MyCo, Part 1 Imagine an unusual company. MyCo is in the reviews businesses. It initially made its mark by using machine learning to develop its proprietary MYCO score, which quickly toppled Fair Isaac’s dominant standard for credit ratings. But MyCo didn’t stop there. It expanded its algorithms far beyond credit, purporting to provide ratings on almost anything you might conceivably measure about a person: Sociability, punctuality, hygiene, you name it. Its most popular incarnation, however, combines all its categories into a grand, unified Personal MYCO score. Personal MYCO scores have become pervasive. These days, it’s rare to see a LinkedIn resume, college application, Tinder profile, or campaign ad that doesn’t include one. And yes, quite a few people do consider this development rather dystopian. So much so that expanding its algorithm to rate the bona fides of competing dystopian objectors became a nice little growth market for MyCo. Unlike FICO scores, MYCO users pay an annual fee to be rated. MyCo has had a monopoly on this score for many years and no credible competitive threats have emerged. Its user agreements surrender rights to enormous amounts of personal information that feed into and supposedly improve its AI ratings system. Unsurprisingly, MYCO has become a household name with powerful brand recognition. Penetration approaches 100%. It is so dominant, however, that its high-growth days are behind it. You can only win so much until you’ve won.But, MyCo is an unusual company. Let us count the ways.1. MyCo has a strange governance structure:A. MyCo’s voting rights are not proportionate to its economic ownership. This of course is not that unusual. But MyCo has a class of shares with no economic interest that controls all the voting rights. These shares, called “U” shares, are distributed to every fee-paying MyCo customer. U shares are not apportioned by volume. As long as you are a current customer in good standing, you have one U share and one vote. U shares are inalienable. Shareholders, who own “A” common shares, do not have any voting rights (except to the extent they are also customers with U shares). B. MyCo’s bylaws contain a unique directive: “The Company’s primary objective shall not be maximizing shareholder value. The Company will serve shareholder interests by ensuring their investments provide extraordinarily safe and stable returns. The Board shall always endeavor to consider and promote the interests of MYCO users everywhere and to meticulously maintain MyCo’s stellar reputation.”In practice, MyCo’s Directors have interpreted this provision by vowing to never let its stock drop by a Significant Amount. Beyond that, it prioritizes the other goals identified in the Charter. A “Significant Amount” is generally taken to mean a low single digit annualized percentage. What this means is that MyCo aims for its stock price to reliably decline a little every year. Why actually aim for an actual annual stock decline rather than, say, setting it as a floor? Because once shareholder safety and stability is assured, the Board believes its main priority is to protect MYCO users and the MYCO brand. It believes that allowing stock price increases would violate both their first directive of stability and their secondary directives by implicitly favoring shareholders over users and the overall MYCO brand.2. MyCo loses money.While many firms lose money, MyCo has a monopoly position and has reached growth maturity yet still loses money. In fact, while MyCo has had some years of positive operating income, more often than not it has lost money. Here are MyCo’s revenues and expenses over the last five years:(billions)Revenue 300 310 320 330 340Expenses 310 325 345 335 350__________________________________________Earnings -10 -15 -20 -5 -10 Now, many argue that a significant portion of those expenses are discretionary and largely orthogonal to revenue. For example, a big chunk of MyCo’s expenses, around $100 billion a year, consists of its annual contributions to the MYCO Foundation. The Foundation serves millions of low MYCO score users, subsidizing fees, providing free training on ways to improve your score, and offering proactive restitution to any groups that it deems inherently disadvantaged by the MYCO scoring system. The Board believes the MYCO Foundation is crucial to fulfilling the directives of its Corporate Charter, and it is popular with many MYCO users (Class U shareholders). Most analysts believe that these Foundation expenditures (along with a lot of MyCo’s other expenses) could be substantially reduced without significantly affecting sales, though there is no clear consensus on this issue.Moreover, few believe that MYCO scores are priced at a level that would maximize MyCo’s potential monopolistic profits. MyCo has generally, though not smoothly, raised prices over time. While there is some evidence that revenues are sensitive to price increases, most observers agree that MyCo could raise prices meaningfully without a full offset from lower sales. Of course, raising MYCO usage prices tends to incur the wrath, if not the attrition, of MyCo customers. 3. MyCo common “A” shares have a special feature.If you hold MyCo common A shares, you are permitted to display your MYCO score in a proprietary golden font anywhere it is used or queried. This has become known as your MYCO Flair. The more shares you own, the fancier your Flair gets. Although not everyone cares about their MYCO Flair, many people do. The relative fanciness of your Flair is often considered a premium signal, like Porsche or Rolex, over and above the actual MYCO score. Academic studies have generally found some evidence that, given equal MYCO scores, greater Flair seems to modestly increase your chances of getting a loan, job or date. MYCO does not sell Flair separately. You can only access it by holding its common A shares.There are one billion MyCo A shares outstanding. As a result of its past losses, it has a near-infinite NOL carryforward with no expiration. MyCo does have some debt, but for now pretend it is debt free and holds no excess cash. The Company proudly trumpets its current streak of complying with the Significant Amount clause for 89 consecutive quarters, the longest stretch of its multi-decade operating history. So... How do you value a share of MyCo?***This is the first in what I hope will be a series of notes about MyCo, assuming there is at least a modest level of interest. Why? I have this model in my head about some things that are tricky to think about, or at least have been for me. It’s an uncommon approach, and I’ve found it much more useful than conventional frameworks. So maybe other investors will find it useful, too. I thought this strange semi-socratic method might be more effective than just trying to flatly spell it out. I could be wrong about that, though. I’m just experimenting with the best way to tell this story. For now, I recommend thinking about the question above -- how would you value a share of MyCo given these unusual dynamics and with such limited information, and maybe also what other information you would want if it were attainable? It might help if you think out loud on this thread. I might not answer questions where information was intentionally held back, but I’d like to gauge interest/willingness in playing along before continuing.
(billions)Revenue 300 310 320 330 340Expenses 310 325 345 335 350__________________________________________Earnings -10 -15 -20 -5 -10
In practice, MyCo’s Directors have interpreted this provision by vowing to never let its stock drop by a Significant Amount. Beyond that, it prioritizes the other goals identified in the Charter. A “Significant Amount” is generally taken to mean a low single digit annualized percentage. What this means is that MyCo aims for its stock price to reliably decline a little every year. Why actually aim for an actual annual stock decline rather than, say, setting it as a floor? Because once shareholder safety and stability is assured, the Board believes its main priority is to protect MYCO users and the MYCO brand. It believes that allowing stock price increases would violate both their first directive of stability and their secondary directives by implicitly favoring shareholders over users and the overall MYCO brand.Clarifying questions: Does this section mean that shareholders of the A shares are guaranteed a small negative annual real return? And by what mechanism is MYCO able to accomplish this?Tim
I don't know?but I can think out loudas you know, I don't tend to think much about my investmentsthis is not an advantage in general but can be to me, as if I think something is obvious, it is likely that it really is obviousplus, I believe in the adage that I can't value all businesses, and in fact i don't try in the traditional waythat said...- voting rights. I can't recall one instance in my vast experience (only half joking) where governance meant anything, as described. Doesn't mean there aren't but I can't recall a prominent example- bylaws. I don't understand what you mean here - spending alone doesn't make a stock do anything, so I'm not sure here what they would be doing to 'stop' stock price increasesNegour goal is not to maximize shareholder valueMyCo aims for its stock price to 'reliably decline a little every year' (????)Poswants to ensure investments provide very safe and stable returns-loses money. at this point, has nothing to do with how it will be valued - could be emphasizing cash flow, deferred income, etc. After all, if MyCo decides to buy Whole Foods, then all the shareholders are not going to think how stupid this is to compete in the grocery business and lose focus but how wonderful it will be that machine learning will magically make this business more profitable and wonderful for customers. -special feature - provides an incentive to NEVER sell shares - ever. A modest increase is a huge increase. How to value it?NO clue - but a LOT. you would want to be absolutely sure of the competitive issueyou can assume the company would be valued in such a way to ignore many negatives (other bets)and there is always a chance that the company will change things upfor the good of societyI was listening to a podcast about subscription models and suchJohn Malone style investingyou look at Saul's board and they buy companies that don't make money (not always)but it never matters - lately - and they build bullet proof balance sheetsand the longer it goes on the stronger they get financiallySo I don't knowbut some multiple x not reported earnings but what people think are important earningsthis can be a hard exerciseI should have bot more of OLLI instead...
Clarifying questions: Does this section mean that shareholders of the A shares are guaranteed a small negative annual real return? And by what mechanism is MYCO able to accomplish this?so I'm not sure here what they would be doing to 'stop' stock price increasesThese are good questions but you're on your own for now in coming up with what if anything they might do to accomplish this goal and how if might affect your valuation guess.
You can certainly make the price go down by paying a dividend.
How do you value a share of MyCo? Stream of consciousness thought-process per roark request:1) This is certainly a strange bird with its combination of U shares (one U share, one vote) and explicit shareholder minimizing bylaws. U shares = voting no economic interest and A shares = economic interest with no voting power. Wow.2) Initial valuation for the A shares is that if we assume for the moment that there is no opportunity for distribution of profits via dividend or share buybacks then the intrinsic value of the A shares is zero.3) To the extent there may be an opportunity to change the by-laws or (more likely) change the interpretation of the by-laws to be more shareholder friendly (and at the same time, likely VERY management friendly) then isn't there some optionality value in the Class A shares?4) Personal experience with demutualization-like group ownership in MA and V and CME and (sadly missed) NYSE suggests possibility of demutualization can exist.5) However, we return to the strange separation of voting power (U Shares) from economic interest (A Shares) which makes structural change difficult.6) Personal experience and benefit from being a policyholder in EIG Holding (later Employers) as it pursued demutualization suggests that the odds are much higher when economic and voting and management interests for demutualization are all aligned. Does not exist (or very low odds) with MyCo.7) Similarly, what the odds Vanguard turns into a publicly traded asset manager? Very low. I wouldn't pad my net worth just because I am a "owner" since Vanguard is mutual company.Therefore I assign negligible value to MyCo Class A shares. If MyCo Class U shareholders could legally be allowed to share in the potential economic benefit of MyCo perhaps I would assign some optionality to the shares ...ET
Okay, maybe not the crushing deluge of entries I was imagining, but I'll push the ball a little further. thanks for those who humored me with responses, especially ET's good summary of some of the uniquely strange aspects of the story. A few brief comments on the replies to-date before going on to part two.Some wondered how management could succeed at keeping its stock price depressed. This can be an interesting question. What would happen, for example, if Mark Zuckerberg (who has 60% voting control) announced tomorrow that he considered it in Facebook shareholders' long term best interest that it donates 80% of earnings to charity every year? I mean, sure, lawsuits, but in the meantime you probably don't want to own the stock that morning. Naj mentioned dividends as a reliable method, and of course it usually is, but it's interesting to think whether that necessarily applies to something as strange as MyCo. After all, most firms see their value drop on the ex-date by the value of the dividend because they are presumed to be maximizing future profits and they have unloaded some of those profits. But MyCo may not be maximizing future profits at all, in fact it specifically claims the opposite, so it isn't clear whether a dividend should ex-post affect the stock price much at all. More on that later. But a couple of thing that were in the writeup that didn't get any attention seem important: The Company proudly trumpets its current streak of complying with the Significant Amount clause for 89 consecutive quarters, the longest stretch of its multi-decade operating history. Skeptical or not about management's power to influence the stock price, it has to at least catch your interest that they have hit their bizarre goal of negative low single digit stock returns for over twenty years running. Sure it could be ephemeral, but it gets your attention. And maybe this cuts both ways? For example ET was not skeptical about management's ability to burn the building down (given their strange corporate governance), so he thought the shares were maybe close to worthless. But for twenty years running MyCo's stock has reliably only dropped a little, never a lot, exactly as promised (interestingly, no one asked about the current stock price in determining value, despite this strange regularity and management's express guidance). Not only that, but those A shares have actually been offering you a bonus in addition to those small losses: If you hold MyCo common A shares, you are permitted to display your MYCO score in a proprietary golden font anywhere it is used or queried. This has become known as your MYCO Flair. The more shares you own, the fancier your Flair gets. Even if the option on toppling MyCo's strange Bylaws and U share governance system never gets exercised, are we sure this combination of promised returns and bonus value are worthless? That lead to the next part. MyCo, Part 2: Flair ValueIn Part I I sketched out a picture of MyCo as an unusual company and asked how you would start to think about valuing such a strange thing so roughly described. So let’s add some information about MyCo. Start with a key piece of information deliberately hidden in Part 1: The MyCo stock price. Normally, a true blue value investor might scoff at the idea of needing the trading price of a stock to figure how to value a business. And maybe you feel the same here. But as mentioned in Part I, MyCo is at least a little different than most companies, in that the Board has a unique goal of keeping the stock price in a narrow, stable range where it reliably declines a low single digit percentage every year. Maybe the Board can’t simply will this goal into existence by fiat, so you don’t think it matters much. I mean, companies can write down in their Charters they’d like the stock to double every year, but that doesn’t mean it will happen. But to the extent you were wrong and the Board somehow could shape MyCo’s stock performance in accordance with its goals (which are rather modest in comparison), the stock price would suddenly matter a whole lot. So here it is. MyCo is trading at $100 a share. So with one billion shares out its market cap is $100 billion. Ten years ago today the stock was at $125. The interim drop has been mostly linear, with very modest volatility. During that time it paid no dividends, so the CAGR for MyCo shareholders has been about -2% per annum. The company considers this result fully compliant with its Charter directive to provide extraordinary safety and stability.In fact, the Board was so happy with its stock performance it recently approved a contract extension for the CEO. But not the CEO of the main MyCo business. The company is operated in two primary segments: Reviews and Flair. Reviews covers the core MYCO business, while Flair is solely focused on the emblazoned score perk enjoyed by Class A shareholders. While the Reviews’ CEO is generally considered the big kahuna, the two divisions rarely interact.Because Flair cannot be sold directly but is instead automatically determined by the number of A shares owned (more shares = more Flair), the Flair division is mostly relegated to a corporate treasury type function. The Reviews segment covers everything else. Both CEOs are charged with following the Board’s overall directives in their interpretation of the MyCo Charter, as opposed to maximizing the value of only their particular segment of the business. Given her natural focus on MyCo’s shares, the Board long ago assigned the Flair CEO primary responsibility for compliance with the Charter’s directive to maintain safe and stable stock returns. Flair CEO primarily pursues her objective through strategically implemented stock buybacks and issuances. Let’s talk about how this has worked. For the most part, it is straightforward.She watches the stock price assiduously. If the stock starts to show volatility that threatens her preferred trend of annualized low single digit declines, she acts by either purchasing (if the stock is dropping too much) or issuing shares (if the stock is rising). Of course the Flair CEO, like all corporate treasuries, has limited resources. So she can’t just repurchase unlimited amounts of stock to prevent it from falling. In fact, most CEOs who hoped to tightly control their stock price by altering buybacks and issuances would sooner or later be swamped by market forces and run out of resources. Not only that, but issuing/buying shares doesn’t necessarily make the stock price drop in the first place. She is not simply giving them away or making them vanish. She is selling shares in secondary offerings or buying them for market value. But she does have one advantage most CEOs don’t: Flair. Most stocks are held solely for pecuniary returns. As a result, the quantity of shares outstanding doesn’t matter much, by itself. You can at least imagine a company with a billion shares outstanding and $100 billion in market value doing a huge billion-share secondary offering, doubling shares outstanding, and using the proceeds to buy another company (or pay down debt or hold cash or invest in an index fund, etc.) without affecting the share price much. But MyCo is different. If MyCo does that, it is doubling the supply of Flair outstanding, because each share represents a unit of Flair. MyCo has a monopoly on MYCO Flair, so as supply increases the marginal value of Flair declines (and it can expect that the price it receives for each incremental share issued will reflect this). Similarly, when she buys shares, she reduces the supply of Flair and its marginal value starts to rise as people who really like their MYCO Flair bid it up. This gives her a way to affect MyCo’s stock price that most companies don’t have, or at least not nearly to the same degree. Seen through the prism of Flair Value, MyCo’s stock price goals might suddenly seem a bit more more credible than that of a typical firm. When a normal CEO buys or sells shares in the open market, the per share price impact is small and does not inherently change the firm’s value per share. When the Flair CEO does so, she increases (buyback) or reduces (secondary) the per share value of Flair by changing the supply of a monopoly product. So now you know the current stock price and you have an idea of how MyCo attempts to manage it to meet its Charter. You also have some indication that MyCo believes, perhaps reasonably, it has succeeded in meeting its goals in recent years. But we are investors. Even in a unique situation like this, the stock price isn’t everything, right? We value things. Does this information change how you value MyCo from your original answer? Are there new things you want to know now to value MyCo? Can Office Space sue me?
Are there new things you want to know now to value MyCo? You wrote: If you hold MyCo common A shares, you are permitted to display your MYCO score in a proprietary golden font anywhere it is used or queried. This has become known as your MYCO Flair. The more shares you own, the fancier your Flair gets. If Flair value is crucial then I would like to know more about current Class A ownership. I presume that Class A owners cannot sell or rent their Flairs and that only direct or beneficial owners (through brokerage accounts) can display Flairs.1) Is MyCo ownership unusually tilted towards retail (individual) shareholders? A related question: Can institutions (for-profit or non-profit) display Flairs and how does this affect their business prospects?2) Do most Class A shareholders own few shares or is there a normal distribution of large and small shareholders? Put another way, does the marginal benefit of a fancier Flair follow a normal diminishing returns curve or is there some unique superior good or kinked demand curve to go along with the other strange attributes of MyCo?3) Perhaps it has very little impact on valuation but I am curious how ETFs and S&P 500 and similar indexes handle MyCo and Flair display. A part of me wonders about the appeal of MyCo for day traders and algos but that's a side point. ET
well...no sane company on earth would have the goals you mention, and no company on earth can control the price of which public companies trade - at least, reliably. I don't CARE how much a business is worth, I care how much the market thinks it is worth. If the market thinks it is worth $100 and it going to go down reliably, then I would say the stock is exactly worth what the market says it is. Given I have no way to control the outcome anyway, I would not even begin to try. In fact, most CEOs who hoped to tightly control their stock price by altering buybacks and issuances would sooner or later be swamped by market forces and run out of resources. Not only that, but issuing/buying shares doesn’t necessarily make the stock price drop in the first place. She is not simply giving them away or making them vanish. She is selling shares in secondary offerings or buying them for market value.I had to look up 'pecuniary'. Even in a unique situation like this, the stock price isn’t everything, right? it is if you think it will stay in that range. It is the ONLY thing. We LOOK for volatility as investors - if the only guarantee is that management will do everything in its power to make it go down, I would never try to value it. Value is a fiction after all...
If the market thinks it is worth $100 and it going to go down reliably, then I would say the stock is exactly worth what the market says it is.I agree. I wouldn't bother "valuing" the company given its quirks since the economics, moat, market appeal, etc. are likely to be wildly different if those quirks were absent. So the stock price is exactly at its fair value with the buy side being composed of people who put a higher intangible value on flair and people who find themselves in situations (ie, hyperinflation) where a small negative nominal return represents a compelling opportunity.Tim
it doesn't matter, but:Similarly, when she buys shares, she reduces the supply of Flair and its marginal value starts to rise as people who really like their MYCO Flair bid it up. is what I meant by "special feature - provides an incentive to NEVER sell shares - ever. A modest increase is a huge increase." But knowing human nature, in our desire to achieve one more advantage over our fellow man, this would overwhelm any company's resources. In a recession, you'd have panic buying of MyCo so people could get more of an advantage. It would be like the every higher increases in college costs - people pay more and more and more (my daughter is finishing up at Duke, but there are folks who go there to get an elementary education degree for example) for an education that is nowhere near justified by the cost each year -and the cost goes up every single year period. MyCo would be overwhelmed by buyers with very big pockets, and they could never ensure this was offset. Again, this assumes that flair provides a real advantage that can't be competed away.
p.s. if I knew it would go down 95% by 2% a year, I'd value it far less than the current price cause I wear snoopy shirts and have no flair - and I'm old, so flair for me would not provide an advantage and I would not want my children to be corrupted what eventually would become a materialistic desire to be possessed by such an evil thing...
Can Office Space sue me?No, but you should copyright this and be prepared to sue Dave Eggers if he turns it into a novel.As for valuation, I have no idea even where to start. I'm as confused by this as I am by Bitcoin. I'm just chiming in to show that I am interested, and prove that I have nothing intelligent to add to the discussion right now.
i'm assuming that flair would increase as the number of MyCo shares increase - that right?if so, MyCo would eventually structure their issuance and buys and so forth of flair to benefit the people they feel are morally superior...and eventually there would be Flair riots and storming of their offices and cyber attacks and finally the government would hold hearings and step in and take over that business...
So...I guess the value looks like the % value you get on Flair each year [meaning you/the marketplace whichever] minus ~2% per year. Over time, ceteris paribus, given the pecuniary nature, etc.So, Flair clearly has some value for a $100Bn firm.You seem to be indicating there's not going to be an overthrow of mgmt to run for stock increases so I'm not going to wade into that.Obviously, we need to know as much as possible about Flair, and someone posted a few good questions on that. If MyCorp donates huge sums of money each year [$2 Billion?] and other companies/people get social/investor interest & benefit for holding some shares of it [We're allowing them to donate by buying shares!] and the more you hold the better your Flair is to the world that could be a huge boon to differentiating yourself as a bank or beverage firm or retailer. Or as a person.If Flair becomes seen as 'too valuable' by that CEO then she issues more shares and donates the money, everybody mostly wins. Owners of Flair get to selfishly feel good for buying MyCo stock, they are essentially donating the money, and they get the public Flair which is proof [socially as well] of their actions. You can even put it on the BlockChain! Blockchain blockchain blockchain blockchain.I'm going to ignore global questions of hyper/deflation.I could probably writeup a more interesting scenario if MyCo stock could be part of a bank's capital structure, but even with BoJ and Norway buying shares hand over fist of worldwide public firms -- I don't think it would ever fit their requirements for, you know...actual bank capital. If the 2% loss was actually near-guaranteed at some point, hell can't be much more risky than holding mortgage debt depending on the value of Flair. But I don't think a relative valuation exercise of imaginary flair vs Danish mortgages is what you had in mind and if it is, you're a sick, sick man who deserves to read KMX credit tranche detail for all eternity.
Imagine an unusual company. MyCo is in the reviews businesses. It initially made its mark by using machine learning to develop its proprietary MYCO score, which quickly toppled Fair Isaac’s dominant standard for credit ratings. But MyCo didn’t stop there. It expanded its algorithms far beyond credit, purporting to provide ratings on almost anything you might conceivably measure about a person: Sociability, punctuality, hygiene, you name it. Its most popular incarnation, however, combines all its categories into a grand, unified Personal MYCO score. Personal MYCO scores have become pervasive. These days, it’s rare to see a LinkedIn resume, college application, Tinder profile, or campaign ad that doesn’t include one. And yes, quite a few people do consider this development rather dystopian. final thoughtyou understated it here this isn't 'rather' dystopiansounds like a combination offacebookgoogle amazonthe best argument for an inheritance tax is that the leaders of these companies will have the wealth to dictate policy for generations to come - and not everyone is a WEB-martian, card carrying member of everything is literally going to hell club...
sorry, one more thoughtbefore any i do, or before any dateyou want to see their MyCo scoreyou'd have entire segments of the population marrying just to increase their scorelife as we know it would be meaninglesswithout that blasted scoreSociability, punctuality, hygiene, you name it.yikes!
my last post (promise!)If you hold MyCo common A shares, you are permitted to display your MYCO score in a proprietary golden font anywhere it is used or queried. This has become known as your MYCO Flair. The more shares you own, the fancier your Flair gets. Although not everyone cares about their MYCO Flair, many people do. The relative fanciness of your Flair is often considered a premium signal, like Porsche or Rolex, over and above the actual MYCO score. Academic studies have generally found some evidence that, given equal MYCO scores, greater Flair seems to modestly increase your chances of getting a loan, job or date. MYCO does not sell Flair separately. You can only access it by holding its common A shares.define: "modestly increase" the part about getting a date is REALLY bothersome...but it is sinister and evil(I'm only half joking here)
...you are permitted to display your MYCO score in a proprietary golden font anywhere it is used or queried. MyCo would also have to have the ability to CONTROL how this occurred - in virtually every setting this could used (otherwise, fraud would render the proprietary golden font meaningless). The technology to do this only leads to one conclusion: MyCo = Skynet
the stock price isn’t everything, right? We value things. MyCO is USD, the board is Federal reserve, and its mandate of 2% inflation ensures a consistent debasing of the currency, while the shareholders (citizens) don't have voting power but implied economic power through their ownership of the republic, the consumers big banks (JPM, etc) actually have voting power, without economic interest on the USD.The Fed can issue and buyback (either directly or through interest rate manipulations), etc.So how do we value USD? Don't know. While I understand the absurdity of me holding so much cash there is a strange comfort that WEB also holds so much cash. Why? Because, whether rightly or wrongly I am worried I could destroy the value of my wealth lot faster than Fed's planned debasing. So I accept 2% debasing and happy to leave the money in the checking and waiting for the wonderful day where I might find something valuable to buy.
Wow. Okay, I will be back later when I have a little more time but I just skimmed the thread and see that I may as well just throw Part 3 out there now. MyCo Part III: Debt In Part I, I mentioned that MyCo did have some debt outstanding. In fact, there’s 1 trillion of MyCo debt, which is ten times the current market cap of 100 billion. Like most things MyCo, this debt is a little unusual: All MyCo debt is in the form of mandatorily convertible PIK bonds. Mandatorily convertible means they automatically convert into MyCo A shares at maturity. PIK means that whatever interest they pay is payable in kind, in this case that actually means A shares as opposed to more debt. MyCo has two kinds of these converts:1. Fixed. These bonds convert into a fixed number of A shares at maturity. The interest they pay is also a fixed number of A shares, determined as the coupon rate multiplied by a stated A share quantity at inception. For example, MyCo recently raised 20 billion in ten-year, 5% Fixed Converts. The bonds automatically convert into 200 million A shares at maturity and pay 10 million A shares per year in interest. Fixed Converts constitute more than 90% of MyCo bonds outstanding. 2. Adjustable. These bonds have rates that float with the market rate. Their conversion rate into A shared also increases one for one with every percentage point drop in the stock over some preset amount. In that sense they are a lot like conventional “death spiral” convertibles. Of course if the stocks acts roughly as expected, as it has for quite some time, they just act like normal bonds. So in total MyCo has 1 trillion of bonds outstanding (in both par value and market value), convertible into 10 billion A shares at maturity. The average maturity of this debt is around 7 years and the average interest rate is about 5%, which is the same as current market rates for an extremely highly rated issuer. Thus, annual interest costs run about 500 million A shares. As a reminder, there are 1 billion A shares outstanding and the most recent stock price is $100. The Flair CEO is very familiar with these converts, because all her buybacks and issuances are actually conducted as debt/equity swaps. So when the Flair CEO wants to prevent the stock price from rising, she will issue stock in exchange for outstanding MyCo converts. And she will generally keep an inventory of those converts on hand so they she can use them to repurchase A shares when the stock is threatening to decline excessively. It might seem strange that Flair CEO is conducting these treasury operations via debt/equity exchanges. But this is no different from a company that conducts a secondary and uses the proceeds to deleverage, or borrows for buybacks. As mentioned in Part II, what distinguishes MyCo isn’t the way buybacks are conducted, but the Flair Value of its A shares. Because of Flair Value, the value of A shares fluctuates as the quantity outstanding increases or decreases, just as the price of Rolexes change with supply. In Part I, I showed a table of MyCo’s losses for the last five years and mentioned that while it had sometimes generated profits, historically losses were more common. But those were operating profits, i.e. before interest expense. If you include the interest costs of its debt, MyCo has been even less profitable, having produced net income only a few times over its many-decade history. You might wonder how MyCo has been servicing all this debt with that track record. Actually, you probably wonder something a bit different, since the debt is all PIK converts: Why hasn’t MyCo’s share count exploded under this mountain of converting debt with no profit available to pay it off? The answer, of course, is more debt. As the converts pay interest in A shares and later convert to A shares entirely, MyCo has consistently issued replacement debt. It uses its replacement debt to soak up the increase in A shares. This doesn’t mean A shares haven’t increased at all over time; they have. But not enough to lead to declines in the Stock Price greater than a Significant Amount, at least in recent years. In that case, though, is MyCo a Ponzi scheme? How is it able to raise a trillion of debt without profits? Opinions differ, but current consensus seems to be that MyCo is like any other company with significant debt and equity market capitalization yet little to no profits: Markets and bond holders believe that while it isn’t earning money now, it does have the earnings power in the future to pay of its liabilities. Typically companies that get this treatment are sacrificing current profits for future profits or seeking scale in hyper-growth mode. But MyCo is mature. In this case, investors instead seem to believe that MyCo is unprofitable by choice, but could (and in the very long term will) decide to make enough money to pay off its stakeholders. Investors are giving MyCo credit for 1.1 trillion in EV. This equates to (1) One trillion of present value of future profits needed to pay off the debt— this is primarily the province of the MYCO CEO who is solely responsible for both bond issuance and company operations (2) 100 billion in present value for the equity. This 100 billion for the equity is of course a little unusual because it need not all be the present value of future profits: equity holders also receive the present value of future Flair Value. As a result, it this portion of the EV is a bit of a mixed responsibility. Yet as mentioned and despite this seemingly lopsided sharing of the pie, the Flair CEO is generally considered the main protector of the share price.Questions.Now that you know about MyCo’s 1 trillion in debt, does it change your valuation?Does it make sense that the Company and much of the market seem to act as if the Flair CEO, with a relatively small domain compared to the MYCO CEO, is responsible for the stock price?
I hate to take up valuable real estate here (and that is not sarcastic). My brain doesn't work well with such hypothetical questions, and not seeing all the facts. The reason I am chiming in, is although I am not capable of offering competent comments here, I sure do like and appreciate the thread. It does sound to me that Kingran might have hit it being the USD.Anyway, thanks for sharing this exercise, and selfishly for me (us), the more you post the better we are (maybe not you though ;-))On on
"I hate to take up valuable real estate here (and that is not sarcastic)."I already did that. :-)--Still like the Terminator angle...nobody else did, but... -----------------|back to lurker| -----------------
This was a Black Mirror episode last season. Bryce Dallas Howard stared.
Questions.Now that you know about MyCo’s 1 trillion in debt, does it change your valuation? Well, it would have been nice to know about the 1 trillion in debt in Part I being that it is not an non-material figure. As I read Part 1 and concluded that in the long term MyCo was likely to be worthless due to its unusual corporate structure and by-laws, let me go on the record and state that the substantial debt load actually INCREASES my valuation of MyCo.Why? Because the pressure and incentives creditors explicitly or implicitly will place on the company in the future likely lead to an incentive reorganization . As an aside, I am curious to see if MyCo ends up being the federal United States Government, with its substantial taxing and spending powers and debt load and (arguably) separation of voting and economic power. Does it make sense that the Company and much of the market seem to act as if the Flair CEO, with a relatively small domain compared to the MYCO CEO, is responsible for the stock price? Part of me is convinced that howardroark is using these posts as an investing Rorschach test. The responses so far seem to be indicative of how posters interpret and investigate problems rather anything else. To answer the above question more specifically, I would need to know if the MyCo CEO can replace the Flair CEO at will or at regular intervals or if Board involvement and approvals required and how that power has been exercised in the past. ET
Why? Because the pressure and incentives creditors explicitly or implicitly will place on the company in the future likely lead to an incentive reorganization . Prima facie the logic is sound but so far that incentive has not kicked in. The creditors are lending fully knowing they will get converted into A shares. Also, the economic interest without voting rights (or limited voting rights) has limited influencing power, on the other hand voting rights without economic rights, allows them to appropriate economic rights through their voting rights. This could temporarily swing but over long time the economic rights attained by the accumulation of A shares can be appropriated by voting rights either by diluting the value of A shares by issuing large number of A shares or changing the fee structure, etc.
Okay, since someone partly figured out the metaphor (nicely done), this seems like a good time to explain what the hell I'm trying to do here. The point of this was not a guessing game charade, but to try to lay out a framework for thinking that I've actually found useful. I thought a few other people might, too. I appreciate you guys playing along. So here is what I'm trying to say with this parable.If MyCo had a title it would be "Monetary Macro for Investors." The MyCo board is not the central bank (that's the Flair CEO), it's the government. MyCo common A shares are base money: currency and reserves (and U shares are actual voting rights). There are more parallels to draw, but let me stick with the bigger picture for a bit. This is not an attempt to take any particular viewpoint about what matters most in monetary macro or why money has value or even what determines the price level. Instead, it's just a way to think about those things and a lot more on turf that's familiar to investors. And let me state the obvious that I am far from the first person to suggest thinking of money as stock. As one example, you can read John Cochrane's paper conveniently titled "Money as Stock."https://faculty.chicagobooth.edu/john.cochrane/research/pape...But Cochrane, and everyone I've seen trying to use this idea, really only applies this metaphor to focus on a particular, somewhat narrow angle about money and the price level. As a result, it isn't developed into a very useful go-to monetary template, more like a very specialized tool. But I think it has as ton of potential as a kind of grand metaphor. I use it so commonly now that when I read almost anything about monetary policy my brain automatically does the MyCo translation (weird, yeah). Here is a very abbreviated list of pitfalls I've seen myself and others (especially, but hardly exclusively, investors who are not monetary macro experts) fall into when thinking about this stuff that I think this metaphor can help avoid.-It's just hard in general to think about the nature of money and prices, and even harder to integrate the never ending parade of twists like QE and IOR and how fiscal policy affects inflation into a coherent whole, so it's useful to have a centralized metaphor where they can all play together in a familiar environment (for investors). It's fairly easy to map almost any monetary twist onto this model with very high fidelity and try to think through the ramifications. For example, you don't need a separate model to think about Fiscal Theory of the Price Level here. We can easily a imagine a situation where markets start to believe that MyCo cannot or will not pay off its enterprise value, i.e. it has breached the ceiling of its maximum future profits, and dilution will follow. In that case, the Flair CEO loses almost all her power (because there is not nearly enough Flair value she can create to make up for it) and the stock price crashes. Zimbabwe. But in the same model, we can imagine how the Flair CEO is more commonly proximately responsible for the price level, as long as the overall entity has plenty of room between the EV and maximum future profits and the MYCO CEO is focused on other things than micromanaging the stock price.-It's understandably common to think about money primarily through the lens of interest rates, but it's usually a bad idea that leads to all kinds of unintentional inconsistency. You can use this model to think about interest rates, but at first pass it is not a rate-centric approach. -There's a temptation to act as if the mechanical things happening in the monetary world, like any given Federal Reserve rate action, can be analyzed separately from the more ethereal background, which is the never-ending coordination equilibrium between what people and markets expect and what the Fed/Government might contingently do as the world changes. But ethereal or not, those things are always and everywhere intertwined. I think using this metaphor helps keep the hydraulics attached to their environment. It's obvious that MyCo has a ton of power as to the value of its A Shares in many (but not all) circumstances, and so it matters a lot not just what it's doing with open market operations and IOR and revenues/expenses right now, but why it's doing what it's going and what people think it might do in various possible futures. -It hammers home the importance of interaction between what the Government is targeting and where the price level happens to be right now. In this example the current stock price was very important. The reason it was important, in part, is because the Significant Amount target requiring LSD declines every year was implicitly based off wherever current stock price happened to sit, much like a standard inflation target. We can imagine other types of targets that change this equation. For example, maybe the bylaws instead had a level target, mandating a multi-decade CAGR of -2% rather than -2% in any given year, such that the Company had to make up for its misses. Then the recent stock price wouldn't be nearly as important. You'd want the starting (or ending) point. This can be really important in thinking about monetary policy and how weird it is that the so called nominal anchor might just be a random point in nominal history. So anyway here are some of the mappings in the story for the small percentage of you who actually like this idea and want to think through it the same way I do. MyCo A shares: Base Money, currency and Central Bank reserves The price of A shares: This is the Price Level and in real life it is not actually observable as a single priceFlair: This is the convenience yield of base money. People willingly hold currency that pays zero interest even though very short term treasuries or bank deposits are available that pay (typically) higher interest. So they are getting some other benefit, call it convenience for short.Flair CEO: Central Bank.Board/MYCO CEO: The federal government elected/appointed.MyCo PIK Converts: US Treasuries, which are only payable in money (A shares).Flair CEO buybacks/repurchases: Conventional Fed open market operations. Recently, the Fed has been conducting policy by paying interest on reserves instead of trying to increase the value of money's convenience yield (Flair) by reducing supply. IOR requires a very different method by the Flair CEO and would look like paying a stock dividend on MyCO A shares.MyCO P&L: This is the federal budget.Significant Amount: The overall government's inflation target, whether explicit or implicit.Mandatorily Convertible PIKs: These are Treasuries, which of course are payable only in base money (A shares).
I only knifed thru this and didn’t read all the comments and only got to Roark’s MYCO post#2As a “shareholder”, when you buy a share what do you get? In effect, I think 2 things:1) a legal claim on the assets of the company, whatever FMV of that is – you can do the expected value of what happens if MYCO “turns” into a for profit organization and starts churning out cash flows of $X/yr, times that by a probability, etc. This is effectively an option (you are buying the option of what if it turns into a for profit, or if it liquidates and pays out its assets, etc.).2) you buy flair. Which is worth whatever the FMV of flair is, and somehow you factor in your expectations for how MYCO will “manage” the share price.I haven’t thought enough about this, but I think the value of a share is mostly from #2.From a value investor’s perspective you wouldn’t value #1. Too hard pile. I’d keep it there and do some analysis on it to understand what that option might mean, how much it might be worth, but I’m not paying for it (I’ll take it for free though).So it comes down to what flair is worth. To people who use flair. Which isn’t easy either. But if I was to stray from the value investor’s roots, I would buy the shares and then try to “pump” the value of flair. Like pay an influential athlete to say that flair matters tonnes. To drive up the demand for flair and hence the price. I don’t think MYCO can effectively manage the price of flair if someone with incentive/resources wanted to drive price up. To the extent I believe I can drive up price, plus to the extent that the market hasn’t already factored this into the price, that will be my valuation of flair, and its share.(in this context, I guess valuation no longer matters. If I can reliably drive up the price of flair and I can make money over my cost of capital, then who cares about valuation? Just make money.)I hope the argument kind of holds together (somehow I just know it’ll get picked apart). Just curious what kind of “valuation” lesson we’ll take from this from Roark and others thru discussion. I’m just a lurker here and have benefited a lot thru the years. I don’t usually post but this was really interesting and I’m enjoying this so far, even if I’m only showing my ignorance by posting. Thank you all for the content and discussions!
One factoid not yet noted that may be relevant: MyCo operates the most powerful military force in the world and has demonstrated that its willing to use it when the CEO and board believe it's in their interest to do so. You do not f*ck with MyCo. Top execs of other companies buy lots of MyCo debt and equity, because if their own companies should suddenly fold, those execs can take MyCo's highly liquid, highly fungible debt and equity with them.
I may have missed something, given that I saw this thread a bit late. However, it appears to me that the MyCo/money as stock mental model has some large gaps that need to be addressed before it serves as a useful model (simple enough to be widely applicable, but yet capturing the main features of reality).- It needs to be incorporated that MyCo accepts payment from users exclusively in A shares (taxes). In some circles (MMT) one would say taxes drive money. The perspective here is that this is what drives the value of the A shares and not the P&L. Anyone can issue money (subway tokens, pizza coupons and in fact banks), the tricky bit is getting enough people to accept it. Since the MyCo score is necessary to participate in MyCo's hypothetical society and MyCo will only accept payment in MyCo A shares to give said score, one has in built demand and value.- The model primarily discusses high powered money (reserves and physical currency). However, arguably what is relevant from the perspective of reality is broad money - which effectively is bank deposits. The latter is created by banks and the government (via deficit spending). Presumably, this is what Flair is in the parable - Flair = broad money. If so, then there is a bigger problem here: the assumption that A shares determine the amount of Flair, i.e., money multiplier, is basically false. Since this statement usually gets me branded as a raving lunatic (after all, every introductory economics textbook yammers on about the money multiplier), I like pointing to the horse's mouth/the Flair CEO:https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/m...(click on the PDF in the page; I didn't want to link it directly).In the above I am effectively pointing out two salient features of monetary systems (for nations with sovereign fiat currencies - so U.S., U.K., Canada, Japan, etc. but NOT Greece, Germany, etc.):- money is endogenous (this is uncontroversial as the earlier link should convince you);- taxes drive money and fiscal deficits (MyCo running at a loss) increases the money supply (this has controversy around it, but most of this controversy doesn't revolve around these mechanics, but instead revolves around conflating a description of the mechanics with a prescription that the govt./MyCo should spend willy nilly).Since this thread is a bit old and I am a bit late, I'll leave it at that for now.
In the above I am effectively pointing out two salient features of monetary systemsI can see you mean well and are probably mortally convinced of the salience of these features. But I've had enough conversations with Randall Wray's victims to last a lifetime and they are almost never worth the slog. The best I can say is that I've read Wray and Lavoie and even Warren for President and Knapp and Lerner before them. My slightly unkind generalization is they say a series of uncontroversial things dressed in Halloween radical that in most cases are appropriately usurped by simplifying assumption until they don't, at which point they say silly things or nothing at all. I understand the plumbing of the banking system and the US Mint and I even know a guy who can explain the code behind the software of the ACH system, but if I thought the putative endogeneity of those mechanisms were critical, useful features to capture in a boiled down model of monetary macro and equilibrium price level determination I would have included them.
I can see you mean well and are probably mortally convinced of the salience of these features.Nah, I am not mortally convinced of anything - just haven't found any major flaw with Wray and gang's description of the mechanics of what goes on... yet (their prescriptions are another matter) - so do elaborate (I certainly would love to get a hold of someone who is intimately familiar with the software behind ACH - I am not kidding - I do want to know the nitty gritty). I am also quite interested in your take on why money creation by banks isn't relevant even for a boiled down model?That's a vague query on my part - I mean the quick answer would be that you just don't - I am hoping you can say more than that. My rough take is that much of the interesting stuff is happening at the broad money level, so ignoring deposit creation would miss a large chunk of what's happening there. I am not convinced that what's happening at the high powered money level (apart from extreme scenarios) has much of an effect on the price level.A bit more specific question would be: do you think a constant money multiplier assumption is sufficient for a boiled down model? My (possibly incorrect) interpretation of the MyCo model is that the answer to the latter is yes (but then, am I also interpreting correctly that MyCo wouldn't be particularly appropriate in dealing with incongruities like QE and the like? Basically, simplifying model assumption vs. all the ins and outs of reality? Or...?).
But I've had enough conversations with Randall Wray's victims to last a lifetime and they are almost never worth the slog.As an aside, I do have empathy for the aforementioned sentiment. I am, however, hoping that you'll ignore past experience and attempt one more conversation (I am not actually sure I am a Wray victim - I have read him and the accompanying troupe, but don't think am at the mindless minion level).
A bit more specific question would be: do you think a constant money multiplier assumption is sufficient for a boiled down model? My (possibly incorrect) interpretation of the MyCo model is that the answer to the latter is yes (but then, am I also interpreting correctly that MyCo wouldn't be particularly appropriate in dealing with incongruities like QE and the like? Basically, simplifying model assumption vs. all the ins and outs of reality? Or...?).Yeah it's easy to see how someone would think this was in there, but it's definitely not. In fact I agree with the post-keynesians (or neo-chartalists or MMTers or whatever) that the money multiplier is not only time-varying but a generally useless concept and undergrads around the world would probably be better off if they never heard the phrase. But most mainstream economists would secretly agree with this, too; there's just a lot of inertia in textbooks and teaching models when people don't have any better ideas.It may seem like the a money multiplier is implicit in MyCo because of the appearance of base money, but it isn't except in the most literal sense. Base money is in the story not because it bears some critical, fixed relationship to broad money or anything else, but because it historically has been the proximate way the Fed has exercised its unique dominion over the definition of the medium of account. And I think the first-best abstraction of monetary policy is an expectations equilibrium between a government with unique power over the ultimately arbitrary (in a fiat system) nominal anchor and the market. Anyone who gets overly ensconced in any particular hydraulics within that equilibrium, whether it's some false sense of one-way causation through broad money like in the multiplier or meandering aimlessly through the mechanics of the banking system like the endogenous money camp, ends up losing the plot. Whenever you have an arbitrary nominal yardstick, then sure, M3 is endogenous and so is every other nominal variable. Welcome to the soup. The thing that's exogenous is the Fed/Government's ultimate, credible power to enforce its nominal will and its nominal target, and you cannot find the keys to that exogenous factor hidden in the gears. But there's also such a thing as too much abstraction, especially when it comes to these cute little intuition pumps. I think some kind of hyper-abstract model that focuses only on the game theory equilibria and ignores all details like base money altogether also isn't very useful (or at least runs a lot of risk in missing how the expectations equilibrium is actually set in the real world), and leads you to really weird results like the recently popular "neo-fisherite" camp who have convinced themselves that the Fed raising rates is inflationary by surfing the equilibrium plane for too long. Just because the fulcrum poses as a noisy soup doesn't mean the lever isn't powerful. Even with mass substitutes like bank deposits and nothing even resembling a fixed multiplier, the Fed still has a monopoly on base money and it usually provides a higher convenience yield than substitutes (i.e. people willingly hold zero interest currency even when checking accounts pay interest). As long as there is some either current or expected future convenience yield the Fed can affect the price level with its conventional tools by changing expectations for the quantity of this monopoly good that it will contingently provide relative to demand. And it doesn't particularly matter how that demand relates to nominal flows (velocities) or stocks (multipliers) because the Fed's reaction function is contingent and based on its larger nominal target. And if the monopoly disappears entirely (both current and expected future base money are equivalent to substitutes), the Fed has alternative ways of exerting its nominal influence. Hidden in the recesses of every fed action, lurking even beneath even what seem to be the legal and operational limits on fed power, are all the strange and unpredictable things the Fed might actually find a way to do when it is desperate to make its nominal voice heard. We saw some of those things not too long ago. Less radically, many central banks (and now the Fed, too), conduct policy with a floor or corridor IOR system that blurs the line on whether it is using its conventional monopoly or covert fiscal levers to conduct policy. In fact, one of the points of MyCo is show how these two levers -- monopoly on base money ("Flair Value") versus fiscal policy -- can co-exist and interact in form that allows you to think about both the putative institutional limits on the CB (the Flair CEO) but also how those limits might not be fully binding when the entire Company (Government) generally share a larger nominal target. People like to dump on the "signaling" aspect of fed policy, probably because it feels squishy and ethereal and we are used to words being cheap. But when you are dealing with a entity that has many ways of redefining what an inch is you better pay attention to the signals it sends along the way. Similarly if FB reported a great quarter but Mark got on the call mentioned he might start giving 80% of profits to charity sometime soon you'd better step away from the P&L and listen to the signals. In reality central banks and governments operate in a nether region between platonically lingual omnipotence and Rube Goldberg like models of purely mechanical operations. For this reason, the mechanics can matter, not only because there are some institutional limits to CB power and overall government power, but because some aspects of those mechanics often provide the context for how to interpret what exactly is being signaled. But they only matter so much, and getting lost in the morass of constituent variables several steps removed like how banks "create" deposits is almost certainly a jargon filled dead end. Of course, there is nothing wrong with understanding how the banking system works, but more often than not it leads to making prescriptive or normative assumptions about money and prices that are actually not at all implicit in the normal equilibrium factors that determine the endogenous banking quantities like bank deposits and loans. To me the nominal anchor in a fiat system is like a special case of a Schelling point dance with a uniquely powerful but still limited communicator. Anything that takes you too far from understanding the context of that coordination game and its limits is probably a red herring.
In fact I agree with the post-keynesians (or neo-chartalists or MMTers or whatever) that the money multiplier is not only time-varying but a generally useless concept and undergrads around the world would probably be better off if they never heard the phrase. But most mainstream economists would secretly agree with this, too; there's just a lot of inertia in textbooks and teaching models when people don't have any better ideas.Tangentially, I agree here. I also can't, and don't have the patience for, keeping the names of all the various schools and their axioms straight. Anyway, moving on to more interesting stuff.It may seem like the a money multiplier is implicit in MyCo because of the appearance of base money, but it isn't except in the most literal sense. Base money is in the story not because it bears some critical, fixed relationship to broad money or anything else, but because it historically has been the proximate way the Fed has exercised its unique dominion over the definition of the medium of account. And I think the first-best abstraction of monetary policy is an expectations equilibrium between a government with unique power over the ultimately arbitrary (in a fiat system) nominal anchor and the market. Anyone who gets overly ensconced in any particular hydraulics within that equilibrium, whether it's some false sense of one-way causation through broad money like in the multiplier or meandering aimlessly through the mechanics of the banking system like the endogenous money camp, ends up losing the plot. Whenever you have an arbitrary nominal yardstick, then sure, M3 is endogenous and so is every other nominal variable. Welcome to the soup. The thing that's exogenous is the Fed/Government's ultimate, credible power to enforce its nominal will and its nominal target, and you cannot find the keys to that exogenous factor hidden in the gears. You address this (partly) next, but it might be worthwhile for me to comment/query anyway. I am going to paraphrase (in keeping with how I think about it), so do quibble if you find the take discordant. I agree that as far as the govt.'s ultimate power to enforce its targets (say Fed funds for something specific and concrete) is concerned, the specifics of the machinations with reserves, treasury purchases, high powered vs broad, etc. is more or less irrelevant (albeit interesting if you are into these kind of things - I am). So why not just get rid of thinking about all of that and simplify the whole situation down to say the Fed Funds target?The problem I can see with that is the issue of expectations in the real world, as you state:But there's also such a thing as too much abstraction, especially when it comes to these cute little intuition pumps. I think some kind of hyper-abstract model that focuses only on the game theory equilibria and ignores all details like base money altogether also isn't very useful (or at least runs a lot of risk in missing how the expectations equilibrium is actually set in the real world), and leads you to really weird results like the recently popular "neo-fisherite" camp who have convinced themselves that the Fed raising rates is inflationary by surfing the equilibrium plane for too long. But now we get into this funny business that as far as expectations go, it doesn't matter how the world works, but rather how everyone (or most) thinks it works. I am not making that statement in a disparaging way - there are plenty of self-fulfilling prophecies and I think it is problematic to ignore them just because "that's not how things work". Effectively, as you say (later) there are aspects of a Schelling point dance here.After all, one of the two things we would all love to know about the future is what bloody discount rates to use from now to infinity and beyond.The above is just commentary, I am not saying anything particularly useful. This is an arena where I would like to have multiple Dennett pumps, but it isn't ever clear to me which ones, of those that I have, are appropriate depending on the situation. It doesn't help that the ones that I often think are appropriate frequently lead to contradictory conclusions - but maybe that is a good thing.Hidden in the recesses of every fed action, lurking even beneath even what seem to be the legal and operational limits on fed power, are all the strange and unpredictable things the Fed might actually find a way to do when it is desperate to make its nominal voice heard. We saw some of those things not too long ago. Less radically, many central banks (and now the Fed, too), conduct policy with a floor or corridor IOR system that blurs the line on whether it is using its conventional monopoly or covert fiscal levers to conduct policy. Yeah, but this is partly why I come back to thinking that all the machinations and operational details seem to end up being irrelevant - something like the Fed funds rate will be what the Fed wants it to be, end of story.Where things get nebulous for me are along the lines of: why the hell does the Fed wan't the Fed funds rate (say) to be what it is, presumably this has to do with with the "natural rate of inflation" and things of that nature, but a lot of these seem to be pretty mystical notions. A part of me has sympathy for the guy (Jim Grant?) on the soapbox yelling that the Fed needs to find religion and just get out of the business of messing with interest rates (flood the system with reserves so that banks, in aggregate, have no problems clearing payments, no IOR, no corridor mechanism, no open market operations, nothing,let the Fed funds/interbank rate drop to zero, and let everyone figure out rates based on actual risks and utility).To some extent, I don't think that the Fed has much control on something like inflation. Short term interest rates - yes; inflation/price level - too much mysticism.It might seem that I am making some sort of artificial distinction between the Fed and the govt. To be clear, I am not. Just emphasizing that I am not necessarily convinced by the seemingly well accepted connection between interest rates and price levels (there obviously is some connection, even the most naive can see that).To me the nominal anchor in a fiat system is like a special case of a Schelling point dance with a uniquely powerful but still limited communicator. Anything that takes you too far from understanding the context of that coordination game and its limits is probably a red herring. Well, that's just the usual game with models - the only model that captures all the features of reality is reality itself. Different models elucidate different aspects, trick seems to be figuring out what's appropriate when. I don't know whether I should smack or hug the guy who presents Japan as their "model".I am messing the order of your statements up (you can't stop me!):more often than not it leads to making prescriptive or normative assumptions about money and prices that are actually not at all implicit in the normal equilibrium factors that determine the endogenous banking quantities like bank deposits and loans.I think I may have originally come across as being overly focused on the operational details - I probably was, since I am way too accustomed to people getting them (and the implicit motivations behind them) wrong.More or less, what I am trying to get a handle on with your MyCo parable is as to what sort of features it clarifies and, importantly, what rabbit holes one should not go down with it.Certainly, I am skeptical that the model has clarifying features that outweigh the pitfalls.* This has to mainly do with framing issues - too many knee jerk reactions associated with "shares", "P&L", etc., and if one does get to the point of being very careful about not treating issues with MyCo as any old firm, well than at that point the cute little intuition pump that could stops being one and actually starts taxing System 2.* - my default reaction (which doesn't make many friends) to most things is "No, it doesn't work".
So why not just get rid of thinking about all of that and simplify the whole situation down to say the Fed Funds target?Because interest rate centrism is like a virus in the minds of otherwise healthy humans. It makes seemingly reasonable investors slip into off-the-reservation jelly doughnut analogies and perfectly respectable economists see inflation under their rapidly depreciating beds. There is so much that is counterintuitive about money-as-rates. 1. It seems to fool people into thinking low rates somehow represent "easy money." It doesn't have to fool people. It doesn't fool everyone. Michael Woodford knows. But it fools a shocking number of otherwise brilliant and even qualified people. We just spent the better part of ten years with well more than half the world talking about how accommodating the Fed was being while repeatedly falling short of its nominal target, primarily because interest rates were lower than historical norms. This is an amazing mass delusion that we got to witness live, and I attribute most of it to rate centrism.2. Words are convenient because they summarize things. Naturally they also screw us over because they sometimes summarize too much and draw sneaky, arbitrary lines in doing so. Then we spend all our time arguing over those lines instead of thinking clearly. "Rates" are a poster girl for that. People easily slip into the idea that rates are a singular thing, temporarily forgetting that rates are gross summaries of many prices. The prices of time and risk, both nominal and real. Rates are also just as endogenous in equilibrium as M3. A dovish central bank who "lowers rates" is really trying to raise rates in equilibrium. Well, they are at least trying to raise the component of rates represented by long term nominal expectations and likely nominal term premia. They are probably also trying to raise real rates (on safer assets like Treasuries) in the sense that the full employment world they seek might portend higher marginal returns on investment and lower risk spreads, but that is open to debate. These nuances of a CB trying to lower some rates in a counterfactual scenario in order to raise some rates in the desired equilibrium combine with sticky short run prices to really screw up the way people talk about monetary policy. Especially, in my experience, investors who don't have a lot of experience force feeding themselves the general equilibrium implications or even economists who aren't good at switching between models and intuition. It is possible to talk only in the language of rates and have effective conversations but here on the ground it's a unicorn.3. Rates have a zeroish bound. People who are used to talking about rates had to leave their dictionaries behind when we started doing strange things like QE and Twist and the improvising wasn't impressive. Or, worse, they kept thinking about rates as if the rate implications from attempting to kink the ten-year with QE are identical to the "rate" implications from conventional Fed Funds operations. MyCo is a more flexible framework. You easily can imagine a world where so much common is issued that current Flair value is zero (the ZLB with massive excess reserves) and MyCo tries to switch to swapping even more reserves for some of its ten year converts. You can also easily separate the potential impact of this on MyCo's stock price into (1) Whether you can create some weird Sargent-Wallace violation by bidding up whatever term Convert you happen to buy (2) The signaling effect of reducing expectations of future, conditional expected Flair Value, even with no ability to reduce current Flair Value. 4. But this doesn't mean you can leave rates behind altogether and just swim happily in the equilibrium like the neo-fisherites ("raising rates is dovish"). Rates are still a language used by central banks in communicating their plans and that communication is almost always important. A good model allows you to understand what the lord of the focal point is saying but still translate it into a useful, flexible model that can apply to Zimbabwe, QE, the Zero Bound, IOR or conventional OMO.To some extent, I don't think that the Fed has much control on something like inflation. Short term interest rates - yes; inflation/price level - too much mysticism.Yeah if you believe this then you are not going to like MyCo or anything else I have to say on this topic. I think Central Banks have almost as much control over inflation as they do over daylight savings time, subject to the government budget constraint violations you see in places like Venezuela and Zimbabwe which I tried to include in the MyCo model. I think it's no coincidence that many Central Banks around the world picked 2%ish and mostly got 2%ish for several decades, and also that there is absolutely nothing more "natural" about 2% than 4% or 6% or 12% that we've seen in places like Central and South America. But, you know, some people think that fiat prices are just this thing that floats out in ether, buoyed by some strange equilibrium coordination process, with the government and central banks just standing by whispering impotently into the maelstrom. I don't.
you know, some people think that fiat prices are just this thing that floats out in ether, buoyed by some strange equilibrium coordination process, with the government and central banks just standing by whispering impotently into the maelstrom. I don't. I think I understand what you are getting at. Let's see if I can re-phrase it. I should emphasize that it is your mention (admiration?) of Woodford that's leading me to what follows, so I am to a large extent echoing his viewpoints and presuming that your lens is similar.Effectively, the Fed (or CB in general) sets the price level by managing expectations. The methods of shaping expectations, whether they be through interest rate management, or policy communication, or what have you, are functionally the CB saying "I AM the maelstrom".Or, a more interest rate centric viewpoint: the CB isn't "just" setting an overnight rate but also communicating the path of all future overnight rates. How effective this overall communication is determines the degree of influence on expectations and consequently price levels.While the means of signalling (such as the current level of overnight rates) are important as to how effectively they deliver the intended signal, they are simply a means to an end: managing expectations which have the attendant effect of influencing the price level.Fair enough characterization?Again, I am switching up the order of your comments:Yeah if you believe this then you are not going to like MyCo or anything else I have to say on this topic.I should clarify, the key phrase in my statement about the degree of the Fed's control on inflation is "To some extent, I don't think". That phrase also isn't/wasn't intended as an easy out. More accurately, it represents a certain level of schizophrenia I have around the topic of monetary policy. I am not quite silly enough to believe that the CB/govt. is a mouse squeaking in the maelstrom, but depending on the day of the lunar cycle I am silly enough to believe that "market participants" can and do often mistake the maelstrom for the mouse which leads to a self-fulfilling prophecy. Alternatively, market participants misinterpret the signals, again leading to unintended expectations and the like.Unless, I am completely mis-characterizing what you are saying, I think I understand the attractiveness of the MyCo model. It doesn't quite work as an intuition pump for me: I would much rather have had you simply post the words "Michael Woodford" as the only response to my original post, but that's more a statement about language, communication, and my own foibles. Of course, any second now you are going to point out that I am completely misinterpreting what you are saying.
My mom once saw me drinking a single cup of tea and without further ado for my next birthday sent me enough boxes of tea to kill Mary Poppins. I think you just tea bagged me with Michael Woodford, so to speak. We’re moonwalking in opposite directions at this point, but thanks for honestly engaging. MyCo may have failed you as a monetary epiphany but that Woodford joke alone had to be worth the price of admission.
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