Thursday, March 15, 2012

Show Me the Money

My younger brother is one of the brightest people I know. He has a degree in finance (or econ, or business, or...I'm not really sure) from the University of Richmond. He is also a Certified Financial Analyst – a program he pursued instead of his second choice: an MBA program at the Wharton School of Business, University of Penn. He rose to the level of vice president of his company before he turned thirty.

Now he makes sandwiches.

Full disclosure, he makes very high-end sandwiches, in his own shop, the franchise for which he bought with the considerable severance that he got from his previous company. Still, his choices say something about where the economic universe is headed and one ignores Mark’s insights about the economic universe at one's peril.

The global financial crisis (or is it Global Financial Crisis, or GLOBAL FINANCIAL CRISIS!!!?) is the latest in a steady stream of boom-bust cycles caused by people ignoring the way money actually is made. The first one that I personally experienced was the dot-com bubble. In the early days of the internet we all knew that it was going to be huge, and important, and game-changing. What we didn’t know was how exactly this was going to come about. Instead of waiting to see, or taking time to figure it out, lots of people put lots of money indiscriminately into anything having to do with the internet. One of the most famous examples was, but there were lots of others. In fact, I don’t really understand why is a universal joke, and rules the world—other than the fact that books are much easier to ship than bags of dog food. The fact that Amazon will now ship you dog food only deepens the mystery.

Related side note: my school district's notoriously stingy school board participated in this bubble by approving a course in those days called Introduction to the Internet—subsequently renamed something else, but which I will continue to call Advanced Concepts in Web-Surfing. The wherewithal it takes to design a class to teach kids how to use search engines is, if not admirable, at least remarkable.

The more recent boom-bust started in housing. For a while, I was watching a couple of shows called something like  "Flip This House." The moral of these shows was that anyone could buy a house for $120,000, or $234,000, or $689,000, spend six weeks goobering on a nice coat of paint and throwing in some attractive landscaping, then be pretty much guaranteed to double his/her money. Almost no one mentioned the terms of the financing, other than the fact that the mortgage payment was a carrying cost for the extra month it might take to finish the project (always the suspense part of the story) and get a new buyer. It simply didn’t matter what your financing looked like when when you were going to get out quick with a wheelbarrow full of cash. Until the housing bubble burst, that is.

In both of these examples--plus Enron, plus the Great Depression--people stopped thinking about what was actually being exchanged in the transaction and were instead blinded by the vast amounts of money. Stock markets are especially prone to boom-bust cycles, sometimes on a much smaller scale, particularly when amateurs are involved.
One day, I opened an Ameritrade account and bought stock in Palm, and Krispy Kreme, and Honda, just because I liked their products. I eventually got out, not because I was terrible at picking stocks (though I was), but because the fees were so high that my tiny little investment was quickly getting cleaned out by them. The rise of defined contribution retirement savings, and the fall of defined benefit, means that lots of individuals recently got a say on which stocks they own. Sometimes they like the company they work for so much that they buy stock in it for retirement (see also: Enron - above)

Most of the time they do it through comparatively safe mutual funds, but even that is is tricky. Stocks, bonds, commodities (by the way, spell-check suggested “commode” for this word when I messed it up), and the financial “instruments” made from them can rise and fall based on real things, but also based on perception. Money flooding into (or out of) the market gives the perception that things are going well, which draws money into (or out of) the market. When computers get into the act, things can get ugly very quickly.

Populist money pundits like Suze Ormond and Jim Cramer speak with the kind of authority, confidence, and straightforward vocabulary that can make us all feel as though we understand this stuff, but the system is intentionally over-complicated. The more complex something is the more opaque layers can be inserted between people and their common sense. Think collateralized debt obligations.

What does this have to do with my brother’s sandwich shop? You thought I forgot. Fair enough.

Mark learned to critically analyze very complex situations and work out the fundamental way that money is supposed to be made--ignoring, as necessary, the fact that a huge amount of money may be changing hands. People like him were going to conferences with hundreds of other analysts--a situation further scaled-up by  being repeated in half-a-dozen other cities across the country-- all getting the same information. He came to the realization that if all of those men and women were going back to the office and acting on this information, that he was dealing with the very definition of a self-fulfilling prophecy.

In other words, he figured out that no matter how good he and his company were, his place in the process was quickly becoming less and less dependent on his own considerable skills. He declined the offer of a transfer and decided to sell sandwiches instead. The important thing about selling sandwiches is that you know immediately if you’ve done well, and it is immediately obvious to everyone involved what you have provided. Sure, I could buy a slicer and keep it in my kitchen, bake bread, stock all of the ingredients for a wide variety of sandwiches, keep everything out of the temperature danger zone so that I avoid food-borne illness, and then wash everything in the kitchen when I’m done. Or I can buy a sandwich.

A Planet Money podcast discussed a very similar shift in thinking that has been brought to us by Apple. While Apple may very well be the new evil empire, they have done a rather remarkable thing in the evolution of internet commerce—gotten people to pay for music, and now software. By having the App store, with its linked credit cards, and the same checkout procedure whether you’re getting the software for free or not, Apple has created a situation where people can be paid for the software they create.

 It’s remarkable because most of the other internet juggernauts right now are making their money on advertising. In fact, lots of our “free” internet stuff is paid for with advertising, to the point that we don’t really think about it too much. It’s a profoundly important issue, though, because advertising lives in this three-steps-removed world where you generate traffic, lure people into spending, and then try to prove that the advertising made a difference. If you are actually selling something of value, for money, the food-chain is shortened considerably.

All of this said, at the moment I'm not sure I did so well on this whole thing myself. I certainly didn’t choose music education for the money--in fact, having attended Catholic school, I thought that teachers pretty much took a vow of poverty. By that standard, things have worked out pretty well so far.

Still, education in general, and music education specifically, is in a very bad way right now. Communities are wrestling with the very real question of what value does public education bring to their lives. Meanwhile, the nation is experimenting with a fad of budget cutting. Rather than go after actual big ticket items--national defense, Social Security, and Medicare/Medicaid--we're trying to plug billion and trillion dollar holes with million and hundred-thousand dollar bungs. Add to that the fact that PA's educational system is divided into 500 fiefdoms, funded on the backs of farmers and the elderly, and ruled over by farmers and the elderly. Suddenly you're looking at some pretty substantial and fundamental problems with the money situation.

For one thing, I believe in public education, in part because private industry has tended to make rather a balls-up of it when they've given it a go. See also: here, and here. Also, though, I believe that we offer a pretty good value. Recently I watched a public school kid recite pi to 1042 digits. Recently I watched 208 (mostly) public school kids form a remarkable ensemble with nothing more than a guest conductor and 23 hours of rehearsal over the span of three days. It's not always clear what we're doing in public school teaching, but these moments, and thousands of others through the course of a year, give you some idea. If you're really looking.

In the wider world, no one knows where the next boom-bust is coming from. There will be no shortage of opinions, but I theorize that if more people start creating things of value and finding a way to get paid for them that this could help a great deal. So, it's simple really: just make something worthwhile, determine its value to others, and get them to pay you a proper amount for it. Simple doesn't always mean easy.

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