On Crowdfunding in Start-Ups

Yesterday, federal legislation went into effect to allow small start-ups to ask for equity investments publicly, such as through social media sites or elsewhere on the Internet, without having to register the shares for public trading. Business owners will now be able to raise any amount, though only, at this point, from accredited investors—those individuals deemed wealthy and sophisticated enough to understand and withstand (tremendous) risk (basically, if you make $200,000 in income per year or have more than $1 million in assets, excluding your primary residence).

I was thinking about this for some time, but I’m glad I read Felix Salmon’s piece “The Idiocy of Crowds” about this latest news. Basically, he thinks it’s a terrible, terrible idea and an easy way to part with your money:

Today’s a big, exciting day for anybody who has found it simply too difficult, to date, to throw their money away on idiotic gambles. Are you bored with Las Vegas? Have you become disillusioned with lottery tickets? Do micro caps leave you lukewarm? Does the very idea of a 3X ETF fill you with nothing but ennui? Well in that case today you must rejoice, because the ban on general solicitation has been abolished, and the web is now being overrun with companies like Crowdfunder and RockThePost and CircleUp which offer a whole new world of opportunity when it comes to separating fools from their money. You can even lose your money ethically, now, if that’s your particular bag. The highest-profile such platform is probably AngelList: as of today, founders like Paul Carr (alongside, according to Dan Primack, over 1,000 others) are out there tweeting at the world in an attempt to drum up new investors.

It is conceivable that over time, these equity crowdfunding platforms will learn from their inevitable mistakes, and the few which survive will learn how to be something other than a hole in which to pour millions of dollars…

I thought the email that Felix received from an anonymous angel investor was particularly wise:

These guys are building their business on the notion/dream that somehow the internet can disintermediate social and relationship capital. I’d argue that this is precisely what the internet can not do: if you’re going to invest in a startup, you’d better know the founders, and you’d better know something that most people do not know. Information asymmetry is the only way to lower the risk profile on such crazy risky investments.

Disclosure: I am staying on the sidelines; I just thought the news was interesting.

What Happened in the Markets on September 18, 2013 at 2PM?

This is an intriguing analysis at Nanex of what happened in the financial markets (equities and futures) on September 18, 2013 milliseconds before the FED announcement of “no taper” at precisely 2:00PM.

One of Einstein’s great contributions to mankind was the theory of relativity, which is based on the fact that there is a real limit on the speed of light. Information doesn’t travel instantly, it is limited by the speed of light, which in a perfect setting is 186 miles (300km) per millisecond. This has been proven in countless scientific experiments over nearly a century of time. Light, or anything else, has never been found to go faster than 186 miles per millisecond. It is simply impossible to transmit information faster.

Too bad that the bad guys on Wall Street who pulled off The Great Fed Robbery didn’t pay attention in science class. Because hard evidence, along with the speed of light, proves that someone got the Fed announcement news before everyone else. There is simply no way for Wall Street to squirm its way out of this one.

Before 2pm, the Fed news was given to a group of reporters under embargo – which means in a secured lock-up room. This is done so reporters have time to write their stories and publish when the Fed releases its statement at 2pm. The lock-up room is in Washington DC. Stocks are traded in New York (New Jersey really), and many financial futures are traded in Chicago. The distances between these 3 cities and the speed of light is key to proving the theft of public information (early, tradeable access to Fed news).

We’ve learned that the speed of light (information), takes 1 millisecond to travel 186 miles (300km). Therefore, the amount of time it takes to transmit information between two points is limited by distance and how fast computers can encode and decode the information on both sides.

Our experience analyzing the impact of hundreds of news events at the millisecond level tells us that it takes at least 5 milliseconds for information to travel between Chicago and New York. Even though Chicago is closer to Washington DC than New York, the path between the two cities is not straight or optimized: so it takes information a bit longer, about 7 milliseconds, to travel between Chicago and Washington. It takes little under 2 milliseconds between Washington and New York.

Therefore, when the information was officially released in Washington, New York should see it 2 milliseconds later, and Chicago should see it 7 milliseconds later. Which means we should see a reaction in stocks (which trade in New York) about 5 milliseconds before a reaction in financial futures (which trade in Chicago). And this is in fact what we normally see when news is released from Washington.

However, upon close analysis of millisecond time-stamps of trades in stocks and futures (and options, and futures options, and anything else publicly traded), we find that activity in stocks and futures exploded in the same millisecond. This is a physical impossibility. Also, the reaction was within 1 millisecond, meaning it couldn’t have reached Chicago (or New York): another physical possibility. Then there is the case that the information on the Fed Website was not readily understandable for a machine – less than a thousandth of a second is not enough time for someone to commit well over a billion dollars that effectively bought all stocks, futures and options.

The conclusions the authors draw? The announcement was leaked:

The Fed news was leaked to, or known by, a large Wall Street Firm who made the decision to pre-program their trading machines in both New York and Chicago and wait until precisely 2pm when they would buy everything available. It is somewhat fascinating that they tried to be “honest” by waiting until 2pm, but not a thousandth of a second longer. What makes this a more likely explanation is this: we’ve found that news organizations providing timed release services aren’t so good about synchronizing their master clock – and often release plus or minus 15 milliseconds from actual time. Their news machines in New York and Chicago still release the data at the exact same millisecond, but with the same drift in time as the master clock. That is, we’ll see an immediate market reaction at say, 15 milliseconds before the official scheduled time, but in the same millisecond of time in both New York and Chicago. Historically, these news services have shown a time drift of about 30 milliseconds (+/- 15ms), which places the odds that this event was from a timed news service at about 10%. 

Something does sound fishy based on the charts provided by Nanex. I’ve read some of their analyses before and they have been overwhelmingly convincing. We’ll see how this one unfolds pretty soon, I think.

When Gucci and Louis Vuitton Handbags Serve as Collateral for Loans

Say hello to the handbag-backed loan. A company in Hong Kong, Yes Lady Finance Co., provides loans to customers if they’re able to bring in their beloved handbags as collateral.

Yes Lady provides a loan within half an hour at 80% of the bag’s value—as long as it is from Gucci, Chanel, Hermès or Louis Vuitton. Occasionally, a Prada purse will do the trick. Secondhand classic purses and special-edition handbags often retain much of their retail prices.

A customer gets her bag back by repaying the loan at 4% monthly interest within four months. Yes Lady says almost all its clients quickly pay off their loans and reclaim their bags.

The company recently lent about US$20,600 in exchange for a Hermès Birkin bag, but Yes Lady’s purse-backed loans start at about US$200.

This is bizarre, and one of those “markets in everything” phenomena. The best part? Some people try to get away with bringing in fake luxury handbags. You should read the article on how Yes Lady handles those scenarios…

Did Goldman Sachs Overstep in Criminally Charging Its Ex-Programmer?

Michael Lewis’s latest piece for Vanity Fair is an 11,000 examination of how Goldman Sachs acted after finding that one of its ex-programmers, Sergey Aleynikov, allegedly stole computer code. There was a federal trial, and the 41-year-old father of three was sentenced to eight years in federal prison. Investigating Aleynikov’s case, Michael Lewis holds a second trial. The entire piece is worth reading, especially the interviews with Aleynikov in which he presents his views on life (quoted at the bottom in this post).

First, this was an interesting anecdote on why Russians are the best programmers on Wall Street:

He’d been surprised to find that in at least one way he fit in: more than half the programmers at Goldman were Russians. Russians had a reputation for being the best programmers on Wall Street, and Serge thought he knew why: they had been forced to learn programming without the luxury of endless computer time. “In Russia, time on the computer was measured in minutes,” he says. “When you write a program, you are given a tiny time slot to make it work. Consequently we learned to write the code in a way that minimized the amount of debugging. And so you had to think about it a lot before you committed it to paper. . . . The ready availability of computer time creates this mode of working where you just have an idea and type it and maybe erase it 10 times. Good Russian programmers, they tend to have had that one experience at some time in the past: the experience of limited access to computer time.”

A new rule created by the SEC in 2007 called Regulation NMS led to the proliferation of high frequency trading (HFTs):

For reasons not entirely obvious (yet another question for another day), the new rule stimulated a huge amount of stock-market trading. Much of the new volume was generated not by old-fashioned investors but by extremely fast computers controlled by high-frequency-trading firms, like Getco and Citadel and D. E. Shaw and Renaissance Capital, and the high-frequency-trading divisions of big Wall Street firms, especially Goldman Sachs. Essentially, the more places there were to trade stocks, the greater the opportunity there was for high-frequency traders to interpose themselves between buyers on one exchange and sellers on another. This was perverse. The initial promise of computer technology was to remove the intermediary from the financial market, or at least reduce the amount he could scalp from that market. The reality has turned out to be a boom in financial intermediation and an estimated take for Wall Street of somewhere between $10 and $20 billion a year, depending on whose estimates you wish to believe.

Goldman decided to hire Serge Aleynikov to beef up their algorithms to compete with the likes of big hedge funds like Citadel:

A lot of the moneymaking strategies were of the winner-take-all variety. When every player is trying to buy Pepsi after Coke’s stock has popped, the player whose computers can take in data and spit out the obvious response to it first gets all the money. In the various races being run, Goldman was seldom first. That is why they had sought out Serge Aleynikov: to improve the speed of their system.

The article explains how Goldman is a money-making machine, but the appearance of black swan events led many Wall Street firms to lose millions of dollars at the height of the financial crisis, Goldman included:

Day after volatile day in September 2008, Goldman’s supposedly brilliant traders were losing tens of millions of dollars. “All of the expectations didn’t work,” recalls Serge. “They thought they controlled the market, but it was an illusion. Everyone would come into work and were blown away by the fact that they couldn’t control anything at all. . . . Finance is a gambling game for people who enjoy gambling.”

This was probably the most damning paragraph in the piece about Goldman’s relationship with open source software:

But most of his time was spent simply patching the old code. To do this he and the other Goldman programmers resorted, every day, to open-source software, available free to anyone for any purpose. The tools and components they used were not specifically designed for financial markets, but they could be adapted to repair Goldman’s plumbing.

Serge quickly discovered, to his surprise, that Goldman had a one-way relationship with open source. They took huge amounts of free software off the Web, but they did not return it after he had modified it, even when his modifications were very slight and of general rather than financial use. “Once I took some open-source components, repackaged them to come up with a component that was not even used at Goldman Sachs,” he says. “It was basically a way to make two computers look like one, so if one went down the other could jump in and perform the task.” 

On the individualistic (selfish) nature of competition at Goldman, even when efforts were collaborative in nature:

It made no sense to him the way people were paid individually for achievements that were essentially collective. “It was quite competitive. Everyone’s trying to show how good their individual contribution to the team is. Because the team doesn’t get the bonus, the individual does.”

And then we get to the meat of the piece, where Michael Lewis invites people in the HFT industry to come up with their own verdict of whether Serge Aleynikov did something nefarious and/or illegal:

Our system of justice was a poor tool for digging out a rich truth. What was really needed, it seemed to me, was for Serge Aleynikov to be forced to explain what he had done, and why, to people able to understand the explanation and judge it. Goldman Sachs had never asked him to explain himself, and the F.B.I. had not sought help from someone who actually knew anything at all about computers or the high-frequency-trading business. And so over two nights, in a private room of a Wall Street restaurant, I convened a kind of second trial. To serve as both jury and prosecution, I invited half a dozen people intimately familiar with Goldman Sachs, high-frequency trading, and computer programming.

You have to read the piece for the conclusion. As one of the jurors assembled by Michael Lewis says: it was nauseating how Sergey was treated.

One last bit in the informal jury process that caught my attention was Serge’s demeanor and approach to life. Take things as they come; negativity is pointless:

At one point one of the people at the table stopped the conversation about computer code and asked, “Why aren’t you angry?” Serge just smiled back at him. “No, really,” said the other. “How do you stay so calm? I’d be fucking going crazy.” Serge smiled again. “But what does craziness give you?” he said. “What does negative demeanor give you as a person? It doesn’t give you anything. You know that something happened. Your life happened to go in that particular route. If you know that you’re innocent, know it. But at the same time, you know you are in trouble and this is how it’s going to be.” To which he added, “To some extent I’m glad this happened to me. I think it strengthened my understanding of what living is all about.”

What are your thoughts?

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There’s a very interesting addendum in Vanity Fair in which Michael Lewis is interviewed about his piece. Here, he shares his personal thoughts on Sergey’s time in prison:

Q: For the past 200, 250 years, prison has been an essential part of the Russian experience. Like Dostoyevsky and other Russian authors, and their heroes, Serge found some sense of purpose in his incarceration. Do you think an American could have come away from the experience with that same perspective?

[Michael Lewis]: In the 1950s, European filmmakers, when their films were going to be made for both a Russian and American audience, would change the ending. They would make a happy ending for the American audience and a tragic one for the Russian audience. There’s a photographer named Tacita Dean who has done a series of photographs called “Russian Endings” where she has played on this. I would say that in some ways, there’s something in the water in Russia that enables you to derive a kind of pleasure from a tragic experience. That is not in the water in America. A kind of richness from a tragic experience. And whatever chemical is in the water, Serge drank plenty of it. He is very persuasive on the subject that this was not an all-together bad experience for him. It woke him up to many aspects of life that he had previously been asleep to. I believe him. I don’t think it’s just superficial rationalizing.

When you’re with him, it’s shocking how without anger or bitterness he is. You would never guess, at the dinners I had, that he was one who spent time in jail. You would have picked every other person there.

Also worth highlighting is financial blogger Felix Salmon on his reaction to Lewis’s piece:

I’m increasingly coming to the conclusion that America’s system of jurisprudence simply isn’t up to the task of holding banks and bankers accountable for their actions. The only people who ever get prosecuted are small fry and insider traders, rather than the people who really caused the biggest damage. And the lesson of Sergei Aleynikov is that if and when the laws get beefed up, the banks will simply end up taking advantage of those laws for their own vindictive purposes, rather than becoming victims of them. Given the ease with which Goldman got the FBI to do its bidding, one has to assume that, most of the time, the government will be working on the same side as the big banks, rather than working against them. Do we really want to give those banks ever more powerful weapons?

Post-Scarcity Economics by Tom Streihorst

Tom Streihorst, a filmmaker and writer who publishes articles on finance and economics, pens an excellent essay titled “Post-Scarcity Economics” in The Los Angeles Review of Books:

We fly across oceans in airplanes, we eat tropical fruit in December, we have machines that sing us songs, clean our house, take pictures of Mars. Much the total accumulated knowledge of our species can fit on a hard drive that fits in our pocket. Even the poorest among us own electronic toys that millionaires and kings would have lusted for a decade ago. Our ancestors would be amazed. For most of our time on the planet, humans lived on the knife-edge of survival. A crop failure could mean starvation and even in good times, we worked from sun up to sundown to earn our daily bread. In 1600, a typical workman spent almost half his income on nourishment, and that food wasn’t crème brûlée with passion fruit or organically raised filet mignon, it was gruel and the occasional turnip. Send us back to ancient Greece with an AK-47, a home brewing kit, or a battery-powered vibrator, and startled peasants would worship at our feet.

And yet we are not happy, we expected more, we were promised better. Our economy is a shambles, millions are out of work, and few of us think things are going to get better soon. When I graduated high school, in 1975, I assumed that whatever I did, I would end up somewhere in the great American middle class, and that I would live better than my father, who lived better than his. Today, my son doesn’t have nearly the same confidence. Back in those days, you could go off to India for seven years, sit around in an ashram, smoke pot and seek spiritual fulfilment, and still come home and get a good job as a copywriter at Ogilvy and Mather. Today kids need a spectacular resume just to get an unpaid internship at IBM. Our children fear any moment not on a career path could ruin their prospects for a successful future. Back in the 1970s, pop stars sang songs about of the tedium and anomie of factory work. Today the sons of laid-off autoworkers would trade anything for that security and steady wage.

Most of us are working harder, for less money and with no job security. My father and I both worked at the same large corporation but there was a difference, a difference determined by our respective eras: he was staff, I was freelance. When he got sick, the company found him doctors, paid his salary, put considerable effort into his recovery. Had I ever gotten sick, they would have simply forgotten my name. He yelled at the CEO habitually without any fear of losing his job. I mouthed off once to a middle manager and was never hired again. He had a defined benefit pension paid for by the corporation, the government gave me a tax break should I choose to save for my own retirement. The company had legal and moral responsibilities to him, which both he and they viewed as sacrosanct. All they owed me was a day’s pay for a day’s work. His generation gave their you to a corporation, and the corporation took care of them in their old age. Today loyalty, if it exists at all, goes just one way. Many of my college buddies, are unemployed at 50, or earning less than they did ten years ago.

He discusses economics in the context of Paul Krugman, Keynes, and Alan Greenspan. Worth a read.

Joining Wall Street to Save the World

The Washington Post profiles a 25-year-old Jason Trigg, who’s decided to join a high frequency trading firm to make the most amount of money as he can. But why? So he can give a lot of it away. He figures it’s a better bet than going into academia:

He’s figured out just how to take measure of his contribution. His outlet of choice is the Against Malaria Foundation, considered one of the world’s most effective charities. It estimates that a $2,500 donation can save one life. A quantitative analyst at Trigg’s hedge fund can earn well more than $100,000 a year. By giving away half of a high finance salary, Trigg says, he can save many more lives than he could on an academic’s salary.

In many ways, his life still resembles that of a graduate student. He lives with three roommates. He walks to work. And he doesn’t feel in any way deprived. “I wouldn’t know how to spend a large amount of money,” he says.

While some of his peers have shunned Wall Street as the land of the morally bankrupt, Trigg’s moral code steered him there. And he’s not alone. To an emerging class of young professionals in America and Britain, making gobs of money is the surest way to save the world. When you ask Trigg where he got the idea, his answer is a common refrain among this crowd: “I feel like I’d read stuff by Peter Singer.”

Interesting, to say the least.

Warren Buffett: Women are Key To America’s Future Prosperity

Warren Buffett joined Twitter today. To coincide with that move, he also penned a piece in CNN/Fortune, in which he explains how women are key to America’s prosperity:

Start with the fact that our country’s progress since 1776 has been mind-blowing, like nothing the world has ever seen. Our secret sauce has been a political and economic system that unleashes human potential to an extraordinary degree. As a result Americans today enjoy an abundance of goods and services that no one could have dreamed of just a few centuries ago.

But that’s not the half of it — or, rather, it’s just about the half of it. America has forged this success while utilizing, in large part, only half of the country’s talent. For most of our history, women — whatever their abilities — have been relegated to the sidelines. Only in recent years have we begun to correct that problem.

Despite the inspiring “all men are created equal” assertion in the Declaration of Independence, male supremacy quickly became enshrined in the Constitution. In Article II, dealing with the presidency, the 39 delegates who signed the document — all men, naturally — repeatedly used male pronouns. In poker, they call that a “tell.”

Finally, 133 years later, in 1920, the U.S. softened its discrimination against women via the 19th Amendment, which gave them the right to vote. But that law scarcely budged attitudes and behaviors. In its wake, 33 men rose to the Supreme Court before Sandra Day O’Connor made the grade — 61 years after the amendment was ratified. For those of you who like numbers, the odds against that procession of males occurring by chance are more than 8 billion to one.

I couldn’t agree more. Go Warren go!

A Fortune for No One

The New York Times profiles the story of Roman Blum, a Holocaust survivor who died last year but left no will. He had a fortune of more than $40 million, the largest unclaimed estate in the history of New York state:

Much about Mr. Blum’s life was shrouded in mystery: He always claimed he was from Warsaw, although many who knew him said he actually came from Chelm, in southeast Poland. Several people close to Mr. Blum said that before World War II, in Poland, he had a wife and child who perished in the Holocaust, though Mr. Blum seems never to have talked of them, and the International Tracing Service in Bad Arolsen, Germany, has no record of them in its database. Even his birth date is in question. Records here give it as Sept. 16, 1914; identity cards from a German displaced persons camp have it as Sept. 15.

But perhaps the greatest mystery surrounding Mr. Blum is why a successful developer, who built hundreds of houses around Staten Island and left behind an estate valued at almost $40 million, would die without a will.

Read the rest.

Who Are the Bitcoin Millionaires?

Business Week profiles three people who are paper millionaires for having invested in Bitcoin:

Owners store their Bitcoins in electronic wallets, which are identified by a long string of letters and numbers. The wallet 1933phfhK3ZgFQNLGSDXvqCn32k2buXY8a, for example, currently owns 111,111 Bitcoins, which amounts to more than $15 million sitting on someone’s hard drive. Whose hard drive is a mystery: While anyone can view the wallets, the owners’ identities are not public. As of April 2, there were about 250 wallets with more than $1 million worth of Bitcoins. The number of Bitcoin millionaires, though, is uncertain—people can have more than one wallet.

Charlie Shrem, 23, discovered Bitcoins on a website in early 2011, when he was a senior at Brooklyn College. Shrem didn’t mine coins himself but bought them on Tradehill. His first purchase was 500 coins at about $3 or $4 each; he bought thousands more when the price hit $20. When he was still in college, Shrem started BitInstant, a company that allows its customers to purchase the digital currency from more than 700,000 stores, including Wal-Mart Stores and Duane Reade. Shrem wears a ring engraved with a code that gives him access to the electronic wallet on his computer. Friends tease him that a thief could cut off his finger to get the ring. “They started calling me four-finger Charlie,” he says.

My take: if they’re still invested in BitCoin, they might lose it all come next month. They better cash out quick. Oh wait, they can’t at the moment…

The Great Norwegian Diaper Arbitrage

Matthew O’Brien reports on an interesting scheme going on in Europe: people from certain European countries are driving to Norway and emptying store shelves of diapers. Why? Because they can resell these diapers in their home countries for double the price.

There are lots of ways supermarkets can get customers in the door, and away from the competition. But in parts of Norway, cut-rate diapers have become the preferred lure. It’s set off something of a price war, which would be great news for Norwegian parents if they could actually find diapers in stock. They can’t. As Reuters reports, prices are so enticingly low that foreigners, mostly Poles and Lithuanians, have started trekking to Norway for the sole purpose of buying up every last diaper they can find. 
Here’s how the arbitrage math adds up. The ferry costs approximately $275 round trip, and gas is about $8 a gallon in Sweden, which, if we assume our car gets around 30 miles per gallon, gives us $435 in expenses. Throw in food, lodging, and other miscellaneous costs, and the total should come in around $600 or so. Remember, diapers costs more than twice as much in Lithuania as they do in Norway, so we only need to buy that much to break even. In other words, if we buy just $600 worth, which we can resell in Lithuania for double, we can cover our basic costs — and we can make enough profit to make the whole trip worth our while if we buy another couple hundred dollars worth. Of course, $1,000 worth isn’t very much when it comes to diaper arbitrage; Norwegian customs officials have seen people pack their cars with as much as $9,000 worth — good for more than $8,000 of profit. Not too shabby.
I don’t see how these prices can remain at such low levels in Norway for the foreseeable future…
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