Ten interesting things we read this week

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At Ambit, we spend a lot of time reading articles that cover a wide gamut of topics, ranging from zeitgeist to futuristic, and encapsulate them in our weekly ‘Ten Interesting Things’ product. Some of the most fascinating topics covered this week are: Investing (Detecting business fraud), Economy (Case for negative interest rates), Integrity (Tim Cook says no to FBI’s backdoor entry to iPhone), Business (Can Neobanks succeed in India?) and Technology (Big Tech got even bigger in the Covid-19 era). 

Here are the ten most interesting pieces that we read this week, ended May 15, 2020:  

1) Bad arguments and how to avoid them [Source: Farnam Street] 

When being powerfully persuasive matters, it’s important that we don’t use bad arguments that prevent useful debate instead of furthering it. To do this, it’s useful to know some common ways people remove the possibility of a meaningful discussion. This piece elaborates on three common types of bad arguments; 1) straw man; 2) hollow man and 3) iron man. What is the purpose of debate? Most of us, if asked, would say it’s about helping someone with an incorrect, harmful idea see the light. It’s an act of kindness. It’s about getting to the truth. But the way we tend to engage in debate contradicts our supposed intentions. Any time we engage in debate, we need to be honest about our intentions.

If you want to have useful, productive debates, it’s vital to avoid using bad arguments. In Intuition Pumps and Other Tools for Thinking, the philosopher Daniel Dennett offers some general guidelines for using the principle of charity, formulated by social psychologist and game theorist Anatol Rapoport: 1) You should attempt to re-express your target’s position so clearly, vividly, and fairly that your target says, “Thanks, I wish I’d thought of putting it that way.” 2) You should list any points of agreement (especially if they are not matters of general or widespread agreement). 3) You should mention anything you have learned from your target. 4) Only then are you permitted to say so much as a word of rebuttal or criticism.

We often use bad arguments without realizing it or experience them without recognizing it. But these types of debates are unproductive and unlikely to help anyone learn. If we want our arguments to create buy-in and not animosity, we need to avoid making bad ones. The reality is that most of the debates we have are not rationally thought out; they’re emotionally driven. This is even more pertinent when we’re arguing with people we have a complex relationship with. Sometimes, it’s better to walk away.

2) Carson Block, a short-seller, has mastered how to detect business fraud [Source: The Economist]

Carson Block is an activist short-seller and his firm, Muddy Waters, borrows shares in a shifty-looking company and then sells them. Instead of pounding the mean streets, Mr. Block ploughs through reams of company documents. He makes his findings freely available. He then shows up on CNBC’s “Squawk Box” to denounce the bad guys. The stock of covert embezzlement—what John Kenneth Galbraith, a quotable economist, called “the bezzle”—varies with the business cycle. It grows during booms. Tell people that XYZ Corporation is a fraud, and they won’t listen. Short-sellers get short shrift. But the cycle always turns. The bezzle peaks just as boom turns to bust. For short-sellers, these are the good times.

Muddy Waters has evolved into a short-seller with a global purview. The art of the bezzle is to inflate profits, pump up the stock price and quietly sell your shareholdings to credulous outsiders. But money is not the only incentive. Vanity is also a factor. Each stock fraud is fraudulent in its own way. But there are common elements. One is a breach between earnings as defined by Generally Accepted Accounting Principles (GAAP) and non-GAAP measures. Another is an increase in “days payable outstanding”, a yardstick of how long it takes a company to settle bills with suppliers. Delay boosts cashflow, at least for a while. So does gathering more quickly payments you are owed. Firms with dressed-up earnings also tend to pile on debt because they lack strong underlying cashflow. 

But looking only at numbers is not enough. They need to be cross-checked with other information. Muddy Waters has built a reputation for diligent research. A pronouncement by Mr. Block has the power to move prices. That worries regulators. Mr. Block sees no shortage of firms with accounting that distorts reality. “There are real excesses out there.” The bezzle has only grown fatter.

3) Can Neobanks Succeed in India? [Source: hind.substack.com]

This article talks about neobanks in the US and EU and think about what their Indian equivalents might look like. Neobanks, digital only banks, are aiming to change the way retail banking happens. There are a number of factors that have led to the rise of neobanks over the last half decade. These include legacy tech infrastructure that doesn't appeal to mobile-first millennials, broadly poor customer service, including charging high overdraft fees and providing unattractive interest rates, which only further alienates a poorly served customer base, and in the case of the EU, a proactive regulatory environment that aimed to foster competition. 

Neobanks seem to be the flavor of the season with VCs in India. In an article Mint noted, "Neo banks raised $116 million in 2019, up seven times year-on-year. While the figure is not huge, what’s striking is that many of these firms have raised seed rounds of $5-20 mn on paper ideas alone." In 2013, the RBI constituted the Nachiket Mor committee to study and propose ways to further financial inclusion, and increase access to financial services. On the recommendations of the committee, it introduced licenses for two kinds of niche banks: 1) Payments Banks and 2) Small Finance Banks. 

In 2015, the RBI gave 11 entities licenses to operate as payments banks (including PayTM, and telco players like Airtel, Reliance, and Vodafone). However, this category of bank has not taken off - only 7 of the 11 entities even started operations, and of those only 4 have any sort of fully fledged business. Nearly two-thirds of all transactions in the country are now digital. Digital transactions have unsurprisingly spiked in the face of Covid. 1.25B UPI transactions were carried out just in the month of March, before the country shut down. In Indian context, there are many ifs, but there is clearly a lot happening in consumer retail banking in India and some of the neobanks have really experienced founders/operators at the helm. It will be interesting to see how their products evolve and adapt and where things go.

4) The case for deeply negative interest rates [Source: Project Syndicate] 

Adopting negative interest rates is a step ahead says Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University. A once-in-a-century (we hope) crisis calls for massive government intervention, but does that have to mean dispensing with market-based allocation mechanisms? After the crisis, wealth will be destroyed on a catastrophic scale, and policymakers will need to find a way to ensure that, at least in some cases, creditors take part of the hit, a process that will play out over years of negotiation and litigation. For bankruptcy lawyers and lobbyists, it will be a bonanza, part of which will come from pressing taxpayers to honor bailout guarantees. Such a scenario would be an unholy mess. Europe and Japan already have tiptoed into negative rate territory. Suppose central banks pushed back against today’s flight into government debt by going further, cutting short-term policy rates to, say, -3% or lower.

Negative rates would lift many firms, states, and cities from default. If done correctly – and recent empirical evidence increasingly supports this – negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment. A number of important steps are required to make deep negative rates feasible and effective. The most important, which no central bank (including the ECB) has yet taken, is to preclude large-scale hoarding of cash by financial firms, pension funds, and insurance companies. A policy of deeply negative rates in the advanced economies would also be a huge boon to emerging and developing economies, which are being slammed by falling commodity prices, fleeing capital, high debt, and weak exchange rates, not to mention the early stages of the pandemic.

Influential bank lobbyists hate negative rates, even though they need not undermine bank profits if done correctly. The economics profession, mesmerized by interesting counterintuitive results that arise in economies where there really is a zero bound on interest rates, must share some of the blame. Emergency implementation of deeply negative interest rates would not solve all of today’s problems. But adopting such a policy would be a start. 

5) Architect of Sweden’s no-lockdown strategy insists it will pay off [Source: Financial Times] 

While the world is still trying to contain the spread of Covid-19, Sweden seems to plan a step ahead of all. Anders Tegnell, Sweden’s state epidemiologist who devised the no-lockdown approach, estimated that 40% of people in the capital, Stockholm, would be immune to Covid-19 by the end of May, giving the country an advantage against a virus that “we’re going to have to live with for a very long time. In the autumn there will be a second wave. Sweden will have a high level of immunity and the number of cases will probably be quite low,” Mr. Tegnell told. “But Finland will have a very low level of immunity. Will Finland have to go into a complete lockdown again?”

Primary and secondary schools, restaurants, cafés and shops are mostly open as normal in Sweden, with health authorities relying on voluntary social distancing and people opting to work from home. Schools for over-16s and universities are closed and gatherings of more than 50 people are banned, but it is still the most relaxed approach of any EU country. Sweden’s virus-related death toll recently reached 3,040. This is significantly higher than Nordic neighbours Denmark, Norway and Finland, which have registered fewer than 1,000 between them. The epidemiologist has become something of a cult figure in Sweden, with reports of people having tattoos done of him.

Many countries’ hope is that they can keep the virus at bay until a vaccine is found. But Mr. Tegnell said that, even in the best-case scenario, it was likely to take “years” to develop one, before it could be administered to an entire population. “It’s a big mistake to sit down and say ‘we should just wait for a vaccine’. It will take much longer than we think. And in the end, we don’t know how good a vaccine it will be. It’s another reason to have a sustainable policy in place.”

6) The FBI Wanted a Back Door to the iPhone. Tim Cook Said No [Source: wired.com] 

This piece throws light on Apple’s stance on privacy and security. Apple received a writ from a US magistrate ordering it to make specialized software that would allow the FBI to unlock an iPhone used by Syed Farook, a suspect in the San Bernardino shooting in December 2015 that left 14 people dead. But Apple refused. Cook and his team were convinced that a new unlocked version of iOS would be very, very dangerous. It could be misused, leaked, or stolen, and once in the wild, it could never be retrieved. It could potentially undermine the security of hundreds of millions of Apple users.

Apple’s team working on this came to the conclusion that the judge’s order was a PR move—a very public arm twisting to pressure Apple into complying with the FBI’s demands—and that it could be serious trouble for the company. Apple “is a famous, incredibly powerful consumer brand and we are going to be standing up against the FBI and saying in effect, ‘No, we’re not going to give you the thing that you’re looking for to try to deal with this terrorist threat,’” said Sewell. But this wasn’t easy for Tim Cook. There were many questions that would crop up like is the company on the side of the terrorist? Etc. He had to show the world that he was advocating for user privacy rather than supporting terrorism.

“The implications of the government’s demands are chilling,” he wrote in an open letter to customers. “If the government can use the All Writs Act to make it easier to unlock your iPhone, it would have the power to reach into anyone’s device to capture their data.” Apple had been working with the FBI to try to unlock the phone, providing data and making engineers available, Cook explained. “But now the US government has asked us for something we simply do not have, and something we consider too dangerous to create… a backdoor to the iPhone.” He continued, “In the wrong hands, this software—which does not exist today—would have the potential to unlock any iPhone in someone’s physical possession.” Later, the FBI backed down and asked the court to suspend the proceedings as they had successfully accessed the data stored on the phone, though it didn’t explain how.

7) The global resilience imperative [Source: Project Syndicate] 

The on-going crisis has made all countries mull over strategy to contain it. Many governments have come up with various measures for the short term. But, if today’s short-term measures to reopen economies do not promote long-term economic resilience through effective governance of the global commons, the next disaster will be only a matter of time. Pandemics, for example, become more likely as we continue to transgress planetary boundaries controlling Earth’s stability. Rapid deforestation accelerates global warming and degrades natural wildlife habitats. Add high-risk behavior (such as so-called wet wildlife markets) and low emergency-response capacity, and conditions become ripe for disease outbreaks that spread from animals to humans and then spiral into catastrophic global disease outbreaks.

The global risks are directly linked to a scarcity of global public goods such as disease control, as well as to overuse of global commons such as clean air and water, a stable climate, biodiversity, and intact forests. Our long-term priorities must therefore be to improve the provision of global public goods, build resilience into our global commons, and find ways to mitigate the inevitable economic shocks. So, as policymakers seek to kick-start the economy, three reforms are essential. 1) Governments must integrate the various multi-trillion-dollar rescue packages into a green recovery plan that follows certain key principles. 

2) Must focus on generating human prosperity within planetary boundaries, thus avoiding the catastrophic effects of global warming, environmental degradation, and zoonotic disease outbreaks. 3) Must strengthen the governance of our global commons. Just as the atmosphere is a shared global common, because the behavior of one country affects every other, so are human interactions with wildlife, which affect the likelihood of zoonoses. And, to be better prepared for future pandemic outbreaks, we urgently need to strengthen the capacity of international institutions such as the World Health Organization and the United Nations Environment Program.

8) Why global crises are the mother of invention [Source: The Economist]

In April 1815, a volcano erupted in Mount Tambora (now Indonesia). Not only was it one of the largest in recorded history, but also deadliest. In China the cold weather killed trees, crops and water buffalo. In North America a “dry fog” reddened the sun and there was summer snowfall in New York. Riots and looting broke out in Europe as harvests failed. Food prices soared and tens of thousands of people died from famine and disease. Horses starved or were slaughtered, as the high price of oats forced people to choose whether to feed their animals or themselves.

And that’s when Karl von Drais, a German inventor, devised a personal-transport machine to replace the horse: a two-wheeled wooden contraption which he called the Laufmaschine (literally, “running machine”). A demonstration ride, in which he travelled 40 miles in four hours, showed that it was as fast as a trotting horse, and could be powered by its rider without much effort. The tricky part was keeping it balanced while gliding along, which took some practice. 

Once everything returned to normal, enthusiasts continued to improve on Drais’s design. The crucial addition of pedals occurred in France in the 1860s. Other refinements included better brakes, a steel frame, lightweight metal wheels and a chain to drive them. By the late 1880s these elements had been combined into a recognisably modern design: the bicycle. What innovations might the coronavirus outbreak of 2020 spawn? The pandemic will surely inspire new approaches to online education, say, or package delivery by drone – and, no doubt, some less obvious ideas. Who would have guessed, after all, that a volcano would give rise to the bicycle?  

9) Trillion-dollar club tightens grip on fund market during crisis [Source: Financial Times] 

It is said that the largest 1% of investment groups manage 61% of total industry assets. And as the market corrected, managers like BlackRock, Vanguard, State Street and Fidelity have tightened their stranglehold. The market leaders in recent years have capitalized on their economies of scale to implement ferocious fee cuts. These have attracted new investors. In 2018, Fidelity Investments pioneered a range of zero-fee index funds, a move that spurred a flood of new investor money. 

Quantitative investment specialist Dimensional, bond giant Pimco and American Funds, the retail arm of Capital Group, also feature among the 27 groups that make up the 1% of asset managers, according to analysis from US-based research group Flowspring. Fidelity’s inclusion in the ranking refers to US-based Fidelity Investments, combined with its international sister companies. The research company’s calculation is based on a universe of 2,772 managers and includes data for open-ended, close-ended and exchange-traded funds globally.

Seven out of 10 largest global funds, including money market funds, are index trackers, according to Morningstar Direct. Two of the largest, Vanguard’s Total Stock Market index fund and State Street’s S&P 500 ETF Trust, attracted more than $24bn in new money in March. Warren Miller, chief executive of Flowspring, warned that the concentration of assets in the hands of fewer decision makers could increase baseline market volatility in future. Also, he added, “It could also make the heads of the largest asset managers incredibly powerful influencers of the global economy as they can exert serious pressure on their portfolio companies.” 

10) How Big Tech got even bigger in the Covid-19 era [Source: Financial Times]

It was expected that the economic downturn would bring an end to investors’ love affair with fast-growing but expensively priced. But that’s not what’s happened. Fang stocks, originally Facebook, Amazon, Netflix and Google, but Microsoft and Apple also often thrown in to the mix, became emblematic of the US technology-driven rally after the global financial crisis of 2008. They helped drag the index up, resulting in stretched valuations. A key measure of that, the ratio between the Nasdaq 100 companies’ share prices and expected earnings, rose to more than 25 at the start of this year, against a 10-year average of 19, according to S&P Capital IQ figures. Many expected a fall. 

With millions cooped up at home, companies like online retailing giant Amazon and internet streaming service Netflix are clear winners. They are both up about 30% so far this year. Google, Facebook and Apple are also now roughly flat for this year, after each falling more than 30% from the February highs. Some of the coronavirus-era stock market winners are likely to stay buoyant once the crisis recedes, as the outbreak accelerates existing trends such as online streaming and shopping. 

But, the bigger question is…whether the global stock market rally is sustainable or a temporary bounce, engineered by central bank and government stimulus packages that will fade as the virus’s economic destruction hits. “Many promising bear rallies fizzle as the initial euphoria clears and the grim realities of underlying fundamentals come to the fore,” said Andrew Lapthorne, a strategist at Societe Generale.