What is a song worth? Who creates the value: the songwriter, the singer, or the “star-maker machinery behind the popular song”? Perhaps all three, but how to divvy up the spoils equitably?
Taylor Swift’s decision to withdraw from Spotify has become a flashpoint for such questions. In her Yahoo interview last week, Swift is quoted as saying “… everything new, like Spotify, all feels to me a bit like a grand experiment. And I’m not willing to contribute my life’s work to an experiment that I don’t feel fairly compensates the writers, producers, artists, and creators of this music.”
The question of fair compensation to creatives is not new, but some new tools have become available to talk about it. Not surprisingly (since this is an R&R blog,) securitization is one of them. Rather than launching into a factual defense of securitization or explain here how it was sabotaged, this short blog presents a succinct case for using securitization in arts finance by attacking the standard interpretation of the balance sheet.
The balance sheet is a brilliant construct that simultaneously displays the resources of the world (assets) and the claims on it (liabilities and equity). However, the narrow scope of interpretation imposed on it is, arguably, ruinous. That is because the only people who really look at balance sheets are financiers and accountants; and, in the for profit world, the rules on constructing balance sheets prohibit the listing of most intangibles. There is no place on the asset side of Apple Inc. for the colors and sleek design that draw customers into an Apple store en masse, nor that of Dream Fluff Donuts (Berkeley) for the tantalizing first bite of their glazed buttermilk bar, nor that of MCG Jazz for the music, history and sense of belonging it has given jazz artists in America for the past 35 years.
No place, except a hint of the value in the time series of their receivables (which is disallowed in standard accounting). How much are people willing to pay for a good or service, and how stable is the demand? As an artist, you don’t have to produce Taylor Swift-like rates of return to earn out a stable revenue stream. You just have to develop a stable following. The information on payment stability translates into a measure of the professionalism of the artist and the loyalty of her or his client base.
Twenty-five years ago, securitization was invented to bridge a disconnect between valuing assets and valuing liabilities. The intangible value of the assets was quantifiable, but only when the receivables were analyzed using private data that are not part of the accounting disclosure package. A firm that was a BB to the financial world and so paid more to borrow money, might actually have AA asset quality and in principle could borrow funds more cheaply using an expanded information set.
The source of the disconnect is an incomplete information set that is biased in favor of lenders at the expense of creatives. In the music world, the same bias exists. It favors the studio, which takes the equity value created by musicians and gives them a salary in return. Unquestionably, studios deserve some of that equity for helping musicians commercialize their art. But the question is, where to draw the line between a fair rate of return and expropriation?
Securitization techniques go a long way to quantify intangible value. Using it to build incentives for creatives to create and giving them a path to build their business on and share equitably in the value they create may be an experiment worth investing in.
We can try to change the system, or we can try to change human psychology and behavior. For my money, attempting to change the system by substituting one vision for another is a better way to change the dialogue.
Ha-Joon Chang is a Cambridge economics professor, Guardian columnist and influential critic of capitalism, on a mission to change the dialogue on economics from a”god-given” puritanical framework that rewards status-quo wealth to a social system that can be improved, for the benefit of nearly everyone. His recent critique of the positive spin on austerity in The Guardian captured my attention:
Twenty years ago, rating agency analysts disagreed on whether non-AAA corporations could issue AAA-rated structured securities. Aircraft finance was the poster child of the debate. “Impossible. Too volatile,” corporate analysts reasoned. Structured analysts would retort: “Not even $1 of securities can be funded at AAA?” And, if $1 can be funded at AAA levels, what about $2? $3? $1 MM?
This spring, R&R got close to the emerging solar securitization market through committee work coordinated through the U.S. Department of Energy’s National Renewable Energy Laboratory (NREL), which is working to promote solar energy and preparing for the imminent (2016) solar tax credit phase-out. In December 2013, NREL’s Travis Lowder and Michael Mendelsohn published a white paper, The Potential of Securitization in Solar PV Finance, which argues for securitization as replacement funding. R&R discovered that rating agency bias exists against solar PV lease securitization, similar to corporate. The agencies willing to issue ratings (some are not) are capping the rating at low Investment Grade risk levels.
Really? Not $1 of securities backed by energy that continuously self-generates is capable of being rated AAA?
Over the last few weeks, much ink has been spilled in an attempt to refute, undermine and marginalize the book “Capital in the 21st Century” by Thomas Piketty, a French economist. In some, unsurprisingly British quarters it has even reached the level of “the lady doth protest too much, methinks.” You cannot convince people of your viewpoint by just silencing the opposition. It’s a safe bet that, had a British economist said the same things or reached similar conclusions, no British institution would have attacked him so publicly. But who knows, perhaps “Le Monde” would have done so with gusto and joie de vivre! It’s clear that the Financial Times is not a proper forum to argue about economic time-series with any seriousness. Although one can find fault with the Mona Lisa, doing so does not take anything away from its value as a work of art.
Two days ago, Business Insider published a good summary of little known facts about Alibaba.
Several facts highlight how the mega trade-web dwarfs competitor e-commerce platforms in the U.S. and in China on several critical measures, including employees, registered users, web visits, sales throughput (on track to handle $1 TN in transactions) and revenues ($1.8 BN in 3Q2013).
Another competitive advantage of Alibaba is that it blocks search engine spiders, thereby retaining the control and benefit of most of the information published on its site. The March 23 2013 Economist article on Alibaba discusses the spider tactic in more detail and offers a deeper discussion of Alibaba’s information advantage generally.
But the most interesting aspect of Alibaba is one that has received almost no attention. That is Alibaba’s role in transforming and developing China’s SME financial services market.
Alibaba, together with its financial backer and deal sponsor Orient Securities Asset Management, is the micro-loan securitization pioneer in China. Approval was granted by the CSRC in June 2013 for the creation of Alibaba Separate-Account Asset Management, a master trust structure. It will issue 10 series, each backed by RMB 100-200 MM, with a 1-2 year maturity. The first series, backed by RMB 500 MM, priced with three tranches (A: 75%, B: 15% and C:10%) of a 15-month maturity. The bonds were listed on the Shenzhen Stock Exchange on September 25, 2013.
With this foray into self-financing, I believe it is well worth reconsidering Alibaba’s business model. Is it really a giant, diversified trade web? Or is it (as I believe) a brand new banking model for the 21st Century?
Floyd Norris, chief financial correspondent for the New York Times, gives a disturbingly uninformative account of RMBS and CDO markets in his article, When a Deal Goes Bad, Blame the Ratings, November 14, 2013. Not having done the research to really understand the causes of the credit bubble, he fails to see the irony of his words: Did you make an incredibly bad decision during the great credit bubble? Don’t worry. Join the crowd denying responsibility.
By Greg Gordon | McClatchy Washington Bureau
WASHINGTON — Moments before the Senate overwhelmingly passed a bill to overhaul the credit ratings industry seven years ago, Republican and Democratic sponsors took turns touting its promise for ending an entrenched oligopoly.
The bill, they said, should break the viselike dominance of three agencies – Standard & Poor’s Ratings Services, Moody’s Investors Service and the smaller Fitch Ratings – in an industry that serves as a crucial watchdog over the nation’s financial system.
What’s escaped public scrutiny until now, however, is that the law’s tough criteria defining when a newcomer could join the industry weren’t written by Congress. They were crafted by a yet-to-be-identified official of one of the big three ratings agencies, a former aide to the Senate Banking Committee has told McClatchy.
Read more here: http://www.mcclatchydc.com/2013/08/07/198739/industry-wrote-provision-that.html#storylink=cpy
“Imagine the pharmaceutical industry having six FDAs, all competing to approve drugs,” said Rob Dobilas, who founded Realpoint LLC, the credit-rating company bought by Morningstar Inc. in 2010, referring to the U.S. Food and Drug Administration. “Everyone would be dead.” See Matt Robinson, Bloomberg News, Ratings Shopping Revived.
Striking quote, but the analogy needs to be tweaked.
Many people confuse the credit quality on corporate bonds with that of securitizations and structured bonds. Corporate bonds are backed by the entire balance sheet of an operating company, with competing payment obligations and a portfolio of assets of different value and liquidity.
Structured bonds are backed by cash flows. Thus different ratings on the same security is tantamount to working in different currencies. Each currency is pegged to an exchange rate a.k.a. the credit rating scale. Thus, the valid comparison would be “imagine six different Feds” who control the money supply on their own terms. Everyone would be broke, except their patron clients. Oh, wait a minute.
And what’s the solution? Very simply, to adopt a unified numerical rating scale for structured. It would considerably curtail ratings shopping and limit the probability of another subprime bubble like the last one.
On May 8, 2013, Sohu Business picked up an article in the HK press about a JV ratings agency between SEC-designated Egan-Jones, a Chinese agency, Dagong, and a Russian agency, RusRating, targeted for listing June 25 in HK. It is called, appropriately, “World Ratings.”
Perhaps not coincidentally, the SEC’s credit rating roundtable is scheduled for May 14 with some industry and academic participants selected by the SEC as well as the heads of the Big Three participating. The goal is to eliminate “ratings shopping,” ie, the search by financial intermediaries for ratings on new structured bonds that impose the absolute lowest capital cost regardless of the actual risk.
The search for cheap substitutes is not a crime; in finance, it keeps the price of capital competitive. A problem arises only when cost and price become decoupled. The cause is usually asymmetrical information. Ratings shopping in structured finance is precisely that: an information problem arising from the failure to develop and promulgate credit risk measurement standards that are valid over the life of the security.
A NYT article today reports on the loss of wealth among Americans since 2007. The article cites many findings in a recent Urban Institute study, “Less than Equal: Racial Disparities in Wealth Accumulation.” Racism is alive and well in the U.S., but it would be a mistake to confuse racism with a dysfunctional economic structure.