Nonprofit Fraud

A recent story on highlights some pretty ridiculous charity fraud. Their investigation finds many cases where telemarketers, in this story the company InfoCision, are hired by a charity to raise money for a cause. The people donating are assured by people who pretend to be volunteers that the majority of the money is going directly to the charity but in reality over 80% of it (in some cases it looks like over 100% of it) goes to pay the telemarketers.  Charities raising money in this manner range from medical charities such as The American Cancer Society, March of Dimes, the Diabetes Associate to political groups like Citizens United.  

The charities are doing this in order to identify donors and volunteers that they can later on contact directly for support without giving the telemarketers a cut. But the initial cut isn't just from money raised directly by telemarketers, it's also taken from money raised by the volunteers recruited by telemarketers. And in the meantime donors are often told that over 70% of their money is going to the charity.

It’s an InfoCision filing with North Carolina that reveals that the Diabetes Association got just 22 percent of the money raised nationally by volunteers recruited by the telemarketer in 2011. That figure isn’t found in any public filing with the IRS.

So far, only Ohio has looked into this fraud and they settled with InfoCision for a nominal fee. This strategy of defrauding donors in order to find those willing to donate might work for charities in the medium run, but systematically defrauding new donors and lying to volunteers could impact their brand in the long run. 

Hopefully people who decide they want to donate will learn how to give well instead of funding telemarketers who disrupt everyone's dinner time. In the meantime, there is always the Do Not Call registry (which the founders of InfoCision lobbied against) - and if a friend asks for a donation for their favorite big name charity you'll want to check and see who recruited them to act as a fundraiser.

China's Lack of Trustworthiness: Iron Ore Edition

Garett Jones, guest blogging at econlog, has a post up on the value of trustworthiness in a society. 

I suspect that Adam Smith's pin factory prospered because the UK had found ways to create trustworthiness.  That's because without trustworthiness it's difficult to reap most of the rewards of the division of labor: if firms can't rationally trust each other, if workers and owners are rightly suspicious of each other's motives, if citizens can't trust the police, then everyone has to become a generalist.  In this world, everybody makes his own pins.  

This perspective makes what is happening in China even more interesting. China is a developing market that has moved away from full state control towards a more capitalistic structure. However, this structure is lacking in trustworthiness as highlighted by recent events in the iron ore market. 

The sequence is as follows: benchmark prices drop in the spot market; Chinese buyers walk away from contracts, often at the last minute; suppliers are forced to dump their defaulted-cargos in the spot market at knock down prices, further depressing the spot market; this triggers a fresh round of Chinese defaults. The spiral feeds itself, producing dramatic price corrections.

Even generalized, this lack of trustworthiness isn't going to crush China's economy. However, it does increase the chance that China will end up stuck in the middle income trap.

Political party's rules are made to be broken

It's interesting to see that both the Democrat and Republican party leaders have no respect for the rules they are ostensibly following.  This convention season has seen blatant fake vote counts by the chairs of the conventions to create optics that will favor their candidate in the election.

Exhibit 1: The Republican Party changed the rules so a Maine delegation more supportive of Romney could be sat down. The rule change also ensured that there wouldn't be a counted vote for or against Mitt Romney during the convention.

Exhibit 2: The Democratic leadership realizes that the language in the document pertaining to "god" and Israel will not play will for Obama in the election and change it against the wishes of supporters.

Neither of these changes actually did anything significant. Romney was going to be the Republican nominee either way and Obama's policies on religion and Israel aren't going to shift as a result of the altered platform. They just broke the rules to give themselves better optics to the voters. If they'll blatantly ignore their rules in order to look good to certain voters, it's interesting to think about what party leaders will do when the stakes are higher and something like their business interests are threatened. 

A Chart for EM investors

Those counting on high GDP growth to help their investments should give this chart a second look: 

This post summarized the Morgan Stanley report in more detail, but in general real GDP growth does not necessarily coincide with higher equity returns. Not when your shares are being diluted in order to expand (or in order to enrich shareholders).

CNBC on Facebook

CNBC has been talking about Facebook 24/7. They are focusing on Facebook's stock price and early investor selling, not bothering to mention that this investor was also taking risk off the table all the way up as well. They are constantly asking "Does this mean Facebook was not ready to be a public company?"  What it means is that that Facebook and their investors who sold stock got a very good price for their IPO. Combine Facebook's 50% fall with LinkedIn's 100% rise after its IPO and early investors come out even. Adjusting for Facebook's larger market cap and the early investors in both deals have now taken more money from Wall Street than Wall Street's mispricing cost them.

CNBC's constant harping a little silly until you realize what is really upsetting them. Europe is still largely on vacation and they need a story. No one from Facebook is going on their show to talk to them about what is going on, making their job a little bit harder. In response CNBC seems to be running with the theme of "Talk to us or we are going to say bad things about you." 

It would be amusing if their coverage of Facebook wasn't so repetitive and inane. 

Taleb is fooling himself about randomness

Nassim Taleb is back in the news! This time, he is telling investment professionals not to go into investing in his new paper Why It is No Longer a Good Idea To Be In The Investment Industry

For those unfamiliar with Taleb, he wrote Fooled by Randomness and The Black Swan, books primarily about why he is so smart and everyone else is pretty stupid. In addition to this, the former book was about how causality is generally overestimated and the latter book is about how the world is much more strange than we think. Indirectly, they are also about how the people who Taleb worked with or knows that ended up being far more successful than him did so only because they were luckier.  While this is doubtlessly true in some cases, he likes to exaggerate the case and his latest paper is no exception. He even developed a name for these people. 

The “spurious tail” is therefore the number of persons who rise to the top for no reasons other than mere luck, with subsequent rationalizations, analyses, explanations, and attributions. The performance in the “spurious tail” is only a matter of number of participants, the base population of those who tried.

With fat tails, he sees the spurious tail as far too hard to out compete. There is undoubtedly some luck when it comes to investment returns, as investors are making decisions while taking into account varying states of the world, only one of which will turn out to be true.  But this analysis assumes that the only thing that matters are investment returns and ignores the rest of the factors that those in charge of allocating capital use when deciding to trust their money to an investment professional. Returns do help raise funds, but there are many other variables that matter, especially now when funds have to be registered with the SEC and people are worried about losing their money to another Madoff that the population of investors making spurious returns and raising capital is not rising that much relative to the assets deployed to investment professionals.

So what is Taleb's final advice?

To conclude, if you are starting a career, move away from investment management and performance related lotteries as you will be competing with a swelling future spurious tail. Pick a less commoditized business or a niche where there is a small number of direct competitors. Or, if you stay in trading, become a market-maker.

The "find yourself a niche with fewer competitors" idea is always good advice, but as for the other... maybe Knight Capital is hiring?

This is a little scary

China won nearly twice as many medals as the closest countries in the 2008 Paralympics, winning over 200 medals. Their take in 2004 was only 1.5 times their nearest competitors. We know that China starts training their athletes from the age of 4. China's out sized success at the paralympics makes me suspect that those who can't quite make the cut are incentivized to injure themselves in such a way as to make themselves viable competitors in the paralympics. Think of it as a more glamorous version of Indian beggars who are forcibly amputated in an attempt to increase their donation rate.  Another possibility is that the training routines in China are so rough or general safety conditions are so much worse in a large developing country that when this is combined with a government program focused on winning medals then many more athletes end up being qualified compared to developed countries. Diminished mental capacity qualifies athletes for certain events at the paralympics, so those who decide to fake it at least don't have to inflict permanent bodily harm on themselves.

Strange source of sanity

There is a massive drought in the US and corn production looks like it will be lowest that it has been in 15 years. Still, ethanol targets need to be hit so much of that corn is going into government subsidized ethanol production. So it falls to the UN to be the voice of reason.

The UN has called for an immediate suspension of government-mandated US ethanol production, adding to pressure on Barack Obama to address the food-versus-fuel debate in the run-up to presidential elections.

If the EPA also removed the ethanol requirements in gasoline then getting rid of the mandate and subsidies could even bring corn back down to its pre-drought levels.

A theory on Stripe

I saw Stripe on CNBC today.  They do online payments for developers and have raised money from some very big names.

Regardless of their revenue stream, they have a lot of value to these investors. Stripe's customers are generally start ups (they also have a lot of retail stores) and they can track their revenue in real time. This gives their investors access to additional information for judging potential investments and can put new companies on their radar. 

I wonder if the people at Stripe will be able to monetize this value. Done properly, it should be worth much more than the $20 million they recently raised.

Musings on fashion and start ups

I recently came across an article about fashion in Silicon Valley. It is interesting, but it doesn't really touch on why being fashionable, in the context of spending money on Chanel and other brands, doesn't work too well at start ups.

1. Fashion is a status game that most engineers are not good at. Making sure that engineers are appreciated is a big deal, so bringing in people who put a lot of importance on status outside of the ability to solve problems is not going to help the culture of a company.

2. The article mentions brands like Chanel. These things cost money. Spending lots of money around people who are taking low salary/high equity compensation is not great for the culture of a start up. It encourages people to leave in order to take high pay/low equity at a more mature technology company. A entrepreneur who always dresses in expensive clothing is showing off their wealth the same way as one who drives a Maserati. 

3. Following fashion rules and trends is correlated with other types of conformity. In a culture that prides itself on how non-conformist they are an interest in fashion is not a good signal.

That said, engineers at start ups have been willing to push fashion boundaries in ways not seen elsewhere in the professional world. The difference is that this is done by breaking fashion rules, ignoring current trends and not spending lots of money at boutique shops. (If I was less respectful of my friends' privacy I would now post a picture of three engineers from a very successful start up: one person has a mustache, the other with a mullet and the third with a neck-beard) Maybe the fashion industry, like the car industry, can make more inroads into Silicon Valley at the successful companies where many people have already made their money but it's going to be hard for them to get in on the ground floor and attract people building the next great companies.