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September 18, 2024September 18, 2024

Book Review: On The Edge, by Nate Silver

Nate Silver published On The Edge: The Art of Risking Everything on August 13th and, well, I knew I had to jump it on the top of my reading list.

Silver is best known for creating the election-forecasting blog FiveThirtyEight, which he reconstituted on Substack in 2024 as The Silver Bulletin.

For newspaper-reading political obsessives like me, it’s Nate Silver’s world between now and November 5th, and we’re all just living in it. He aggregates and weights polling data, inputs other calibrated factors into his model, and suggests a probabilistic approach to electoral college results.

In his new book, Silver gives coherence – and the name “The River” – to a community of practitioners and thinkers who I admire, and who I try to channel in my own writing.

Silver’s thesis is that there is a particularly successful and newly salient group of people from a variety of walks of life who share a common epistemology.

Epistemology is the 50-cent word for a theory of knowledge or a way of thinking.

The River

So this group, the River, primarily shares a way of thinking about risk.

Among other things, they think probabilistically about risks in rational and objective ways, rather than emotional or traditional ways. They compare the probability of success versus the size of the rewards. They specifically seek to take risks when there is positive expected value – where the size of the reward is big enough to overcompensate for the probability of failure. They are competitive. They are strategically empathetic, by which he means they try to see how the other side of a contest is thinking. They update their views when new data comes in. They try to not be overly wedded to one world-view or one model of how things work. They can be contrarian in the face of societal consensus.

The meat of the book is derived from interviews and observations of people who share this epistemology from the worlds of technology, private equity, trading, gambling, cryptocurrency and artificial intelligence. Silver is a member of The River, so he’s eager to explain the advantages of this method, as it serves him and others well when investing, gambling, sports-betting, election-model building or other risky endeavors. He’s also a careful journalist and writer, so he sifts through – especially in later chapters – how this type of thought can go wrong for individuals or the world.

For an example of the latter, you get in this book very close-up conversations with Sam Bankman-Fried before, during and after his spectacular cryptocurrency rise with FTX, and his subsequent fall and fraud conviction.

You also get the most in-depth explanation of the rise of artificial intelligence I have read to date, including an attempt at a technical explanation of how large language models (LLMs) like ChatGPT work for a non-technical reader like myself. You’ll get far more poker history and lore and strategy than you’ll ever need, as well as the methods and thought process of a sports better.

My Own Retrospective Guide

Narrative, connectivity, identity, justice, and status-quo pattern recognition, are examples of other useful intellectual techniques common in academia, government, and journalism. They also may be at odds with the hyper-rational, probabilistic, contrarian risk-orientation of The River.

What I hadn’t expected is that Silver’s new book would provide a kind of retrospective guide to my own mental aspirations when writing this column. I naturally gravitate to stories about practitioners from The River, probably because I think it’s a great corrective to the typical epistemology of traditional journalism.

While there are quite a few members of The River and an extensive philosophical tradition – as explained in detail throughout On The Edge – the vast majority of us do not apply enough of these thought processes.

Silver dedicates two chapters to the rise of artificial intelligence, and especially the worries of leading rationalists like Eliezer Yudkowsky who see an existential threat from AI, something I became alarmed about last year.

Silver is a major advocate for prediction markets like Manifold, Polymarket and PredictIt, which allow the collective bets of crowds on outcomes in a probabilistic manner, and with which I’ve become obsessed in the past few months.

The River’s way of thinking informs my view of why retail options trading is not likely to be profitable in the long run.

My views on the organization GiveDirectly – which attempts to bring a rational and probabilistic mindset to philanthropy – stems from this same impulse.

The Recent Texas Lotto Example

This one didn’t come from Silver’s book, but an excellent Hearst investigation of a lottery scheme in Texas is one of the best recent examples of River vs. non-River thinking from the Lone Star State.

The most commonplace piece of personal finance wisdom is to never buy lottery tickets. And this is true, you should not, precisely because the “expected value” of every lottery ticket you’ve ever bought is less than the price you pay. The more tickets you buy, the more you will lose over time, like any other game of chance at the casino. This is Expected Value 101.

On the other hand, if there were a theoretical lottery game in which the payout had a positive expected value, then you should play that lotto. In the real world this is extremely rare, and requires specific circumstances and some sophisticated techniques.

The investors and implementers behind a lottery scheme in 2023 are an example of people from The River who know how to calculate and exploit expected value opportunities, even with lottery tickets. You should look up the Hearst investigation yourself as its quite interesting, but the short version is this:

For the April 22, 2023 Texas Lotto drawing, an investment group managed to spend an estimated $25.8 million to purchase every numerical combination possible in order to guarantee a win of the $57.8 million lump sum offered by the Texas Lotto, plus smaller prizes as well. Their expected value calculation depended upon the payout getting very large over many months without a jackpot, plus their confidence they had solved the technological and logistical problem of buying up every number combination over the course of two days. They basically brought an Oceans 11 approach to winning the Texas Lotto, and it was all legal.

If you don’t know how to do that, you should not ever be buying lottery tickets.

As a p.s. to the story, the Texas Lottery Commission will probably change the rules to prevent this kind of exploit in the future.

Texas Lotto changes rules after a Houston Chronicle investigation

Improve Our Thinking

I’m not claiming to be particularly great at The River’s mode of thinking, but I am naturally attracted to it. I aspire to it.

My interest began as a childhood board game player, was enhanced by years working on Wall Street, and is kept percolating through hobbies like dabbling in poker, investing, and prediction markets.

I’ve been exposed enough to it throughout the years to see it as something that can give me, and other people, a possible edge in understanding the world. Whether you’re a member of The River already, or just want to avoid the pitfalls of conventional thinking, I recommend Nate Silver as your guide.

A version of this post ran in the San Antonio Express-News and Houston Chronicle.

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June 10, 2024June 10, 2024

Book Review: The 15-Minute City by Carlos Moreno

Professor Carlos Moreno first presented his “15-Minute City” idea in 2016 at a climate conference. His big idea was that reducing fossil-fuel emissions required a radical redesign of urban life, reducing automobile traffic by making everything much more accessible to smaller neighborhood units.

Part of the power of Moreno’s concept comes from the fact that current Paris Mayor Anne Hidalgo has adopted the 15-Minute City concept as her guiding leadership principle, and she will be mayor until 2026.

Moreno’s new book The 15-Minute City: The Solution To Saving Our Time & Our Planet published May 7th explains this concept in depth and chronicles attempts by leaders of contemporary cities – first 20 cities, then 40 cities, and now many more cities – to imagine and then implement design and zoning changes to improve urban life.

Moreno’s argument is that we can and should measure the distance in time it takes city-dwellers to reach essential services like education, work, health, food, and entertainment amenities. Healthier cities try to avoid long commutes and traffic jams, some of which are caused by car-centric planning. We can accomplish this partly by creating the conditions for more walking, biking and public transportation modes. Mixing residential and commercial buildings makes it more likely that people can live in complete neighborhoods where much of life can be reached without getting stuck in traffic.

Moreno’s 15-Minute City is a great example of how a cleverly conceived big idea can drive change when adopted by the right people.The mayors of cities as diverse as Paris, Milan, Cleveland, Portland, Melbourne, Buenos Aires, and even Busan in Korea and Souse in Tunisia have explicitly modeled their urban redevelopment plans on Moreno’s concepts, as explained in his book.

The convincing appeal of The 15-Minute City, for me personally, has very little to do with environmental impact or as a way to address climate change. I’m not in fact convinced by his arguments on that aspect of it.

I am convinced instead by the aesthetic and lifestyle improvements that a 15-minute city seem to offer. In the car-centric world of 21st-Century Texas cities, I lament and resent the reliance on cars that our built environment requires. In San Antonio, where I live, we tend to build new residential communities with single access points that connect only to interstate highways. This requires everyone to get in their automobiles, use the interstate like a city street, and then drive three exits down to get to their local grocery store. Congestion is a guaranteed outcome. With this model, time wasted in traffic is inevitable.

We enjoy a number of walkable amenities and a pedestrian-friendly life in my neighborhood. But I still of course get in my car and drive 15+ minutes to go to the doctor, or to bring my daughter to her soccer team practices thrice weekly. It’s fine, but it could be a lot better.

Objections to the Book

This is by no means a perfect book.

First, the book does not provide a proof of his concept in any way. It does not provide rigorous data or analysis on the plan versus other solutions. The book is much more of a manifesto for a better way to approach urban design, as well as a history of what went before his big ideas and what has happened since, to coalesce urban planners around his big idea.

Moreno’s also neither a great writer (English may be his third language) nor a convincing scholar. He repeats himself and relies on fuzzy descriptions of hopeful ideas from around the world that might hopefully accomplish his big idea, ideas which are still very much in the planning phase.

I find the 15-Minute City convincing not because of the quality of his evidence or argument, but because I’m predisposed aesthetically to this kind of urban life. It’s a big idea, I like the big idea, and I think we should aim for it. The 15-Minute City is totally different from the way Texas cities are being built right now, and that’s a damn shame.

The Wacko Objections To The Book

One version of good-faith criticism of the 15-Minute City is that urban design emphasizing small, slow, and localized neighborhoods inside a large city could involve convenience, lifestyle, and economic trade-offs. Developers of new neighborhoods and new office parks clearly find it to their advantage to continue to do more of what they’ve already been doing. Traffic engineers clearly find it to their advantage to build faster and bigger roadways for automobile-oriented transportation. I think I could see why they wouldn’t naturally be big fans of Moreno’s ideas.

Carlos Moreno is a very big Jane Jacobs fan

Then there are the bad-faith critics and wackadoodles. Moreno in news reports has mentioned receiving death threats because of his idea. For a nerdy academic concept like this, the threats are probably a sign that he is on to something big and important.

The 15-Minute City concept is potentially threatening to the status quo of cities as developed since the 1950s. As an idea it’s been twisted by bad-faith critics into some monstrous intrusion into contemporary urban development. Socialism! Europeanism! The death of the automobile!

Earlier iterations of international climate-friendly zoning ideas have acted like a red cape before a bull. A UN-sponsored agreement from 1992 signed by 178 countries, called Agenda 21, became a conspiracy-theory code word for far right commentators who imagined this as a forerunner of a secret “New World Order.” Attempts to limit the potential profits of developers can be, and has been, spun into some threat to an American way of life. What seems like sensible planning for better life in cities to some can be seen as an attack on private property rights to others.

While Moreno is certainly European in outlook and interested in small scale, walkable, and bike-friendly neighborhoods, he does not personally represent a vast conspiracy. He is just a guy, a Colombian-born Parisian professor who happens to have come up with a cleverly-marketed way to help city-planners imagine better cities. And as described in his book, he hit the zeitgeist for many cities on different continents led by leaders looking to revitalize small-scale neighborhood life among modern metropolises.

A version of this post ran in the San Antonio Express News and Houston Chronicle.

Link to purchase book: The 15-Minute City by Carlos Moreno

Please see related posts

Book Review: The Death and Life of Great American Cities by Jane Jacobs

Book Review: Going Going by Naomi Shihab Nye

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June 14, 2023June 14, 2023

Is Rackspace Officially Dead?

It’s hard to overstate the importance Rackspace played in San Antonio’s imagination about itself in the year 2009, when I first arrived in town. A scrappy mid-sized technology company, launched by 3 college kids in their proverbial dorm room, had established an early-mover advantage in the growing technology service known as cloud hosting, and was using that advantage to fend off the biggest names in tech: Amazon, Microsoft, and Google. With the cult slogan “Fanatical Support,” hopefuls wondered if Rackspace could do for San Antonio what Dell had done for Austin. Would rackers overmatch the difficult competition and transform sleepy Alamo city into a tech hub?

The relentless, one-way drop in RXT shares from $20 two years ago to just over $2 shares as of this writing tells us that David did not, in fact, slay Goliath. The stock’s chart over the last two years is just a Matterhorn-shaped downward slope with no bottom in sight.

The equity market capitalization dropped in that period from $4 billion to around $250 million by mid-May 2023, approaching one-twentieth of its former size. Looking at that kind of chart in May I naturally ask the fundamental question: “Is Rackspace dead?” And also the technical question, “what the heck is wrong with RXT shares?”

Now, here I want to distinguish between a company and its shares. A good company can be a bad stock investment. And in certain instances a bad company can be a good stock investment. And everything in between. I will mostly save the judgment about whether Rackspace is a good company with good long-term prospects, “the fundamentals,” for a future column. Today I mostly want to discuss “the technicals,” which addresses the question “What the heck is wrong with the stock?” rather than the more profound question of business prospects.

Still, we’ll do 3 sentences on the fundamentals, and then the rest of the column on the specific technical issues that may have plagued RXT, the stock, for the past two years, and in particular the last few months. And then a technical change in stock market plumbing announced last month that reflects RXT’s changed prospects.

The Fundamentals

RXT reported a loss of $612 million for the quarter ending March 2023, following a full year loss in 2022 of $805 million, on $759 million in quarterly and $3.1 billion in annual revenue, respectively.

As of March 2023, the company reports $3.3 billion in long-term debt at an average of 5.5 percent, not due until 2028, giving it attractively-priced debt service, and a runway of 5 years before it needs to refinance the debt.

Cloud computing services, as an industry, are projected to grow between 15 and 20 percent annually for the next 5 years, so an experienced provider that merely maintains market share with the natural tailwinds of the industry could be positioned to grow nicely.

Fundamentally, we have 5 years to find out whether Rackspace is dead.

The Technicals

So then what technical forces are crushing RXT, the stock, these past 2 years?

Technical analysis seeks to explain the current and future price movements of a stock according to the supply and demand dynamics specific to the stock. This is distinct from studying the fundamental revenue, cost, debt, and cash flows of the business itself, as we did above.

The largest holder of RXT remains private equity firm Apollo Global Management with 61 percent of the company’s shares. In 2016 Apollo took the company RAX private from the New York Stock exchange. Apollo then relaunched Rackspace via IPO under the ticker RXT in August 2020 on the tech-oriented Nasdaq. In part because Apollo still owns most shares, the supply of tradable shares, or “float,” is quite small. Very few individual, or “retail” investors own any shares.

The volume of share transactions in RXT has declined over the past year, along with the stock price. A year ago between $5 and $8 million worth of shares traded hands per day. That has slowed to an average of less than $2 million per day over the past two months.

A low “float” of the shares, the declining dollar amount of trading, and a price approaching $1 per share all tend to further depress interest in a stock among professional investors.

Non-Apollo shares are mostly owned by Small Capitalization Index Mutual funds. My strong belief is that this particular fact is the absolute key to understanding the one-way price movement of RXT over the past months.

The top mutual fund holders of RXT are all ETFs and index funds, from Vanguard, iShares Russell, and Fidelity. RXT shares are also held in some “technology,” and “total market” index funds.

A major technical problem for RXT of this ownership is that each of these indexes is “market-weighted.” This means that as the market capitalization of the company drops, the automatic weighting of the company within that index drops. That makes the indexes forced sellers of the company’s shares as prices decline, in a self-reinforcing vicious cycle.

In theory, and as often happens with other stocks, institutional value investors (non-index investor) sometimes jump in to purchase shares in this scenario, which helps to break the vicious cycle. But for most value investors RXT’s float is too small, the trading volume is too small, and most importantly, value investors don’t love annual losses larger than the market capitalization of the company. So far they’ve stayed away.

But I suspect the biggest problem with RXT is the specifics of the Russell 2000 index that happened last month, which determines ownership of small capitalization index funds.

The Russell 2000 index is comprised of US small-capitalization companies, in particular those ranked numbers 1,000 through 3,000 on the list of US companies, by size.

As of 2022, the literally smallest Russell 2000 index company – the 3,000th ranked company on the list – had a total market cap of $240.1 million. Interestingly, RXT breached that bottom floor of market capitalization last month.

The Russell 2000 index makers set April 28th 2023 as the annual cut-off date for determining who is in or out of the index. On that date, RXT had an approximate market capitalization of $320 million. This put RXT on the bubble of being dropped by the Russell 2000 index. The result of that would be further forced selling by the index holders.

New IPOs allow companies to be added quarterly. Other additions or subtractions due to growth, merger, or shrinkage happen just once a year. Companies are subtracted from the Russell 2000 index on an annual basis, and May 19th was the announcement date for whether RXT would remain in the index.

Let me not hold you in further suspense. Despite being on the bubble, RXT did not get dropped from the Russell 2000. The size of the smallest company to remain on the Russell 2000 list dropped to $159.5 million in 2023, 33 percent below the previous floor. RXT was saved in a sense because the standards for inclusion got easier!

RXT actually got added to the Russell Microcap Index for the first time on May 19 2023, the index for even smaller companies with a market capitalization going all the way down to $30 million.

But even though they were not removed from the Russell 2000 list this year, the risk of subtraction from the index, plus the vicious cycle of lower prices leading to lower market weighting, could explain much of the past few months’ price action in RXT.

Getting put on the Russell Microcap Index is somewhat analogous to relegation to a single-A baseball league down from the triple-A league where it had previously played. The stock may take a long time to ever attract major league investors. Or it may never again attract them.

Languishing in obscurity is ok for profitable companies that can put together a good fundamental track record of profit over time. It could get back on the list and in that sense be eligible again for the majors. For a company with $3 billion in debt due in 5 years, and a string of annual losses, it may be a harder slog. Time will tell.

A version of this ran in the San Antonio Express News and the Houston Chronicle

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June 14, 2023June 14, 2023

Higher Education Philanthropy Priorities

April’s big higher education philanthropy news left me grumpy. I mean, yes, it’s nice that financier Ken Griffin has pledged a gift of $300 million to Harvard University. In exchange Harvard will rename its Graduate School the “Kenneth C. Griffin Graduate School of Arts and Sciences.” Higher education is good, philanthropy is good, and Harvard is good. It should be all good.

Still, here’s why I’m grumpy. Harvard is the least worthy use of hundreds of millions of philanthropic education dollars I can possibly think of. They need it the least.

Among universities, Harvard already boasts the largest endowment of any university. With $50 billion under management, cynics (like me) have long quipped that Harvard is a world-class hedge fund with a fine educational institution attached to it.

Harvard does not really elevate learning in our larger society, except in the most extreme trickle-down kind of way. The profile of a student actually boosted by Griffin’s donation is extremely narrowly selected. A $300 million gift seems like a bizarre over-allocation of resources to people for whom resources are truly not scarce.

Among 4-year colleges, Harvard is already quite generous with families of demonstrated financial need. But these students admitted from low socioeconomic strata are extremely few. The path into Harvard is so narrow that only rarely does a student from a lower-income family gain admittance. Second, these narrowly selected students – rich, poor, or middle class – probably would thrive wherever they went. Third, most of Harvard is made up of students from relatively privileged backgrounds, making the institution far less impactful on society as a whole, when considering it as a recipient of philanthropy.

Griffin giving $300 million to Harvard helps an organization that doesn’t need it, which in turn serves mostly students who largely don’t need it, or students who would succeed without it.

What Ken Griffin mostly bought for his $300 million was naming-rights as a monument to himself in perpetuity, burnishing his own reputation as a “success,” via brand-affiliation with Harvard. A personal monument and a name brand. It’s Griffin’s money and he gets to prioritize what he wants. But the gift just struck me as the worst kind of higher-education philanthropy.

Meanwhile, the contrast with the very best in higher education philanthropy is very stark.

In the midst of the pandemic in 2020 and 2021 MacKenzie Scott – author, philanthropist and via divorce from Jeff Bezos a 4 percent owner of Amazon – set a new and better standard for higher education philanthropy. Scott’s lessons were ones that Griffin either didn’t notice or chose to not learn.

She gave billions in total to organizations vetted for accomplishing great work but that suffer from insufficient resources. The opposite of Harvard in terms of need. She gave to hundreds of organizations that actually needed the money.

She thoughtfully targeted institutions – like Big Brother Big Sister, or community colleges, that serve a broad and inclusive swath of people who themselves had insufficient resources. Again, the opposite of Harvard. People who actually needed the support.

Because social and economic class is self-reinforcing (in contrast to our national myth of social mobility) higher status and more selective higher education institutions matriculate students from higher income families, on average. Also, higher status and more selective institutions generally cost more. As a result, if you want to help social mobility through increasing educational opportunity, the place to focus is regional and community colleges. So that’s what Scott did. That’s where the transformation in people’s lives and in society is likely to take place.

At Harvard, less than 12 percent of students come from the bottom 40 percent of households by income. A larger cohort at Harvard, 15 percent of students, come from the top 1 percent of households by income. All of this is according to research done by Harvard’s own Raj Chetty and a team of economists.

At UT Austin, 15 percent of students come from the bottom 40 percent of households by income. Which itself is a result of its highly selective status. At UT San Antonio, 26 percent of students come from the bottom 40 percent of households by income.

In Bexar County’s Alamo Colleges, 43 percent of students come from the bottom 40 percent of households by income. So that’s where Scott gave. Where the students with the most financial need are actually studying.

The socioeconomic origin of families of students is just one measure – but an important one – of the role higher education does, or does not play, in creating pathways to social mobility.

For all of Harvard’s successes in championing lower socioeconomic access to higher education – a pitch made with just about every alumni solicitation for donations that it sends out – a much more effective way to support this cause would be to donate to higher education institutions that truly serve middle and lower-income families. Like community colleges, or public universities that serve a region or state.

In San Antonio, Scott gave $20 million to San Antonio College, and $15 million to Palo Alto College, both part of the Alamo Colleges District.

Dr. Mike Flores, Chancellor of the Alamo Colleges District, admires Scott’s philosophy of giving to under-resourced communities. Further, Scott allows the recipient institutions full discretion in how to best spend her gifts.

Scott’s donations went into programs such as $4 million to support students in high-demand degrees in tech or nursing that will likely transform their lifetime economic prospects for the better. $5 million went toward the $75 million endowment for AlamoPROMISE, which provides scholarships to make an Associates degree affordable for most area high school students.

I think what MacKenzie Scott got for her $25 million to Alamo Colleges was life-transforming social mobility among people who need it most. And they didn’t name anything after her. She doesn’t really get bragging rights through brand affiliation with a community college. Instead she just gets to make a difference.

A huge priority for Alamo Colleges is to make sure any area high school graduate can get free or greatly subsidized tuition, with wrap-around services, on the way to getting an Associates degree, what Dr. Flores deems the “moonshot” program known as AlamoPROMISE.

Dr. Flores, when asked how he thinks about transformational gifts in higher education, “Just imagine, an $80 million dollar gift could guarantee graduating high school seniors access to AlamoPROMISE in perpetuity for Bexar County graduates for decades.”

Scott didn’t build a monument to herself when she gave her gifts, but she demonstrated a far better philanthropic model than the old one Griffin followed this month.

Harvard is not a bad institution. It represents greatness in many fields and is a cool place for a fortunate few. As a destination for philanthropic dollars, I just would personally place it last on my list.

Disclosure: In 2022 I offered consulting services – online personal finance lessons – for employees of the Alamo Colleges District.

A version of this ran in the San Antonio Express News and the Houston Chronicle

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June 13, 2023June 13, 2023

USAA Wobbles

Tell me: do you want the good news first, or the bad news? Fine, we’ll start with the bad news.

In 2022, USAA reported its first yearly “net income” loss since 1923 – the first loss in one hundred years! – of $1.3 billion.

Next, the CFO reported that the company’s own measure of its “net worth,” the difference basically between what it owns and what it owes, dropped dramatically from $40.1 billion to $27.4 billion from 2021 to 2022.

That’s a $12.7 billion drop in net worth, or a 31.6 percent drop year-over-year. Not great.

Finally, USAA had reported a line in its consolidated statements called “Other comprehensive income (loss), net of tax,” a loss of $10.5 billion. Since that was 8 times bigger than its “net income” loss, and roughly the size of its reported drop in “net worth” over the year, I reached out to the company to tell me what the heck “other comprehensive income (loss), net of tax” actually means. It’s not an accounting term with which I was previously familiar.

Brett Seybold, Corporate Treasurer, responded to my query. “The ‘other comprehensive income loss’ was due to unrealized losses in our investment portfolio across all lines of business, about half of which is in our bank. This is the result of lower market valuations from rising interest rates, which impacted the full financial services industry last year. It’s important to note that this accounting value change is temporary and has already improved in 2023 – and any undervalued securities can simply be held to maturity.”

This makes sense (in fact this was my best guess before Seybold confirmed it). It is also worth contextualizing his response with what’s happened lately with other banks.

The larger US banking context

The recent failure and seizures of First Republic Bank, SVB, and Signature Bank by the FDIC (the 2nd, 3rd, and 4th largest bank failures in US history, respectively) have bank customers (and regulators!) on edge a bit these days.

Listed as the largest Texas-headquartered bank by both assets and deposits, USAA carries a sort of flag for the industry in the state.

Unlike past eras of finance wobble, recent bank failures haven’t happened because of crazy risk-taking or irregular accounting or any number of traditionally morally questionable actions for which we might judge bank executives harshly.

Instead, a simple and simplified model of recent bank failures is this.

Step one is that banks like SVB held lots of super-safe assets like US Treasurys which lost their current market value when interest rates rose rapidly throughout 2022. Fixed income assets – the finance term for bonds and similar investments – drop in price as interest rates go up. As long as a bank still holds these super-safe assets and doesn’t sell them, the losses aren’t necessarily locked in. That’s what USAA’s Seybold confirmed made up what happened at USAA with the $10.5 billion loss under the line item “other comprehensive income (loss).” Roughly half the number for the bank portfolio, and half for the insurance portfolio.

The not-necessarily-market-value generally is not a problem because depositors don’t all ask for their money at once. These super-safe bonds will all pay out in full eventually. Regulators are cool with it too. Usually.

Step two with SVB, Signature, and First Republic Banks, however, was that they catered to customers who held large deposits, with a (now we understand to be an overly) large proportion above the FDIC-guaranteed $250 thousand threshold. Those large and relatively sophisticated depositors moved their accounts too rapidly for the banks to sell their assets in an orderly way. Because a significant portion of bank assets were actually worth less than their value on the books of the banks, and the withdrawals happened fast, the market value of the banks – roughly their “net worth” was wiped out just as they faced a liquidity crunch. So, we got FDIC receiverships and forced sales over a weekend for the 2nd, 3rd, and 4th largest bank failures in US history.

There were things these failed banks could have and should have done better, we now know in hindsight. Financial institutions can use interest rate swaps to hedge their declining bond values. They can underwrite or hold shorter-maturity assets that allow them to pivot more nimbly when interest rates rise. They can diversify away from an over-concentration on high-deposit customers, although that last move takes time, and for bank executives is probably counter-intuitive. (Banks generally love and want to attract high-deposit value customers!) But that’s all in hindsight for those particular banks.

What we should concentrate on are banks today. Specifically today, what should we think about USAA’s 2022 performance?

The Good News, or Why I’m Not Worried About USAA

Without insider insight into their fixed-income hedging strategies (although again in hindsight they maybe did not hedge rising rates enough in 2022) two things about USAA seem true, and comforting.

First, USAA is not simply a bank but a diversified financial services company. They are foremost a property and casualty insurance company, and also a life insurance company, and then also a bank. Insurance had its own specific 2022 problems like higher loss claims due to inflation and supply-chain bottlenecks. But in general, with 77 percent of annual revenues coming from insurance premiums, they operate in a different category than traditional banks. Insurance companies always run and manage risks, but bank runs aren’t really their main worry.

More broadly, their banking customer base is not primarily high-net worth individuals, but rather active or retired military personnel and their families. As Seybond confirmed, “Our bank is consumer based, 93% of deposits are within the applicable FDIC insurance limits, and we have access to excess liquidity to serve the needs of our members.”

I’m not at all worried about USAA personally as my bank, since I (sadly for me) do not have balances larger than the FDIC-guaranteed $250 thousand. Mo’ money, mo’ problems as the saying goes, and the inverse is also true when it comes to this specific consumer-banking risk: less money, less problems. Alas for me.

Maybe I should have mentioned, I bank with USAA. My checking, savings, credit card, home mortgage accounts, plus my kids’ bank accounts, are all with the company.

I insure with USAA as well: auto insurance, home insurance, and term life insurance.

I live in the hometown of their headquarters, and have many friends and acquaintances who work for USAA. I wish the company tremendous success but also I am self-interestedly curious about their setback years as well.

People are nervous right now about financial institutions. A once-in-a-hundred-year loss naturally prompts a question of whether it is anomalous bad luck or a trend. As the largest bank headquartered in Texas, USAA enhances public trust by explaining even the bad years when they occur. And even the obscure accounting lines when asked. I appreciate their letting me dig in a bit. Ninety-nine years before hitting a loss year is a pretty good track record.

A version of this post ran in the San Antonio Express News and Houston Chronicle.

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June 13, 2023June 13, 2023

How’s Inflation Going These Days?

How’s inflation going these days?

It was the talk of the town 6 months ago and 10 months ago. The most recently published April 2023 Consumer Price Index rise (the most commonly quoted inflation rate) was 4.9 percent annual, down from the peak 9.1 percent annual rate in June 2022.

Even as the world panicked last year about rising inflation, I will now share with you a teensy confession. I didn’t really see it. Or if I did see it, it felt fine, temporary, non-threatening. I know this is heretical and borderline obnoxious to say.

This week I came across a comment on inflation from the finance writer Morgan Housel, who is one of the very best at what he does.

“What I think is really interesting is that everyone spends their money differently. So no two people have the same inflation rate,” he said in an interview in September 2022. “There is no such thing as the inflation rate. It’s just your own individual household.”

Housel’s insight explains my reaction when compared to the collective freakout I noticed elsewhere. My experience of inflation is different from yours, and yours is different from everyone else’s.

Falling Prices

Now in the latter-half of my intended century on this planet, I could settle gently into the “kids, when I was your age, that used to cost a nickel” phase of my life. But as I look around, that story isn’t particularly true in many areas.

In July 2013 I purchased an Apple Macbook Pro laptop computer for the retail price of $2,499. This past week, the monitor died and I returned to the Apple store in the North Star mall and bought another Mac Pro laptop. In my mind, 10 years for a laptop is a good run. It lived a good long life as far as electronics go and it was time to buy a new one. I paid $1,999 retail for the new one with improved graphics, larger memory and a decade worth of incremental feature improvements compared to the 2013 version.

Last week I booked a round-trip flight to New York City in June for the all-in price of $517.80 (including taxes, travel booking, and airline fees). How much was this flight to New York City 33 years ago? I can’t compare the exact flight but The Department of Transportation reports that the average domestic airline fare from Texas in 1990 was $253.41. Meanwhile the average domestic round trip fare in Texas all-in was $314.75 in 2021.

Depending on the reference years, the average domestic flight costs the same, a little more, or a little less, over the past 40 years. This is actually incredible.

This past winter the internet lost its mind over the price of eggs, which had doubled. (Avian flu had wiped out the hens.) Our collective hive mind pointed to the rising cost of a carton of eggs as if that were some sign of inflation end-times. The price for a dozen large brown cage free eggs from HEB is $2.78 as I write this in mid-May 2023. Pretty much unchanged over the past decade.

I mention computers, flights, long-distance phone calls, and eggs because we notice the rise in prices but rarely their fall. So that’s one piece of the puzzle.

Inflation that we welcome

If you are a capitalist, inflation maybe hits differently. In my own capitalist way of thinking, the rise in both stock market values in my retirement portfolio over a decade and in the value of my home over that same decade are forms of inflation. Benign forms, from my perspective, but inflation nonetheless. Future purchasers of my shares or my home are negatively impacted by that inflation. Still, I’m personally glad for it.

Bloomberg News has run stories this year about companies that engage in “excuseflation.” That means firms that use bad news, like supply-chain disruptions or shortages or war – those were the top 2022 excuses – to raise prices. Companies that can raise prices and keep them high when normalcy returns – without losing market share – then have the opportunity for higher profits.

Investors, in turn, seek to purchase shares in companies that prove they can hike prices and expand margins. This is another way in which inflation hits differently depending on who you are. For owners of capital, price hikes by companies are a sign of strength and an incentive to invest. For homeowners, price hikes are a path to long-term wealth.

Inflation I don’t notice

I’m never going on a Caribbean cruise, where prices are up 14 percent since last year. I work from home, so I am not hurt much when gas prices hike the cost of a daily car commute. I don’t rent my home, so I’ve avoided one of the most brutal rises in costs in recent years.

Now, you’ve probably noticed I have conflated three ideas. First, prices are flat or falling in many areas over the past 30 years. (televisions, computers, long distance telephone calls, plain t-shirts and socks). Second, I benefit from some price hikes (my real estate, stocks in companies that have pricing power to use inflation as an excuse to hike prices and increase their margins.) Third, some price changes I don’t stress about because they hardly affect me directly (gasoline and diesel fuel, cost of caribbean cruises, home rental prices.)

I’m not saying inflation isn’t real. I’m saying our experience of inflation is unique to each of us. There is no objective inflation since we all buy and own different stuff.

My inflation experience is about to get worse

One of the worst areas of inflation over the past 30 years has been the rising cost of higher education. Since I will be paying for this over 8 of the next 9 years for my daughters, you can expect near-constant whining in this space about tuition inflation. It’s going to be brutal. For me to experience and for you to read about.

A version of this ran in the San Antonio Express News and Houston Chronicle.

Please see related posts:

Book Review: The Psychology of Money by Morgan Housel

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