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Alphabet: Less Than Meets the Eye

By James Kwak

The reorganization of Google into Alphabet means … well, not very much, at least for now. Instead of everything being inside one big corporation called Google, now there will be a bunch of corporations (one of them called Google) all owned by a holding company called Alphabet. “Holding company,” in this case, means that Alphabet will have no operations of its own: it will be a corporation that simply owns all the other corporations.

This is supposed to have something to do with making the company “cleaner and more accountable,” “empowering great entrepreneurs and companies,” “improving transparency and oversight,” blah blah blah. In itself, however, it does none of this.

There is no substantive difference between a corporation with a bunch of divisions and a corporation fully owning a bunch of other corporations. In both cases, the CEO at the top of the pyramid has complete control over everything that happens within the entire structure, and is accountable to no one except the board and shareholders of the top-level corporation. As for transparency, there’s no rule saying that any corporation has to release audited financials, or have audited financials in the first place, or publish any financials at all (except for tax filings, which are not public). The rules requiring disclosures only apply to publicly traded corporations, and in the new structure, there is still exactly one of these: Alphabet, which still owns everything.

The new Alphabet is planning to release financial information for its new Google subsidiary, but that’s purely voluntary — and it’s something they could have done already. Any corporation always has the option of disclosing more information than it is legally required to, and most public corporations take this opportunity to release information that they think will help them with their investors (if only because many investors are unwilling to buy stock in companies that don’t say anything about how their numbers break out across product lines or regions).

Alphabet’s subsidiaries will each have a CEO and, presumably, a board of directors. This could be good, it could be bad, but most likely it won’t make a difference. There’s no reason you couldn’t call the head of an operating division its “CEO” instead of “president” or “general manager” as is the case today. Nominally a corporation has to have a board of directors, but in the case of an Alphabet subsidiary all of its members will be named by Alphabet. So to the extent that the board does anything, it will be less efficient than the current situation, in which Larry Page can simply call the head of, say, Nest, and tell him what to do. And to the extent that a subsidiary corporation duplicates any of the infrastructure that is currently handled at the top, Google level (finance, HR, IT, etc.), that’s simply a waste. However, the most probable outcome is that Alphabet will continue doing what Google is doing today: the various subsidiaries will be semi-autonomous, doing some things independently and drawing on shared resources for others.

While we’re at it, let’s clear away the too easily bandied about comparisons to Berkshire Hathaway. Berkshire is a corporation that owns other corporations. But that’s because Berkshire is Warren Buffett’s investment vehicle: he uses it to buy companies that he thinks are undervalued, like most recently Precision Castparts. The companies that Berkshire buys have nothing to do with each other, or with Berkshire’s historical insurance business, so of course Buffett leaves them intact. That also makes sense because he may want to sell them someday, or at least preserve that option. Google, by contrast, has never bought a company solely as an investment play. It has always done so because of supposed synergies between the acquisition and Google’s other businesses. When Alphabet starts buying companies that have nothing to do with its existing companies, then you can start comparing it to Berkshire.

In short, the reorganization of Google into Alphabet doesn’t change anything about how the company has to behave, so any actual changes are things that could have been done without the reorganization. The corporate structure will only really matter if investors can own stock directly in the subsidiaries, so a subsidiary could have a different shareholder mix from Alphabet. Then a host of new rules could apply, including required financial disclosures on the subsidiary level and restrictions on transactions between the subsidiary, Alphabet, and the other affiliates in the group. Then the subsidiary would have to be run independently for the benefit of its shareholders — which is good from its shareholders’ perspective, but bad from the perspective of the conglomerate as a whole, because it limits flexibility.

This week’s reorganization could be a preparatory step in that direction — but, then again, it might not. It’s not clear if Larry Page and Sergey Brin have a master plan. And, if they have a master plan, there’s no particular reason to think it’s a good one. Page and Brin are obviously the technology world’s version of geniuses, having invented the original Google search algorithm and turned it into the world’s dominant search and online advertising business. But there’s no reason to think they have any particular insight into questions of corporate organization. For decades (if not centuries), everyone has known that there’s a basic trade-off between consolidation and autonomy, and that as you get bigger and bigger it gets harder to run everything on a fully consolidated basis.

These days institutional investors tend to distrust companies that combine too many businesses under a single corporate umbrella, so as time passes the pressure on Alphabet to break itself up for real will only grow. In the meantime, the new structure is not a best of both worlds, because there is no best of both worlds: you can’t have a corporate structure that provides maximum autonomy and transparency on the subsidiary level and also permits maximum coordination across the entire group. Not even if you are a Silicon Valley billionaire.

[Also posted at Medium.]

So Tom Hayes Is Guilty. Who Else Is?

By James Kwak

Tom Hayes was a trader at UBS and Citigroup who was very, very good … at rigging LIBOR. This week, he was convicted in the United Kingdom of conspiring to manipulate the benchmark interest rate and sentenced to fourteen years in prison.

There’s little doubt that Hayes was guilty as charged. In his defense, he argued that he had no idea what he was doing was wrong. But contrary to what some armchair attorneys think, that doesn’t matter. In general, the famous mens rea (guilty mind) requirement isn’t that you know you are breaking the law at the time; it suffices if (a) you know you are doing a thing and (b) that thing is against the law. There’s no question that Hayes knew he was conspiring to rig LIBOR, and that’s enough for the prosecution.

And on one level, it’s good that he was convicted and got a stiff sentence. That prospect should help deter criminal activity of all kinds by bankers and traders who have historically been shielded by prosecutors’ unwillingness to go after individual defendants (except in insider trading cases).

But … Tom Hayes as the evil architect of the LIBOR-fixing scheme? Not so much.

As in so many cases, there are only two logical possibilities. Either Tom Hayes’s bosses at UBS and Citi knew what he was doing, in which case they are guilty as well. Or they didn’t know about a widespread conspiracy being conducted across the electronic communications systems of some of the most technologically sophisticated companies in the world, in which case they are recklessly incompetent.

When it comes to Tom Hayes, there is a lot of evidence for the former. Apparently, when he was being recruited from UBS in 2010, he boasted to a Citi executive about how he rigged LIBOR. Back in 2007, that same executive had said in an internal email, “We will continue to pressure the brokers to talk [LIBOR] down and generally press lower” — when asked by a colleague to help lower Citi’s own LIBOR submissions. When Citi attempted to hire Hayes, his boss at UBS tried to arrange a large bonus for him to stay, citing his “strong connections with Libor setters in London.”

It’s hard to believe that senior executives at UBS and Citi didn’t know that LIBOR was being fixed. If they weren’t in on it directly, it’s likely that they turned a blind eye — precisely because they knew that it was good for the bottom line. Hayes himself generated $260 million in profits for UBS in just three years.

When people make that kind of money for the bank — in markets that are supposed to be highly competitive — executives don’t want to know too much about what they’re doing.

As time goes by, it gets harder and harder to figure out how much of the largest banks’ profits is due to their legitimate operations and how much is due to their tolerance of illegal activity (money laundering, rate fixing, bribery, etc.). Maybe bank executives are so inept when it comes to internal wrongdoing because they like things that way. They want their employees pushing the limits of the law to maximize profits. (“If you ain’t cheating, you ain’t trying.”) And when people like Tom Hayes get caught, the bank itself gets away with a slap on the wrist because it’s too big to jail — and the CEO gets away by claiming ignorance. It’s a win-win strategy.

[Also posted on Medium.]

More Misinformation about Banking Regulation

By James Kwak

“Fed Tells Big Banks to Shrink or Else,” the Wall Street Journal proclaimed in the headline of its lead story today.* If only.

What the Federal Reserve actually did is impose new, additional capital requirements for the largest banks. JPMorgan Chase, for example, will have to hold 4.5 percentage points more capital than it would have had to otherwise. This is clearly a good thing, since it means that the banks that could do the most damage to the financial system will be a little bit safer. But it is neither a complete solution, nor is it the draconian constraint that the banks and the Journal make it out to be.

For starters, the rule will have no effect on seven of the eight banks in question (JPMorgan is the exception), since they already have enough capital to meet the new requirements. That alone should let you know how significant a rule this is.

Continue reading

Friedrich Hayek Supported a Guaranteed Minimum Income

By James Kwak

“We shall again take for granted the availability of a system of public relief which provides a uniform minimum for all instances of proved need, so that no member of the community need be in want of food or shelter.”

That’s from The Constitution of Liberty, “definitive edition,” p. 424. Yes, it comes as part of Hayek’s argument against mandatory state unemployment insurance. But it reflects a fundamental understanding that no one should go without food or shelter, and that it is the duty of the government to ensure this minimum level of existence. “The necessity of some such arrangement in an industrial society is unquestioned,” he wrote (p. 405).

The standard that Hayek simply assumed would exist goes beyond merely keeping poor people alive. In a wealthy society, he thought it inevitable that it would become “the recognized duty of the public to provide for the extreme needs of old age, unemployment, sickness, etc.” (p. 406). On this basis, he even endorsed the idea of compulsory insurance, such as the individual mandate of the Affordable Care Act.

I’m not claiming that Hayek would have supported Obamacare — he almost certainly would have favored less government involvement than the system of state-level exchanges. But on the questions of welfare and government intervention in insurance markets, he was to the left of the entire Republican Party today.

[Also posted on Medium.]

I Agree with Milton Friedman!

By James Kwak

In Capitalism and Freedom, Milton Friedman asks what types of inequality are ethically justifiable. In particular (pp. 164–66):

“Inequality resulting from differences in personal capacities, or from differences in wealth accumulated by the individual in question, are considered appropriate, or at least not so clearly inappropriate as differences resulting from inherited wealth.

“This distinction is untenable. Is there any greater ethical justification for the high returns to the individual who inherits from his parents a peculiar voice for which there is a great demand than for the high returns to the individual who inherits property? …

“Most differences of status or position or wealth can be regarded as the product of chance at a far enough remove. The man who is hard working and thrifty is to be regarded as ‘deserving’; yet these qualities owe much to the genes he was fortunate (or fortunate?) enough to inherit.”

I think Friedman is correct here. This is basically the same point that I made in my earlier post: the money that you make because you are smart and hard working is the product of good fortune just as much as the money that you inherit directly from your parents.

Read more at Medium.

What Is the Trans-Pacific Partnership (TPP) Really All About?

By Simon Johnson

The Trans-Pacific Partnership (TPP) is a proposed free trade agreement (FTA) between the United States and 11 other countries.  It is comprised of two main parts: reductions in tariffs (and related non-tariff barriers), of the kind typically seen in trade agreements; and new rules for foreign direct investment and intellectual property rights, which have not previously been prominent in FTAs.

The new rules part has become controversial.  The case for introducing an investor-state dispute settlement seems less than compelling – this would favor foreign investors over domestic investors, not an idea that sits well with the standard idea of equality before the law (going back at least 800 years) and a direct contradiction to the usual principles of FTAs (emphasizing non-discrimination across types of investors).  As currently formulated, it would also be open to considerable abuse.  And the precise rules under consideration for patent protection appear likely to reduce access to affordable medicines in both our trading partners and potentially also in the United States.

As a result, advocates of TPP are now emphasizing the benefits of tariff reductions in terms of boosting US exports.  But the administration’s claims in this regard are greatly exaggerated and the United States Trade Representative (USTR) is unfortunately refusing to fully discuss the broader trade impact, including the precise impact of higher imports into the United States. Continue reading

Over at Medium: Geo-Engineering Doesn’t Reduce Long-Term Risk

By James Kwak

Mark Buchanan — who is actually a physicist, after all — makes a compelling argument against relying on geo-engineering to deal with our climate change problem. For one thing, some of the proposed technologies simply won’t work, because they do nothing about the fact that the poles are warming faster than the rest of the planet. For another, the geo-engineering fairy is being used to lobby against other approaches — conservation and renewable energy sources — that would deal with climate change at its source.

Another reason to be skeptical of geo-engineering is the effect it has on the risk profile of humanity’s future. Technology has produced some amazing things in the past century. But, with zero exceptions that I can think of, they weren’t things that our species needed to survive, or to prevent widespread natural and societal devastation. If we’re talking about technologies that can make our lives better in all sorts of ways, like the Internet or DNA sequencing or quantum computing, then risk is good: we want to place lots of bets that have a high chance of failure but high potential returns.

Read more at Medium.