Why the planned Facebook IPO is not really about creating value?

Roger Martin, Dean of the Rotman Business School in Toronto, recently wrote about the problems plaguing capitalism in the 21^st Century. Among other things, he calls for us to focus more on “creating value, rather than trading it”. The current news frenzy about the impending size of the Facebook IPO is a prime example of how our media and investment communities have become fascinated with “trading value” rather than creating it.

What things of value has Facebook really created in its history? Not much really, in my opinion. All of the technology that Facebook uses already existed, or has been created by human beings not associated with Facebook. Zuckerberg and his team have not really created anything new. They just applied existing software and hardware technology to something it has not been applied to before. That is not the same thing as creating some fundamentally new – creating value.

The innovation that Facebook can claim is that it has allowed individuals to engage over computer networks in a form of communication that has been important to human being for generations that go back past recorded history. Let’s go on a bit of a bio-evolutionary sidetrack to understand this, and then come back to the planned Facebook IPO.

We evolved as social and abstracting, language-using beings. Our multi-layered, complex brains developed over many millions of years and endless generations to cope with the complexities of our lives. Our evolutionary history has resulted in our having brains that can do more than one thing at a time. We have continually added capabilities to our brains, adding the new abilities to while retaining old ones. As a result, we have many capacities that occur at a preconscious level. We have others that result from the interaction of old abilities with newer ones. As a result, our internal psycho-dynamics involve 5 highly intertwined streams of capability.

1. I- Me

We live with a sense of self (I-Me) that is capable concurrently of being-in-the-moment (I) and dissociated from that immediacy through conscious reflection on my immediate being (Me). We are probably the only species on the planet that has this ability. (Although our inability to communicate intelligently with some other highly social species – whales, dolphins, and perhaps elephants – means that we cannot really know for sure.)

2. Us Two

We form and thrive in complex multi-layered pair-bond relationships that last over long periods of time. We form them not just for the purpose of reproduction, but also for enhancing our personal survival, sharing physical and emotional pleasure, increasing our personal growth, and enhancing our status in our social world.

Although other species form pair bond relationships, we humans invest them with a level of meaning and importance that seems unique. We bring our concurrent I-ME psychodynamics into them. We are the only species on the planet that is consciously obsessed with the moment to moment and long term elements in our pair bond relationship.

3. Our Family:

We raise children for an extended number of years, taking them through a complex series of development stages that equips them to live as adults on all of the levels captured in the phrase “I-Me / Us Two / Our Family / My Tribe / If –Then”. We are a unique species in this regard. We have the longest and most complex developmental history of any species on the planet. As a result, the importance of, and the amount of time we spend being aware, of “our family” history and connection is also a defining characteristic of our species. We cannot separate our sense of self (I-Me) from our being a member of “Our Family”.

4. My Tribe

We lived in tribes for far longer than we have lived in societies. Tribes are collections of human beings that number in the hundreds. Each person in a tribe knows, at some level, all of the other members of that tribe. This is the most fundamental characteristics of the tribal human psychodynamic.

Societies are far larger than tribes. Societies are collections of tribes. Societal dynamics are the result of the fact that when living in a society, an individual can be a member of multiple tribes. For instance, when you go to work, in participate in the life of your “work tribe”. When you go to a sport bar and cheer your favourite team with your friends, you participate in the life of your “sports” tribe. When you participate in the activities of a political party, you are a member of your “political” tribe. This is a fundamental characteristic of a society. It allows individuals to concurrently participate in the life of multiple tribes.

Human beings have lives as individuals, as members of families and as members of tribes for millions of years. They have lived in societal groupings for thousands. Although no doubt, evolution is adding capabilities to our brains for participating in societies, we are the very early beginning of this evolutionary process. Most of the time, we cope with the pressures and issue of societal life by using our tribal psychodynamics.

Many of the difficulties we face in current societies come from the fact that we evolved as tribal creatures, not societal ones. War for instance started as an inter-tribal dynamic, when tribes competed for limited resources. We now live in a world where our grasp of technology and our application of it to the tribal business of war threatens our existence as a species. Today in war, our internal psychodynamics, including our emotions, are tribal, but our probability of survival is based on the enormously destructive application of science to the technology of war. War has become disconnected from its first purposes, ensuring the survival of the tribe. War now threatens our survival as a species, something it has only done in the past two centuries. Yet we seem unable to stop war.

We evolved complex in-group / out-group psychodynamics that allow us to participate effectively as individuals, as pair-bond mates, and as family members in tribal life. Our ability to exchange good / services (trade) and our capacity to bind our behaviour through contracts (live by law) developed from our living in tribes and from our interacting with members of other tribes.

We respond to tribal based normative patterns that govern our I-Me, Us Two, and Our Family behaviours. We follow leaders that are necessary for the success and survival of our tribes.

But often the limitations inherent in these tribal capabilities seem to distress the societies we now live in. Just look at the negative parts of the current political process, of which the negative advertising current in the US Republican race for the Presidential nomination is only the latest example.  in the US.

5. If-Then

As well our abilities on these four human levels (I-Me / Us Two / Our Family / My Tribe), our evolving brains also developed the ability to abstract and to reason using language. We have the capacity to think and to reason about space in that that is not limited by the fact that we live, like all living creatures, in an immediate here. Our sense of space transcends the immediate space we are acting in. We think and talk about the here and the there naturally, without questioning the wonderful thing that this ability really is.

In same way, our sense of time is longer than the immediate moments in which we live. We abstract from this immediate now, just as we abstract from the immediate here in which we live. As a result, we have a conscious sense of time that includes the past, the present and the future.

These two capabilities are the basis on which we evolved our ability to logically reason. If-then reasoning involves putting things in past-future sequences. It can only develop if we have a sense of time which includes the past and future – an abstract sense of time.

In the same way, spatial if-then reasoning can only evolve once we have a sense of here and there – an abstract sense of space. Language was necessary to, an evolved as part of us having a Us Two, Our Family, My Tribe level of psychodynamic capability. Language is the framework within which we developed to have ability to do past-future and here-there if-then reasoning. Our ability to logically reason is the result of our complex lives as I-Me, Us Two, Our Family, My Tribe creatures.

Our evolved logical, reasoning abstract consciousness interacts with the preconscious many systems we use to deal with the needs of ““I-Me / Us Two / Our Family / My Tribe” lives. We are not consciously aware of much of this interaction.

Side Note:

But we are developing the ability, through our societal creation of disciplined forms of communicated thought (i.e. science). to gain insight into these dynamics. Our creation of technologies that allow us to examine our brains’ functioning from the outside in (e.g. thermal and magnetic of brain functioning) is contributing to this growing insight.

It will be interesting to see where all of this will lead. More and more, we applying the “if-then” – logical reasoning part of our mental abilities to generating insight into the way that the “I-Me / Us Two / Our Family / My Tribe” parts of our brains work. We are only just beginning.

We also use time and space abstracting, shared logical reasoning to create technologies which have and are dramatically restructuring the material conditions of how we live on this planet. We are being to realize that not all of this may be positive for our future as a species. But we have evolved over millions of years, and barring a self made planet wide disaster, are likely to continue to do so for millions of year to come.

Personal Note:

The only reason that I might want to travel in time is to see where this fascinating l I-Me / Us Two / Our Family / My Tribe / If –

Then evolutionary process might take us in a million years or so. Ah well – it is not to be.

So how is all this relevant to Facebook? What Facebook did was automate one of the two integrating capabilities that evolutionary human beings have developed to cope with the needs of their complex internal psycho-dynamics – gossip. Telling stories about our selves, our partners, our family members and the folks in our tribes is profoundly important to re-affirming who we are on the “I-Me / Us Two / Our Family / My Tribe” levels.

Our other great integrating capability is story telling. Stories, starting with the family stories we hear as children, help us make conscious the results of the complex, intertwining of our I-Me / Us Two / Our Family / My Tribe psychodynamics. Stories, both historical and fictional, also educate us about “what we might be” as a result of our intertwined internal psychodynamics. This explains the tremendous importance of all forms of businesses related to story telling in human history, e.g. writing, publishing, entertainment, movies, etc.

Facebook uses existing technology to make gossip – personal story telling – easier for people. Facebook extends their ability to do so over distances and times that exceed our physical limitations. Suddenly, using Facebook, you could tell a story about yourself or another individual that could be access by other people even though they were far away or not connected to you in you’re here and now time. Given the importance of gossip and story telling in human life, it was no wonder that Facebook took off once people realized what it could do.

As it matured, Facebook the organization then used the size of its community to attract high levels of advertising revenue. Advertising is a form of human story telling devoted to selling products and services.

As a result, Facebook makes billions of dollars annually. But it is from doing nothing something fundamentally new. I personally believe that Facebook almost blundered into this combination of  success factors, using technology to extend the reach of human gossip – personal story telling. But I cannot be sure. After all, I was not there as Facebook the organization developed and grew. That also explains why I am not as rich as Mark Zuckerberg.

I am not the first person to say that Facebook “really does not need the money”. So why is it bothering? How will Facebook use the almost 4 billon in cash it has on its balance sheet and the new 5 billion that financial pundits are saying an IPO will raise? Will Mark Zuckerberg and the other folks who control Facebook use this money to “create new value”? My bet is no.

Instead, I believe that we will see Facebook “trade value” through acquiring other technology companies. That will be unfortunate. But Facebook’s has a history not really creating anything fundamentally new. Instead, it almost blindly applied technology that already existed to parts of human life that had not been automated before. The founders of Facebook seemed overwhelmed by the fact that Facebook’s appeal extended far beyond the universities that they saw as their marketplace just 7 or so years ago. All of this leads me to believe that “trading, rather than creating, value” is the most likely future use of all of this money.

It’s not the Central Bank Rate that Counts Anymore, It’s the Spreads

Bank of Canada to Announce Bank Rate Rise this Morning: July 20, 2010

In today’s economy, it is not the central bank rate that is crucial to the strength of the economy. Rather, it is the spread between the bank rate and various other interest rates that drives economic activity in positive or negative directions.

The decreasing spread between the bank rate and the rate for sub-prime mortgages was one of the things which perpetuated the financial melt down that led to the 2008-2009 recession.

Credit card interest rates have been more or less stable throughout the 2008 2009 recession. This spread has therefore increased, as the central bank rate approached historically low levels. This has had a twofold economic effect. Credit card issuers, largely banks, have won. Credit card holders, particularly those in society who don’t own other assets such as houses and stocks, have lost. Those most negatively impacted by the recession, individuals and families dependent on immediate income and short term revolving debt to finance their cost of daily living have actual contributed to the increased profitability of the existing credit card business. Despite all the protestations of credit card issuers, the credit card interest rates during the recession smacks of the exploitative usury common in historical times. They hurt the economically weakest in our society at a time when they deserve help. Politicians, who regulate such things and need to provide moral leadership to society, should be ashamed for not addressing this issue.

The decrease in the central bank rate has been tied to decreases in the rate paid on direct savings and other asset type savings accounts at banks. These rates are driven by a number of things. First, they have a relationship to the Bank’s prime lending rates, which are in turn linked to the central bank rate. At the same time, the rate that bank’s pay on savings and other similar asset accounts reflect their desire to get more savings on deposit. In the fact, they compete with other banks and similar institutions for such savings. Bank leaders make management decisions about the spreads between these rates. Essentially, they are in a position to manage their profitability through such spread decisions.

The spread between the central bank rate and savings / asset investment rates have not increased during the recession, even though the raw rates have decreased. That indicates that it is not a shortage of cash, but rather an unwillingness to lend it, that is behind the current problems with small business lending. If this were not so, lenders would be competing to get more cash by increasing this spread.

The decrease in raw rates for savings and other asset based returns has hurt asset owners throughout the recession. As well, asset holders’ have suffered real financial pain through the decrease in the value of assets on the stock markets. However, financial institutions, whose behavior clearly contributed to creation of the recession, have largely been able to shelter themselves through managing the spreads between the central bank rate and the other rates they offer for both savings and lendings. The best witness for this is the return to large profits on the parts of North American banks by the summer of 2010.

A low central bank rate has brought down mortgage rates in Canada. This has lead to a robust housing market place in Canada. In general, housing costs in Canada are at a level which many, including the Economist, believe is unsustainable.

The Canadian banks, and others, are still competing for mortgage business, despite this. Mortgages are structured to pay mostly interest up front, not repay principal.  Banks’ profitability from mortgages is therefore tied to turnover in the mortgage market. They tie their mortgage rates to the central bank rate to encourage this turnover. But again, it is their ability to manage the spread, which does not move lock step with the central bank rate, which drives the volatility of the mortgage market, and the value of the housing which reflect this volatility.

Businesses are still hoarding cash according to the Economist. Business investments are driven by risk/return judgments on the part of the involved management leaders. Their investment judgments balance two factors. The first is their evaluation of the future risk related to the investment. Managers see that consumer are still being hurt by the relatively high spreads between the central bank rate and credit card interest rates, and by lower spreads between the central bank rate and savings / asset return rates. Consumers do not have as much disposal income as they had before the recession. As well, the decline in the value of stock market and other similar assets (including housing in the United States) has resulted in a slow down in consumption based on the increase in the value of assets held by consumers. This means that the risk that consumers will not purchase the results of business investments in new products and capacity is still high. At the same time, management leaders are experiencing lower cost of capital rates, which are tied to the central bank rate, as lower. However, business management’s evaluation of the risk related to such investments is still outweighing the contribution of lower capital costs to estimated rates of return on business investments. As a result, they are holding back on investment. The Economist has called this “hoarding cash”.

It is not enough to exhort business to stop hoarding cash. Not even the reputation of the Economist will be sufficient to get business managers to do that. Instead, consumer purchasing power must increase. It cannot increase until at least two things happen. The spread between the central bank rate and credit card rates must decrease. The spread between the central bank rate and return on invested assets must increase. The central bank, through monetary policy, does not directly control either. Bank senior’s managers due. Although they take the changes in the central bank rate into account, they can manage these spreads to suit their short term profitability desires first, and the needs of consumers (and the economy) second.

We no longer live in a world where Keynesian policy, or central bank monetary policy, works directly, in the short term. The growing confusion about the relationship between the central bank rate and the health of the economy reflects the growing complexity of our economic world. We live in a world of spreads of all kinds. Spreads are largely managed by bankers and other financial managers, not politicians. It is time for public commentators on our economy to stop misleading their audience through simple minded comment on changes in the central bank rate. Instead, they need to analyze the differential impact that such changes have on rate spreads. They need to inform us that the spread managers are responsible for what happens in our economy as our politicians and central bankers. They need to place these things in short and long term historical perspective. This is not easy to do in media spots that last a few minutes or take a few paragraphs. But that is no excuse of acting as if public media commentary on these complex dynamics is in fact insightful: something more than 1 person’s open or simple economics based gossip.

Public media business and economic commentators also need to take into account all of the things that impact that intangible called consumer confidence. Increasing taxes either openly or through the indirect taxes called fees negatively impacts consumer confidence. The value added tax increases in British Columbia and Ontario in Canada (HST implementation) are an example of the first. The “eco-fees” that came into effect on 1July in Ontario are an example of the second. Calling something a fee does not mean that it is not a tax. A tax is simply an amount of money taken from individual consumers and commercial organizations by a government, based on its power to legislate.

Day to day consumers can feel the impact of the relationship between rate spreads and direct / indirect taxes on their day to day economic confidence. They don’t need degrees in economics to intuitively feel the impact of such moves by commercial and retail bankers, central bankers and politicians. The least they, as a public audience, deserve from public media commentators on financial dynamics is less “media gossip and personal opinion labeled as insightful analysis” and more true analysis. Public media commentators need to stop their “in-the-movement, in isolation” comments. They need to look at, understand and talk about the connections of things like rate spread changes and tax increases. They need to remember that they have an obligation to educate all of us on the inter-related issues impacting our personal and joint economic health.

A side note.

American, and a number of other, democracies were founded on the principle of no taxation without representation. Generally that has been taken to mean that elected representatives must vote on taxes. When a government moves decisions about taxes from elected representatives to civil servants or to employees of government agencies, it is undermining this basic democratic principle. The tendency of elected governments to do this more and more in the past decades is a shameful thing. Calling the amounts levied on private citizens and enterprises by governmental groups “fees” is a verbal shell game. It does not hide the fact that those who govern, whether elected or otherwise, have a tendency to treat those they govern as “revenue cows”. Historically, every form of government has eventually taxed its citizens into open or passive revolt. Democracy seems to be suffering more and more from this historical tendency. Elected politicians who allow bureaucrats and government agencies employees to impose “fees” on citizens and organizations need to experience a large dose of shame over their non-democratic tendencies.