A silver dollar for Volcker and Bornsley...

In a recent interview with Bloomberg, Paul Volcker shared his concerns over money market funds.

Prior to the Lehman bankruptcy, which caused Reserve Fund units to dip below $1, money market funds tended to receive inflows as market fears arose. Even after Lehman, fund assets remained relatively stable above $3.5 trillion, almost 25% of GDP. Aside from the Reserve Fund, no major fund broke the dollar.

Yet Volker understands that vulnerabilities in the financial structure must be corrected while problems are still speculative. Currently, fund managers value assets according to expected returns, rather than to market prices. This accounting treatment moderates volatility and allows for a stable unit value. It also makes sense, generally, given the short term and high quality characteristics of the assets. But in the event of a black swan or managerial error, actual values may surprise investors.

One might plausibly argue that money market funds practice sufficient diversification and risk management to make another Reserve Fund extremely unlikely. But who is checking? In the days following the Lehman collapse, money market funds quickly announced that they held no Lehman assets. Total assets hardly budged. Over time, successful placement of capital in a given asset breeds complacency, as demonstrated by the U.S. housing market and related securities. Why, given the pessimism surrounding the company, didn't investors pull out of the Reserve Fund en masse prior to Lehman's collapse?

To be sure, money market funds have not collapsed, and they have historically provided competitive returns safely. With that in mind, try to imagine the standing of these funds in the minds of investors 10, 20, 30 years from now. If, hypothetically, they remain pristinely unburdened by major problems, it's conceivable that investors will allow themselves to remain similarly unburdened by skepticism. Absent regulatory authority, however, credulousness may cause serious problems in the future.

Like Brooke Bornsley, the former CFTC chairwoman who attempted to regulate the CDS market in 1997, Volcker's warnings may be too prescient for serious consideration. Hopefully, investors will protect their interests with more care than they displayed with derivatives, mortgage securities, and other financial obligations.

The Value of Intellectual Capital

Paul Krugman wrote this article, White Collars Turn Blue, in 1996. He made a very canny observation about the future of intellectual capital in the internet era:

How, then, can creativity be made to pay? The answer was already becoming apparent a century ago: creations must make money indirectly, by promoting sales of something else. Just as auto companies used to sponsor Grand Prix racers to spice up the image of their cars, computer manufacturers now sponsor hotshot software designers to build brand recognition for their hardware. And the same is true for individuals. The royalties the Four Sopranos earn from their recordings are surprisingly small; mainly the recordings serve as advertisements for their arena concerts. The fans, of course, go to these concerts not to appreciate the music (they can do that far better at home) but for the experience of seeing their idols in person. Technology forecaster Esther Dyson got it precisely right in 1996: "Free copies of content are going to be what you use to establish your fame. Then you go out and milk it". In short, instead of becoming a Knowledge Economy we have become a Celebrity Economy.

The idea that advertising could produce intangible innovation formed part of the basis of my investment in Ticketmaster. The CD format is not protected when mp3s can be downloaded in seconds--and the gap between mp3 and CD is far smaller than that of CDs and vinyl records--but the live music experience has no substitute. I expect that live music will become increasingly important to bands, and that music lovers will have more capital to spend on live shows, as recorded formats become cheaper and more easily obtainable. Ticketmaster's ability to capture a portion of the proceeds from such events is less certain.