping at this particular business.
This program fits in the larger trend of rewarding real-life purchases with virtual currency. By defining what their rewards currency can be converted in, the business has another opportunity to express their mission and connect meaningfully with their customers.
I’ve been thinking about the recent rise in subscription models for content such as The Daily or the New York Times paywall. Alan’s recent invitation for thoughts on his related post gave me the perfect reason to write something.
I’m in the camp of those who think that good content is independent content, produced without influenced from advertisers, and authored by dedicated people who spend precious time to research. I also think that good content is accessible content: available to many, if not to anyone, to read, correct or comment on. It’s content I can share, content that I don’t need to pay for before I read.
Growing up in France, I remember being explained that public channels weren’t really free: for each TV set you’d buy, you would pay a yearly tax called “redevance” or television license to the state. In turns, the state would use audience tracking service to figure which channels were most watched, and would split the reveneus of redevance accordingly to the channels.
I don’t know what the status of redevance is, and I am no fan of statism. That said, I do like the idea of paying a monthly fee that gets split into what you actually consumed and liked. This is what Flattr does, but it works on a voluntary basis, which effectively limits its potential.
For such a system to work, you need:
- a way charge a subscription to a large enough collection of private content,
- a way for subscribers to rate and share content with their friends who are on the same network,
- a transparent allocation of revenues to the content producers according to audience metrics.
I don’t know if NetFlix uses a similar model to compensate content providers, but if not, this could work for them, right now. They could literally open their doors to many short or long form content creators and provide them a share of their monthly subscription fees based on audience metrics.
Think NetFlix + Vimeo + Flattr.
I attended tonight a panel on the interchange rules that will be proposed by the Fed by April 2011 and enforced by July 2011. The panel was composed of representatives from issuers (Bank of the West) acquirers (WestAmericaBank), Prepaid (Mastercard, Plastyc), Alternative Payments (Bling Nation).
There were many disagreements on what the impact will be on the many entities composing the complex card payment ecosystem. If there was one agreement it is that this regulation will have unintended consequences and possibly backfire on the government’s good intentions. But the positive outcome is that it may act as a trigger to force participants to innovate above what may quickly become a commodity: moving money.
Examples of unintended consequences:
- Free checking is likely to disappear. This may increase the population of banking dropouts: “formerlybanked”.
- Savings may not be transferred to consumers.
- Merchants might start to discriminate between cards issued by issuers who are exempt from the Durbin amendment (FIs with assets of $10B or less). “Citi or BofA cards only please” “You came from Redwood Credit Union? we can’t accept that card”. Note that while some Visa rules in theory prevent this, some participants in the audience have argued that these rules don’t have much court value.
- Banks moving to unregulated a.k.a. (yet) unregulated payment networks to drive revenue. “We are interested in you because you are not regulated”.
- Banks will likely move increasingly in the prepaid area, pushing high debit customers into new products like segmented spend, allowance cards. With the right prepaid product, banked employees might switch to prepaid.
- Banks may consider charging for ACH.
- The Fed may end up having to regulate many more players such as Google/PayPal, which may unfairly benefit from such rules.
On the innovation side, Bling Nation’s Wences Casares compared the current payment ecosystem to the telco ecosystem in the late 80s. Everyone back then was focused on voice. Then suddenly voice become a commodity and everyone had to come up with new products. He believes that payment business is in a similar situation of becoming a commodity very quickly as a result of such regulation, which may trigger a wave of innovation on top of the payment layer that can drive revenue.
Patrice Peyret of Plastyc was quick to remind that this analogy breaks down when you look at the current protocols, which are simply flawed at heart. New protocols, designed with security and real-time are likely to be required for innovation to be unleashed.
Towards the end, Wences reminded the audience that contactless has little benefit for the merchant or the customer, that the true revolution in mobile payment is in the new things that can be built on top, starting with but not limited to: Loyalty, rewards, deals, social, etc. I completely agree with this.
I just stumbled upon this interesting paper from the FRB on how to re-ignite the market for low-income housing tax credits. These are credits that investors buy so they earn tax credits they can apply to lower their tax liability. Currently this market has been limited to large players but the FRB paper suggests it may be good to open it to individuals directly.
The universe of Low Income Housing Tax Credit (LIHTC) investors is limited to a small group of large institutions. Since the tax credit was created in 1986, banks, corporations and government-sponsored enterprises (GSEs) have purchased nearly all the credits made available through the program. Unfortunately, the concentration of investor demand in a small group of institutions has introduced volatility to the LIHTC market. Specifically, demand for these tax credits has proven extremely cyclical. As financial institutions and other large institutional LIHTC investors suffer losses (as they have in the current recession), their appetite for tax credits decreases rapidly. The result is a collapse in the price of LIHTCs, which endangers the very feasi bility of tax-credit-financed affordable housing projects.
Affordable housing investment was not always domi nated by large corporate entities. In fact, individual taxpayers played a prominent role in financing afford able housing development during the early 1980s. That role changed with the passage of the Tax Reform Act of 1986.
Prior to this legislation, individuals could deduct construction period interest and taxes, accelerated depreciation, and amortization of building costs. Taken together, these tax benefits were significant enough to attract many wealthy individuals to the mar ket. By 1986, however, Congress had become wary of overly generous tax benefits, loopholes and deductions. The result was the passage of new passive loss, passive credit and at-risk rules. Among other changes, the new rules established a financial disincentive for individual taxpayers to claim credits in excess of their marginal tax rate multiplied by $25,000. These rules have not been updated since 1986 and continue to suppress individ ual demand for tax credit investments.
Benefits of Individual Investors
Bringing individual investors into the LIHTC market would have several important benefits.
First, bringing individuals into the LIHTC investor pool would stabilize pricing and create a more robust market for the credits. Of course, individuals are not immune from economic hardship. Nevertheless, most people carry tax liability from year to year and, presumably, would benefit from a program that offsets this liability.
Second, individual investors would also help round out the LIHTC market’s financing of smaller projects and underserved geographies. Increasingly, large institu tional LIHTC investors have dealt directly with afford able housing project developers. To maximize efficiency, investors have sought large projects with correspond ingly substantial tax credit allocations. As a result, “it has been difficult to attract corporate investor interest to small and rural deals, since corporate investors look for larger deals with higher amounts of tax credits to offset their federal tax liability,” according to the National Association of Home Builders.2 Individual investors, by contrast, have lower tax liability than corporations and might be more attracted to smaller deals.
Finally, opening up the LIHTC market to the grow ing number of individuals seeking social impact invest ments would diversify the investor pool. According to the Social Investment Forum, “socially responsible investment (SRI) encompasses an estimated $2.71 trillion out of $25.1 trillion in the U.S. investment marketplace.”3 This growing market indicates that investors are increasingly looking for mission return in addition to financial return. Financial products such as socially responsible mutual funds, positive and nega tive stock screens, and deposit accounts in community development credit unions are frequently used by individual investors to satisfy both social and financial preferences. Socially motivated individuals might also invest in LIHTCs if given a cost-effective, efficient way of doing so. This would benefit the market by further diversifying the pool of LIHTC investors.
Barriers to Individual Participation in the LIHTC Market
In addition to passive loss tax restrictions, individuals have largely remained outside of the LIHTC market because of four key challenges: high transaction costs, program complexity, compliance risk and the illiquidity of the investment.
High Transaction Costs
The limited tax benefits offered by LIHTC are often insufficient to offset the cost of individual participa tion. Tax-credit-financed deals can be multimillion dollar projects. New construction financed by LIHTCs can require raising tax credit equity of 70 percent of eligible construction costs. The cost of soliciting such investment from small-dollar individual investors is cost-prohibitive for most affordable housing developers (and most syndicators, for that matter). Historically, it has been more cost-effective to engage a select group of large investors not restricted by passive loss rules that can finance whole projects on their own.
LIHTC deals are extremely complex. The technical expertise required to complete a LIHTC project is a dizzying array of real estate, legal, tax, development and policy know-how. Most individual taxpayers lack even a basic understanding of the LIHTC program—let alone how to responsibly evaluate the investment risks.
LIHTC investors are subject to credit recapture and penalties should a project fall out of compliance during the first 15 years of its operation. Compliance is a function of the rents charged to the development’s low-income tenants. Should rents exceed specific federal guidelines, the project is deemed out of compli ance, the credits are recaptured and a penalty is levied. Individual investors have likely shied away from tax credit deals because they lack the expertise to quantify and price the risk posed by this central program requirement.
The 15-year compliance period, coupled with restric tions placed on the reselling of credits, makes purchas ing LIHTCs a relatively illiquid investment. This tends to favor investors with long investment time horizons. Further, the tax benefits that flow from a LIHTC investment only begin when the project is completed. This can be up to three years after the credits are originally allocated. To date, corporate entities with long-term tax obligations have been most comfortable with the illiquidity of the investment.
An Individual Investor Solution
First and foremost, the easiest way to attract indi viduals into the LIHTC market is to change the passive loss restrictions that discourage individual investment. Whether the passive loss limit is increased or the rule is
eliminated altogether, increasing the tax benefit would make the credit more appealing to individuals. Even with tax reform, however, the barriers outlined above would still discourage many individuals from partici pating in the program.
While only a partial solution, the creation of a fully transparent online platform to broker the sale of tax credits to individual investors would address some of these challenges, specifically high transaction costs and program complexity. An online marketplace for LIHTC investments would keep the cost of soliciting capital low while simultaneously organizing and com municating important information to potential small- dollar investors. In fact, such technology already exists in the form of so called “peer-to-peer” (P2P) lending. P2P lending sites attempt to lower transaction costs by cutting out the middleman in debt transactions—usu ally a bank or a credit card provider. While the long- term viability of their core business model is unknown, P2P lenders such as Prosper, Kiva, LendingClub and others have demonstrated that individuals can lend responsibly in the consumer debt market. The same technology could be adapted to match LIHTC inves tors with affordable housing projects.
Direct Investment Model
The simplest method for organizing a LIHTC platform for individual investors is to directly connect these investors with affordable housing developers that have received tax credit allocations. Developers could post project listings on the platform and the tax credits they have available. As part of the listing, develop ers would also have the opportunity to promote the project’s financial and social merits as well as set the initial price for the credits. The investment period could be designated by a preset date or simply end when sufficient equity has been raised to proceed with the development.
Tax Credit Syndicator Model
A second way to organize an online LIHTC plat form would be to use tax credit syndicators. The platform could connect individuals to syndicators who identify and invest in LIHTC projects on their behalf.
There are two reasons to favor this approach. First, it addresses the complexity barrier noted above. Even with detailed project listings, most individuals would be ill-equipped to evaluate the range of risks that come with an affordable housing investment. In contrast, tax credit syndicators have a great deal of expertise and in-house capacity to accurately assess these risks and invest responsibly.
The recent collapse in the price of LIHTCs has exposed the folly in the market’s over-dependency on large corporate investors. Encouraging individual par ticipation in the LIHTC market would diversify and expand the overall investor pool, smooth LIHTC price cycles, bring untapped capital to the market, and help finance small, often rural, affordable housing develop ments that today struggle to raise tax credit equity.
An online LIHTC platform, while potentially dif ficult to scale and develop, would lower transaction and information costs and allow individual investors to enter a market that, heretofore, has been nearly the exclusive purview of institutional investors. Also, such a marketplace could allow for dynamic, real-time price setting. If sufficient scale could be achieved, a price auction mechanism would be effective in either of
the models outlined above and, importantly, it would create complete price transparency. Online platform or not, however, the benefits are clear: It is time to get individuals into the LIHTC market.
Here are some print ads for loan businesses I found in a 1938 San Francisco phone directory, while looking up some artifacts found in my house.
It’s fascinating to me that 70 years later, a lot of these messages are essentially the same, except they are transported via SMS, Web and email. I note also that banks and stock/bond brokers do not advertise.
Whenever I drive I realize how much people behave differently when driving their little mobile avatars than when walking or bicycling. I’m for instance amazed to see people trying to get ahead of a single car in a 5mph traffic. I think there is a lot to learn from these behaviors.
Driving a car on a highway is quite efficient from the perspective of going from point A to point B, at least when and where efficient public transportation options are not available. In addition, driving a car has the advantage of anonymity: other drivers don’t know your who you are, only the car you drive and how you drive it. This implies that any legal but aggressive behavior, or illegal but uncaught by the police, has little consequence unless you get into an accident. Knowing that your name won’t be publicly tainted by your bad behavior is an incentive to behave aggressively.
When you walk or bicycle, it’s harder to get away anonymously. People can easily catch up with you and ask you about your behavior. This I think leads to more courteous behaviors.
To me this is similar to a market. In a market that’s completely anonymous and driven only by numbers and mediated by computers, aggressiveness can be expected to be high. In comparison markets that assume conversations between buyer and seller, haggling, behavior is likely to be more subtle. The main reason is that information about a dishonest participant will circulate very quickly in a human-driven market where anonymity is difficult than in a computer and broker-mediated market.
One option of course is to increase the regulation of the markets, which in highway terms is to have more police cars around: drivers stay anonymous to each other but completed naked to a few policemen. This implies that the monopoly of moral superiority is given to one small group, something I think is prone to corruption.
Another option is to limit anonymity and to facilitate sharing information on market participants. On the highway, this would mean dash applications that gives the ability to rate other drivers, directly from your steering wheel, but also that display right away warnings when a badly rated driver is approaching.
Limiting anonymity is much harder in financial markets, since it is easy to conceal a trade behind a chain of intermediaries. In a way, it’s the intermediaries job to help participants conceal their real intentions, especially those participants with the biggest impact on markets. Our financial markets are like high-speed highways with little police and very fast cars remotely driven by participants, in which many small investors drive their little car.
How can “social” improve the morality of markets, without succumbing to either a monopoly of moral superiority or a wild jungle with no morality?