Howard Marks Tax Memo: “Your Fair Share”

Tax policy is a balancing act between two titans of economics: efficiency and equity. In 2011, Howard Marks wrote an even-handed memo outlining the implicit considerations in our tax laws and just how loaded the question of “fair share” is. Neither liberals nor conservatives will find the porridge just right, so it has become my reference paper for how to think about taxes. My notes on it here.

Speaking of Howard Marks, his memos are iconic in the investment world and I’d make his book The Most Important Thing required reading for any inspiring investor. Blas Moros recently published his lessons from over 10 years of memos for your free enjoyment.

And speaking of taxes, economist Greg Mankiw discusses the “trophy wife tax credit”.

Continue reading “Howard Marks Tax Memo: “Your Fair Share””

Which Principles Are Ok To Bribe?

According to 538, socially liberal / fiscal conservatives comprised 16% of the 2016 election. And the majority of them chose Trump. I found it surprising but hardly difficult to imagine their mental ledger as they weighed pros and cons. When Trump wins I’ll donate half my tax savings to Planned Parenthood. Like a political carbon offset.

We’ve talked about Nimbyism here before and how liberal renters are suddenly long a housing crisis the moment they close on their first home. Values versus narrow self-interest.

The NBA. Activision Blizzard. Recent controversy has them trying to get a quote for the exchange rate between dollars and honor?

Louis CK. Tiger Woods. These guys were pulling pages from Motley Crue’s playbook. Not illegal but don’t expect sponsors to call you back. I retroactively wish instead of Tiger it was Yao Ming just to know if his scarlet letter would have just blended into his Rocket red jersey?

More than ever, morality is on public trial. Offsets and virtue signaling are used to prosecute and defend. Cancel culture and doxing stand ready to enforce sentences that lack time limits or discussions of proportionality. If that doesn’t faze you, the logical extension should. If you are aware of behavior that is clearly legal but controversial you are now an accomplice to a non-crime or if you want to be Orwellian about it, a thoughtcrime. Paranoia about being complicit in a non-crime would seem a comical way to expend some brain cycles but I’m not sure Daryl Morey’s boss would laugh. I doubt he ever thought he was going to be put on trial by his fellow owners whose interests may shapeshift them into wands of the Chinese public.

So we find ourselves in 2019 running ethical parkour, making stuff up as we bounce from one obstacle to another trying to find our footing. So let’s check out a framework from Slatestarcodex that can guide our understanding.

Terms of Ethics

  • Axiology is the study of what’s good
  • Morality is the study of what the right thing to do is
  • Law is what’s allowed by your government

He goes on:

These three concepts are pretty similar; they’re all about some vague sense of what is or isn’t desirable. But most societies stop short of making them exactly the same. These concepts stay separate because they each make different compromises between goodness, implementation, and coordination. Axiology can’t distinguish between murdering your annoying neighbor vs. not donating money to save a child dying of parasitic worms in Uganda. But morality absolutely draws this distinction: it says not-murdering is obligatory, but donating money to Uganda is supererogatory.
So fundamentally, what is the difference between axiology, morality, and law?

  • Axiology is just our beliefs about what is good. If you defy axiology, you make the world worse.
  • Morality is an attempt to triage the infinite demands of axiology, in order to make them implementable.
  • Law is an attempt to formalize the complicated demands of morality, in order to make them implementable by a state with police officers and law courts.

How the Terms Interact

In healthy situations…each of these systems reinforces and promotes the other. In these healthy situations, the universally-agreed priority is that law trumps morality, and morality trumps axiology. So first you do your legal duty, then your moral duty, and then if you have energy left over, you try to make the world a better place.

In unhealthy situations…you can get all sorts of weird conflicts. Moral dilemmas such as the “fat man version of the trolley problem” pit axiology vs morality. Meanwhile, civil disobedience is a battle between morality and the law. Think of conscientious objectors or Edward Snowden.

Drawing Ethical Equivalences

The promise of such a framework is a balance of consistency, convenience, and sensibility to ethical comparisons. By donating to the ASPCA you can’t atone for embezzling from the zoo fundraiser, but it can offset your axiological charges for eating animals (between this example and the fact that I do eat animals I hope I have offended everyone equally). You can’t offset morality, meanwhile, the legal system has its own prices for transgressions.

By keeping offenses in one domain not fungible with offenses in another we are spared the nonsensical task of setting inter-tier exchange rates. That task may be a fun game in the vein of ‘would you rather?’ but in practice feels like measuring the spot of a blind ref. Close enough to the tackle but far enough to be arbitrary.

For the full text of Slatestar’s post on moral offsets, including my highlights, click here.

Living By Your Principles

You may strive to live according to some coherent worldview but in reality, you whizz through life with wide rounding errors in your moral math. You can rationalize the price for anything if you want something bad enough or you are in enough pain. The only people don’t feel pain are dead or soon to be dead. On the practical limitations of living according to first principles, Byrne Hobart writes:

 A fourteen-year-old who just read Foucault or Peter Singer or Ayn Rand can absolutely trounce mom and dad in a fair debate, because the newly-enlightened teenager is reasoning straight from a narrow set of sensible premises. This tells you something important about philosophy and hypocrisy: it’s easy to be morally consistent if you don’t have bills to pay.

For the realists, Hobart proffers salvation:

One approach is to use a model as a tiebreaker rather than an absolute rule: instead of radical honesty, err on the side of honesty; instead of following every rule in Leviticus, start going to church on Easter and Christmas. This produces nonstop hypocrisy, but that’s okay: if you always live up to your principles, you’ve chosen undemanding principles. It’s not really incremental hypocrisy, just incremental awareness.

Beyond ethics, it is no easier to live according to first principles especially when they sit outside the circle of consensus. Your instinct may be to decide your principles, then try to live by them. The truly enlightened approach does the opposite: figure out what everyone else implicitly believes, and what opportunities that presents.

Most middle-class Americans at least act as if:

  • Exactly four years of higher education is precisely the right level of training for the overwhelming majority of good careers.
  • You should spend most of your waking hours most days of the week for the previous twelve+ years preparing for those four years. In your free time, be sure to do the kinds of things guidance counselors think are impressive; we as a society know that these people are the best arbiters of arete.
  • Forty hours per week is exactly how long it takes to be reasonably successful in most jobs.
  • On the margin, the cost of paying for money management exceeds the cost of adverse selection from not paying for it.
  • You will definitely learn important information about someone’s spousal qualifications in years two through five of dating them.
  • Human beings need about 50% more square feet per capita than they did a generation or two ago, and you should probably buy rather than rent it.
  • Books are very boring, but TV is interesting.

You can be a low-risk contrarian by just picking a handful of these, articulating an alternative — either a way to get 80% of the benefit at 20% of the cost, or a way to pay a higher cost to get massively more benefits — and then living it.

Continue reading the whole post here.

ESG, Trump Tweet Trades, Volatility Follow Ups

The Money Angle from Weekly Moontower #32

  • You will recognize ESG as the latest battleground between corporate axiology, morality, and law.
    • Takeaways from Matt Levine compartmentalizing your role as a corporate citizen from your role as a person. He channels realism and illuminates the downsides of mission driven companies. My notes here.
    • Cullen Roche’s pragmatic view on ESG investing. His pragmatic concerns are drawn from matters of axiology, morality, and law.
    • Aswath Damodaran’s explanation of shareholder vs stakeholder views of the corporation.
  • The article dismantling the conspiracy theories of friends of Trump trading ahead of his announcements. At the end of the article I noticed one of the contributors as an anonymous blogger/trader KidDynamite. I have been following him for nearly a decade. His work is top-notch especially his accounting level forensics to debunk claims that precious metals prices are manipulated.
  • Follow-ups from last week’s discussion about volatility’s toll on compounded returns:
    • My notes on a fun paper about how inept even educated people are about sizing wagers and how you can adapt the Kelly criterion for binary type bets.
    • A walkthrough of my simulation of investing in a 2 coin portfolio including the impact of rebalance and the influence of volatility on mean vs geometric returns.
    • An observation: A friend with some rental properties mentioned he does not aggressively raise his tenants’ rent. This incents the tenants to take good care of the place since they don’t want to lose the apartment. That means lower maintenance costs which is a second-order effect that offsets the first-order effect of keeping the headline rent a bit low. Between that and a very low vacancy rate, the returns of the rental properties are less volatile. And we all learned what volatility does to portfolios. An especially interesting bit to keep in mind since rental properties are usually levered.

Matt Levine on shareholder value

Matt Levine discusses:

  • Traditional and progressive views of the role of corporations
  • How a narrow desire to raise shareholder value keeps frauds from capitalizing on investors who appeal to higher causes.
  • Compartmentalizing your job from your personhood as a necessary convenience

Primacy of Corporate profits

Friedman, along with Michael Jensen and William Meckling, is probably the person most associated with the theory that—as his famous article put it—“The Social Responsibility of Business Is to Increase its Profits.” In this theory, managers of a corporation have a singular duty to the shareholders to maximize their economic return as far as possible (while complying with the law), and if managers pursue any other objective—treating workers well or being good environmental stewards or standing up for what they believe in—at the expense of shareholder value, then they are misbehaving. Of course, there is plenty of room to argue that pursuing those other objectives actually enhances shareholder value. And there is much to be said for Friedman’s view—which is also after all Adam Smith’s view—that by focusing on economic profits, a company will maximize the amount of social good that it does, simply because the normal way to maximize profits is to figure out what people want and then sell it to them.

Including More Stakeholders

It is popular, these days, to criticize that view. The corporation is a political construct, embedded in a society; it has many stakeholders whose interests it needs to consider, not just shareholders. You see this criticism everywhere, from attacks on stock buybacks to Elizabeth Warren’s call for “accountable capitalism.” In its more extreme form, you can see shareholder-profit-maximizing corporations compared to science-fiction robot villains, or to psychopaths: If you value only profit and nothing else, then there is something inhuman about you.


That probably overstates matters. If you come to work and focus on maximizing the profits of your company, that probably doesn’t mean that you’re a psychopath. It probably just means that you have a job. You compartmentalize things a bit; your work does not contain the entirety of your personhood; it’s a thing that you do because you need to make a living. In this sense, a company whose philosophy is “we will sell products that people want for more than it costs us to make them so that we can make a profit and increase our share price” is rather psychologically healthy. That is a good goal to work on during business hours Monday through Friday, and then leave. It is a modest, reasonable, businesslike goal. Obviously there are large contested margins, and you shouldn’t do psychopathic things to pursue that goal, and some people do and that’s bad, but for the most part “shareholder value” is the sort of mission that inspires people more or less the right amount. If you go around murdering people to maximize shareholder value then, yes, you are a psychopath, but most people aren’t.

The Difficulty of Accounting for Intentions

But there are other goals. Those goals are bigger, and you can wrap your whole personhood up in them, and you can believe that those goals are so important that they can justify anything. If Facebook’s goal is to maximize revenue by selling targeted ads to clothing companies, and you find out that it has features that enable genocide, then you shut down those features because the ads just aren’t worth it. If Facebook is about the “noble mission” of “connecting people,” then the tradeoffs are murkier. If “Facebook is truly the only company that’s singularly about people,” then … what even … how do you measure how about-people it is being? If you’re the singular company whose focus is people, then whatever you do is sort of necessarily good; your end is so vague and noble that it can justify any means. And for all that Facebook’s meddling with Instagram and WhatsApp seems to be driven by straightforward ad-revenue-maximization considerations, it’s worth saying that Facebook isn’t really answerable to shareholders and that its explicit ideology rejects shareholder value as a goal. “Facebook was not originally created to be a company,” Mark Zuckerberg wrote when it went public. “It was built to accomplish a social mission.” Okay!

Grand Visions Can Be Weaponzied, But Shareholder Value? Not So Much.

I am late to it, but I just finished reading John Carreyrou’s “Bad Blood,” the story of the fraud at Theranos Inc. and his work to uncover it. Theranos—in Carreyrou’s view, and the view of federal prosecutors—issued tens of thousandsof blood-test results to real patients using technology that it knew didn’t work, endangering those patients’ lives. There are a lot of passages in the book about Theranos founder Elizabeth Holmes inspiring and cajoling her employees to work harder, to get with the mission, to override their moral objections to faking the technology and push ahead. None of those passages mention shareholder value or profit maximization. They mention Holmes’s vision of revolutionizing health care to save lives and treat cancer patients. If you want to inspire people to do terrible things, it is very useful to sell them on a grand vision, a higher purpose, a noble mission. Shareholder value is nobody’s idea of an inspiring mission. That’s what’s good about it!”

Lesson from coin flip investing

The setup

  • You invest in 2 coins every week for the next 1000 weeks (19.2 yrs)
  • These coins pay a return each week
  • Every 4 weeks, you rebalance wealth equally between the 2 coins
  • Coins have an expected edge of 10%
  • Simulation is run 10,000x
  • Assume no transaction costs

Individual Coin Payouts

Coin Win Payout Loss Payout Expected Annual Return Expected Annual Volatility
A(Low Vol) 2.75% 2.50% 6.70% 18%
B (High Vol) 8.25% 7.50% 21.5% 54%

Results of the 2 Coin Portfolio1

Strategy CAGR Volatility Median Return Max Drawdown
Theoretical  14.1% 28.5% 10%2
Un-rebalanced simulated 17.9% 32% 6% 68%
Rebalanced simulated 13.9% 30% 9% 64%

Observations from many simulations like the one described

  1. The higher the portfolio volatility, the more the mean and median diverge
  2. Rebalancing pushes median returns closer to the theoretical mean
  3. The rebalancing benefit is positively correlated to the difference of volatility between the coins

How much to wager when you have edge? (Hint: median not mean outcomes!)

Link: Rational Decision-Making under Uncertainty: Observed Betting Patterns on a Biased Coin

  • Optimal bet size as a fraction of bankroll is 2p-1 where p is the probability of winning1. You will recognize this as the edge per trial reported as a percent. So a 60% coin has 20% expected return or edge
  • The formula is a solution to a proportional betting system which implicitly assumes the gambler has log utility of wealth

Imagine tossing a 60% coin 100x and starting with a $25 bankroll

Arithmetic Mean Land

The mean of one flip is 20% positive expectancy

Optimal bet size is 20% of bankroll since you have .20 expectancy per toss

Increase in wealth per toss betting a Kelly fraction: 20% of bankroll x .20 expectancy = 4%

Expected (mean) value of game after 100 flips betting 20% of your wealth each time

$25 * (1+.04) ^ 100 = $1,262

Median Land

The median of one flip betting a Kelly fraction is (1.2^.60 * .8^.40 – 1) or 2%

Median value of game after 100 flips betting 20% of your wealth each time

25 * (1.2^60) * (.8^40) = $187.25!

Things to note

  • The median outcome by definition is the increase in utility since Kelly betting implicitly assumes the gambler has log utility
  • After 100 flips, the median outcome is only about 1/10 of the mean outcome! The median outcome gives an idea of how much to discount the mean payoff. If your utility function is not a log function (ie does quadrupling your wealth make you twice as happy) then a different Kelly fraction should be used

Percents Are Tricky

Which saves more fuel?

1. Swapping a 25 mpg car for one that gets 60 mpg
2. Swapping a 10 mpg car for one that gets 20 mpg

[Jeopardy music…]

You know it’s a trap, so the answer must be #2. Here’s why:

If you travel 1,000 miles:

1. A 25mpg car uses 40 gallons. The 60 mpg vehicle uses 16.7 gallons.
2. A 10 mpg car uses 100 gallons. The 20 mpg vehicle uses 50 gallons

Even though you improved the MPG efficiency of car #1 by more than 100%, we save much more fuel by replacing less efficient cars. Go for the low hanging fruit. The illusion suggests we should switch ratings from MPG to GPM or to avoid decimals Gallons Per 1,000 Miles.

Think you got it?

Give “deflategate” a go. The Patriots controversy brought attention to a similar illusion — plays per fumble versus fumbles per play.

If you deal with data analysis you have probably come across the problem of normalizing data by percents and the pitfalls of dividing by small numbers (margins, price returns, etc).

The MPG vs GPM illusion is more clear if you are comfortable with XY plots from 8th grade math recap. Look at the slopes of x/1 versus 1000/x (in this case think of Y=M/G and the recipricol as gallons per mile. I multiplied gallons/mile by a constant 1000 to make the graph scale more legible).

The Volatility Drain

I don’t want to torment you this week, but if you trust me play along and you’ll be paid off with some non-obvious lessons.

Imagine the wish you made on your 10-year-old birthday candles comes true. You are magically given $1,000,000. But there’s a catch. You must expose it to either of the following risks:

1) You must put it all on a single spin at the roulette wheel at the Cosmo. You can choose any type of bet you want. Sprinkle the wheel, pick a color, a lucky number, whatever you want.


2) You can put all the money in play on a roulette wheel that has 70% black spaces. Place any bet you want, but you must bet it all. And one more catch…you are required to play this roulette wheel 10x in a row. Your whole bankroll including gains each time.

Think about what you want to do and why. Even if you cannot formalize your reasoning, take note of your intuition. I’ll wait.

Let’s proceed.

First of all, the correct answer for anyone without a private jet is #1. Just spread your million evenly, pay the Cosmo its $52,600 toll and try not to blow the rest of it before you get to McCarran. For many of you who computed the positive expected value of option #2 then you might feel torn.

Welcome to a constrained version of the St. Petersburg paradox.

The expected value of a single spin with a million dollars spread over the favorable blacks is $400,000 (.70 x $1,000,000 – .30 x $1,000,000). A giant 40% return.

But if you are forced to play the game 10x in a row, there is a 97% you will lose all your money (1-.70^10).

What’s going on?

This problem highlights the difference between arithmetic or simple average return vs a compounded return. If you made 100% in an investment over 10 years, the arithmetic average would be 10% per year while the compounded annual return would be 7.2%. I won’t demonstrate the math, but you can always ask me or just Google it. The mechanics are not the point. An understanding of the implications will be, so hang on.

In option #1, you will be in simple return land. In option #2, you are in compounded return land. Compounded returns are not intuitive, but they are much more important to your life. Let’s see why.

Sequencing and the geometric mean

  • Compound returns govern quantities that are sequenced such as your net worth or portfolio. If you earn 10% this year, then lose 10% next year, you are net down 1%., right? While the arithmetic average return was 0% per year, your compound return is -.50% per year (.99^2 – 1).
  • Let’s thicken the plot by increasing the volatility from 10% to 20%. If you win one and lose one, your arithmetic mean is 0, but now your compound return is -2% per year. Interesting.
  • Let’s turn to Breaking The Market  to see what happens when we tilt the odds in our favor and really ramp the vol higher. In his game, a  win earns 50%, while a loss costs you 40%.
    • The expected value of betting $1 on this game is 5%. But this is the arithmetic average. The geometric average is a loss of 5%!
    • If you played his game 20x, your mean outcome is positive but relies on the very unlikely cases in which you have an almost impossible winning streak. You usually lose money.
    • As BTM explains: Repeated games of chance have very different odds of success than single games. The odds of a series of bets – specifically a series of products (multiplication)- are driven by, and trend toward, the GEOMETRIC average. Single bets, or a group of simultaneous bets -specifically a series of sums (addition)-, are driven by the ARITHMETIC average.

The most important insights to remember!

  • Arithmetic means are greater than geometric means; the disparity is a function of the volatility.
  • Mean returns are greater than median and modal returns (Wikipedia pic). In other words, even in positive expected value games, if the volatility is high and you bet the bulk of your bankroll, your most likely outcomes are much worse than the mean. 


Using this in real life

Step 1

Recognize compounded returns when you see them. We have already seen them in the domain of betting and investing. 

Consider these questions.

  • I want to raise the price of my product by 60%, how many customers can I lose while maintaining current revenue?
  • If CA experiences a net population outflow of 20% in the next 20 years, how much would it need to raise taxes on those that stayed behind to make up the shortfall?
  • If muscle burns 2x as much calories at fat and I lose 40% of my muscle mass, how much less calories will I burn while at rest?

After groping around with those you may have found the general formula:  X / (1-X)


If you lose 20%, you need to recover 25% to get back to even. Lose 50%, and you need 100% to get back to even. 100% volatility and you are certain to go broke. Look at the slope of that sucker as you pass 2/3.

In other words, negative volatility is a death spiral. Let the brutality of the math sink in.

Why has nearly every real estate developer you know went bust at some point? Because they are in the most cyclical business in the world and love leverage. Leverage amplifies the volatility of their returns by multiples. Compounded returns are negatively skewed. Mercifully for them, zero (aka bankruptcy) is an absorbing barrier.

Step 2

Protect Yourself

  • Diversify your bets. In the earlier casino example, if you could divide your million dollars into 10 100k bets you would now have a basket of uncorrelated bets. If you could bet 1/10th of your bankroll on 10 such wheels you’d expect to make 400k in profit (7 wins out of 10 spins). With a standard deviation of 1.45 you now have a 95% chance of getting at least 5 heads and breaking even on the bet instead of a 97% to go bust in the version where you bet everything serially.
  • When a bet is very volatile, reduce your bet size. If you put 100% of your net worth into a 20% down payment on a home you lose half your net worth if housing prices ease 10%. In investing applications, variations of Kelly criterion are good starting points for bet sizing.
  • Remember that for parallel bets to not be exposed to disastrous volatility, your investments must not be highly correlated. Having a lot of investment in the stock market and high beta SF real estate simultaneously is an illusion of diversification. Likewise, if you own 10 businesses, you will likely want them in separate LLCs. For those in finance, you will immediately recognize the divergence in interests between a portfolio manager of a multi strat fund and the gp of the fund. Izzy Englander wants his strategies to diversify each other while he gets paid on the assets, while the individual PM wants to take maximum risk. Izzy risks his net worth, the PM just her job. If you take one thing away from this paragraph: a basket of options is worth more than an option on a basket.
  • Insurance is by necessity a negative expected value purchase. You buy it because it ensures financial survival. In arithmetic return land it’s a bad deal, but if the insurance avoids ruin, it may have a profoundly positive effect on compounded returns which is what we actually care about.
  • Finally, the power of portfolio rebalancing. If you hold several uncorrelated assets, by rebalancing periodically you narrow the gap between the median and mean expected returns. This is more apparent if there is wide differences in the volatilities of your assets.
    • I ran a bunch of Monte Carlo sims on “coin flip assets” with positive drift. Some takeaways were a bit surprising.
      • If the volatility of your portfolio is about 9% per year, median returns are about 90% of the mean returns. At this level of volatility, rebalancing has little effect.
      • If the volatility of your portfolio is about 15% per year, median returns are about 50% of the mean returns if you rebalance.
      • Rebalancing actually lowers your mean returns when the volatility of the portfolio is high even though it raises the median. My intuition is by taking profits in the higher volatility assets it truncates the chance of compounding at insane rates, but it also cuts the volatility by so much that it provides a much more stable compounded return. The higher the volatility the more of the mean return is driven by highly unlikely right upside moves.
      • The impact of high volatility is stark. It is extremely destructive to compounded returns.
For finance folk and the curious
  • Compounded returns are negatively skewed. Black-Scholes option models use a lognormal distribution to incorporate that insight. The higher the volatility, the greater the distance between the mean and mode of the investment. Example pic from Quora.
    • A recollection from the dot com bubble. Market watchers like to say the market was inefficient. The options market would disagree. Stock prices and volatilities were extremely high reflecting the fact that nobody understood the ramifications of the internet. Had you looked at the option-implied distributions is was not uncommon to see that a $250 stock had a modal implied price of $50. To be hand-wavey about it, the market was saying something like “AMZN has a 10% of being $2050 and a 90% chance of being worth $50.” In other words, if you bought AMZN there was a 90% chance you were going to lose 80% of your money. If you are itching to get technical on the topic Corey Hoffstein’s paper explores how risk-neutral probabilities relate to real-world probabilities.
    • For option wonks, (assuming no carry costs) you’ll recall the concept of variance drain. The median expected stock price is S – .5 * variance. The mode is S – 1.5*variance. The higher the variance, the lower the median and mode! The distribution gets “squished to the left” as the probability the stock declines increases in exchange for a longer right tail like we saw during the dotcom days.
    • The expensive skew embedded in SPX option prices reflects 2 realities. First, the average stock in the index will see its volatility increase but more critically the cross-correlation of the basket will increase. Since index option variance is average stock variance x correlation, there is a multiplicative effect of increasing either parameter. The extra rocket fuel comes from the parameters themselves being positively correlated to each other!

WeWork Was An Inevitable Response to Incentives

In a matter of weeks, WeWork went from being a $50b unicorn to being mentioned in the same breath as the “b” word. I won’t rehash the We saga, but a recent interview with Scott Galloway who has been spitting acid on them for 2 years is one of the best things I’ve read this year. His colorful metaphors and ruthless candor need to be enjoyed in their full glory. Enjoy.

As I mentioned above, overvaluation has a peace dividend, but that doesn’t mean it was correctly allocated capital. Some say if you hit every pitch you swing at, you are probably taking a suboptimal level of risk. That’s a smart observation. But investors in We look like they took a smart idea too far. When a pitcher notices a batter is willing to swing too far out of the strike zone, he’ll try to get away with less honest pitches. Here’s Matt Levine on We founder Adam Neumman:

If you want, you can imagine him as a diabolical genius who explicitly set out to short the unicorn bubble and then walked away barefoot with a jaunty whistle and $700 million of SoftBank’s money, but that does not strike me as necessary or accurate. My model doesn’t require you to think that your startup is dumb! You don’t need to worry about Neumann’s personal beliefs and motivations at all, really. You can just think of him as a product of the invisible hand of the market. A lot of money was pouring into startups, there was a lot of demand, and the demand called forth supply, and the people who supplied the supply got rich; it is elemental and straightforward and has very little to do with questions like “is this a good business model?”

The Peace Dividend of Overvaluation

I started paying the 6-year-old interest on his piggy bank. I figure it will be a neat way to get him to engage with numbers while teaching him about money in the process. Computing percentages is above his pay grade so instead, we created an interest schedule. For example, on Saturdays, he’ll report his savings and if he has between $0 and $200 he’ll receive $.50 interest. If he has between $200 and $400 he’ll receive $1.00, and so forth.

If you produce evidence that you a) share 50% of my genes and b) are not my sister then you too can open a Moontower Savings Account.

The fact that you are drooling at the implied APR tells us so much about financial environment we live in today. Let’s explore.

Your money has nowhere to go

Interest rates are historically low, basically in line or even less than the low inflation rates we are experiencing. In other words, keeping your money in savings accounts means the value of your savings is slowly eroding. This is by design as global monetary policy is meant to encourage you to invest in risky assets or spend your cash. Whether or not the policy is justified, it has certainly affected markets.

Interest rates are low, meaning bond prices are high. Annuities are historically expensive. Real estate is expensive. Stocks are expensive. We are awash in liquidity and attractive investment opportunities are scarce. Another way to say investments are expensive is to say that implied forward returns are much lower. People are willing to pay a lot today for a dollar of cash flow in the future. In reference to the purchasing power of your savings, I regretfully say “your money has nowhere to hide”.

Now what?

Buying assets near all-time high valuations feels like chasing a ball into the middle of a busy street. How do you take the other side of the trade? If the market is supplying infinite cash for investment today, ask yourself: “What is the market begging me to do?”

A sensible thing to do is refinance and you should, but this feels like you’re taking an inch when a mile is on the offer. Another option is to take a low-interest rate loan. But what do you do with the money? Buy an expensive house? That’s like staging an intervention only to find yourself getting drunk with the person you are trying to help.

How hustlers respond to loose capital conditions


While investors are crying over the lack of attractive investments at reasonable valuations, entrepreneurs focus on the opportunity. The investors are the customers. Investments are the product. So give them what they want. “You need to put a billion dollars to work and the SP500 ain’t doing it for you? Here invest in my scooter company.”


In the reach for yield, investors want access to riskier bets to have a chance at more meaningful returns. While traditional stocks and bonds have a mature fund industry bridging the gap between capital and companies, hordes of angel syndicates and venture funds have set up shop to raise money for these start-ups. But the funds who were smart enough to recognize this demand also recognize a market truism — the amount of capital that goes into a sector is inversely correlated with its future returns. The funds are like drug dealers who need to assure their clientele that the drugs (the supply of start-ups) are safe to smoke. So what story do they tell? (I have noticed the VC world is especially obsessed with comedian’s craft, improv, the ability to write, present, influence, convince, sell, promote. This is worthy of its own discussion as a microcosm of what is feeling like an increasingly postmodern world to me. Sorry to be a tease, but that’s a story for another time.)

To understand the pitch is to understand that the story’s most important feature isn’t its feasibility, it’s the scalability. Fake meat. Scooters. Office rental space. Ride-sharing. All of these stories are low margin, low probability of success but…they address humanity’s biggest needs. Food, transportation, occupancy. They have the capacity to absorb oceans of capital. If you need to raise $1mm, nobody cares. Need a billion, just call Softbank. In the equation for expected value, EV = P(X) * X, all eyes are on the magnitude of the payoff, X. The probability is more of an impression than something to inspect with a microscope.

This isn’t irrational. Venture funds need to hit massive home runs on their winners to make up for the many losers since they are investing when companies are very young and extremely speculative. But if we jam more money into venture, they aren’t going to be able to generate the returns by marginal increases in their ability to choose better investments. Instead, the size of the home runs will be the largest factor in the fund’s returns. Play venture capitalist for a moment — would you rather improve your hit rate from 10% to 20%, or maintain a 10% hit rate and increase your payoff from x to 10x?

While the mood in the traditional finance labor markets is besieged by automation and disintermediation, there are growing segments such as fintech and crypto. These are areas where one can find opportunity and a tailwind to reap the benefit of loose capital.

The peace dividend of overvaluation

For investors, these bidding wars will lead to buyer’s remorse. Their loss will be many others’ gain. Entrepreneurs will be paid in opportunity. Matchmakers in fees. But guess who else? Consumers.

You get the ability to hail a ride from your phone and the sum of the world’s knowledge at your fingertips. The fiber optic bubble of the late 1990s wiped out investors but successfully laid the undersea cable that billions of 0s and 1s travel across every second. In fact, the consumer surplus resulting from the overinvestment may be the biggest bounty of all.


overvalued companies —> low cost of capital —> funding for crazy ideas

If you wanted a shortcut for identifying the most speculative themes in markets you can browse the highest-valued ideas on Motif, take note of what themed ETFs are coming to market, or check out platforms for angel and pre-IPO investments (see under Private Investing).

Communism has been described as a system where the intentions are good and the outcomes bad. Well, capitalism is the demonstration of greed leading to good outcomes. The investors, without intention, subsidize innovation and by extension humanity.

Opportunities lie in the inversions

It’s useful to remember that the flipside of overvaluation is a low cost of capital. By funding speculative companies aggressively, the market is signaling a desire for big payoffs and big dreams. Entrepreneurs and funds organize around this incentive to provide the market what it wants.

Instead of crying about the Fed, lack of fiscal discipline, the lack of reasonable investment opportunities, remember that overvaluation cannot exist independently of a low cost of capital. It’s your job to find it then use it for what it begs for…enterprise and creativity.