Tuesday, December 1, 2009


Interfluidity is truly one of the wonders of modern communications technology.  Consider his latest post on a real version of the famed "democratization of finance":

If someone devised an equity instrument that would offer stronger, easier-to-value promises than common equity, that would effectively disperse entrepreneurs' risks while offering investors an upside, that could be efficiently offered in modest chunks small investors could incorporate into diverse portfolios, I think that would be a fantastic financial innovation.

Suppose businesses sold numbered dollars. Dollar number 420,167 has just been rung in. How much would you pay for dollar number 600,000? If you pay 91¢ for that dollar and it takes a year for the business to bring the next ~$180K, you've earned a 10% return. If business is great, and it only takes 6 months reach that sales level, then you earn a 20% annualized return. ROI is dependent only on the briskness of sales, something that is tangible and observable, something that customer/investors can understand and estimate. These claims would confer no control rights upon their holders (except potentially when they are in arrears), so entrepreneurs, the residual claimants, would price their goods and services to maximize profits, not revenue. Holders of fixed income / variable term claims would be along for the ride. Assuming a non-wimpy business owner, investors' best strategy for maximizing the value of their claims is to drum up business, which is a win/win for the entrepreneur and the investor. Investor repayments would naturally correlate with business success: when business is slow, few payments to investors would come due. When business is brisk, lots of claims would mature.

This is quite a bit bit smarter than anything I had to say when I was reflecting on why we have debt to begin with, though it goes in the same direction.  It's funny to think of this as innovative, when it turns out that truly democratic finance would look a lot like the investment companies of yesteryear, minus the fraud of the South Sea Company (we hope).  Everything goes to reinforce the idea that democratic finance shouldn't be trying to "restore the flow of credit" or "allow homeowners to tap their equity" or any of the nonsense that was flogged off as terribly innovative during our latest round of Ponzi finance.  Instead, we should be trying to imagine a system that puts people who save together with people who need the money to build something new, plain and simple. 

Real financial innovation would put a lot of banks out of business, just as real technological innovation made the mainframe obsolete.  And local equity investing would not only be a financial revolution, but you can easily see how it would be the first step in a revolutionary political decentralization as well.  Which of course brings me to my dead horse of recent months, namely that after 500 years of rapid technological development, our species really only has one social technology, applied intermittently at best, to show for its efforts -- I wish my markets improved as rapidly as my motherboard.


rip off victim said...

Now that sounds like a company idea! Although there is also the WR Hambrecht story - great mechanism, modest business success

Clark said...

I don't know quite why the auction idea hasn't caught on more. Maybe because Google's was a bit botched.

The nice thing about this idea is the weird way it sits between debt and equity. You always get par value back, but still have some upside. So it's more conservative than equity, but doesn't have the ticking time bomb effect of debt. As long as your operating cash flow is positive, you just keep going.

Anonymous said...

Didn't know Google had a dutch auction thing set up.

Its a beautifully simple idea, but implementing and marketing it would be a trick. Would you sell tranches in an auction?

Clark said...

Seem to me an auction would work. The tranches could be as fine as every numbered dollar, though that may not make sense in practice. Beyond that you just need some trusted accountant to oversee the cash flows, which I guess could be the SEC or the IRS, or ... wait, why exactly do we have both of these counting different things? Why don't we just have public quarterly tax data and a market for purchasing future dollars, end of story?

The biggest problem I can see is ensuring enough interest so that the entrepreneur has sufficient capital available at a reasonable cost. Otherwise it won't be competitive with simple debt financing. Of course, changing the rules so that interest is no longer tax deductible would help a lot here.

There also may be some weirdness with inventory financing, but it's late and I'm too tired to figure out absolute versus relative numbered dollars right now.

Anonymous said...

SEC, Smech EC. Someone should start or modify a brokerage to offer this.

Clark said...

Would you trust a brokerage to provide clean numbers when it's whole business revolves around getting more companies to issue this stuff?

I think of good business information infrastructure (relatively speaking at a least) as one of the things the US has going for it.