Seth Goldstein

Securitization is a financial technique that pools assets together and, in effect, turns them into a tradeable security. Financial institutions and businesses of all kinds use securitization to immediately realize the value of a cash-producing asset. Securitization has evolved from its beginnings in the 1970s to a total aggregate outstanding (as of the second quarter of 2003) estimated to be $6.6 trillion. This technique comes under the umbrella of structured finance. (from Wikipedia)

In the 1970s, from his perch at the Salomon Brothers trading desk, Lew Ranieri famously applied securitization to the mortgage market, creating what is now referred to as MBOs (mortgage backed securities).  This application has enabled (1) millions of consumers to more easily become homeowners by (2) transferring credit risk away from banks and thrifts to independent financial investors in the bond markets.  To put the size of this market- $2.5 trillion- into perspective, you could take the combined market cap of the entire Internet sector (including paid search, ecommerce, advertising, travel, etc):

• TWX = $90B
• MSFT= $250B
• GOOG= $65B
• YHOO= $50B
• IACI= $15B
• AMZN= $15B
• EBAY= $50B
• Combined Internet market cap= $600B

The innovation and size of the MBO market qualifies Ranieri as a special blend of creativity and capitalism, and this led to his becoming one of the great financial alchemists of all time.

Business Week, November 29, 2004   
Lewis S. Ranieri: Your Mortgage Was His Bond
The bond trader turned home loans into tradable securities 

The past quarter-century has seen a revolution in finance. It’s felt every time a homeowner refinances a mortgage or signs up for a credit card. No one person can claim to have lit the fuse for this revolution– but Lewis S. Ranieri was holding the match. Joining Salomon Brothers’ new mortgage-trading desk in the late 1970s, the college dropout became the father of "securitization," a word he coined for converting home loans into bonds that could be sold anywhere in the world. What Ranieri calls "the alchemy" lifted financial constraints on the American dream, created a template for cutting costs on everything from credit cards to Third World debt — and launched a multibillion-dollar industry.

Last month, online mortgage lead generation company LowerMyBills (LMB) was bought for more than $300m by Experian.  According to the press release, here is how the two companies are described:

LowerMyBills.com is a one-stop destination that offers savings through relationships with more than 400 service providers across 17 service categories including home loans, credit cards, long-distance and wireless services, and auto and health insurance. Since its inception in 1999, LowerMyBills.com has helped more than 500,000 consumers save nearly $200 million.

Experian is a global leader in providing information solutions to organizations and consumers. It helps organizations find, develop and manage profitable customer relationships by providing information, decision-making solutions and processing services. It empowers consumers to understand, manage and protect their personal information and assets. Experian works with more than 50,000 clients across diverse industries, including financial services, telecommunications, health care, insurance, retail and catalog, automotive, manufacturing, leisure, utilities, e-commerce, property and government. Experian is a subsidiary of GUS plc and has headquarters in Nottingham, UK, and Costa Mesa, Calif. Its 12,000 people in 27 countries support clients in more than 60 countries. Annual sales exceed $2.5 billion.

This is interesting on a number of levels, not the least of which is the premise that (1) the mortgage leads and data process of LMB are valuable to an information broker such as Experian and not simply to traditional mortgage companies and (2) the consumer benefits from easy access to creditors who bid in a competitive environment for the consumer’s business.

The essence of securitizing mortgages was to shift the credit risk away from the lenders’ balance sheets and into a open market.  Whereas before, the complexity and regulatory requirements of banks meant that getting approved for a loan might take months, now the determination of credit worthiness was established by a far more efficient marketplace where investors in the business of taking such risks were able to establish a price for this risk quickly and provide consumers with a rate in a matter of weeks (which has become days, hours and increasingly seconds).  Consumers benefit greatly because they are much more in control of their financial futures and not at the mercy of institutions with conflicting priorities. 

I only have a passing understanding of the nuances of the modern bond market but I am looking forward to seeing the Internet evolve into the multi-trillion dollar market that structured finance has become.  Many markets have emerged online in the past 10 years where buyers meet sellers, consumers meet advertisers, and advertisers meet publishers in low-friction, value-added environments.   

Using Chris Anderson’s framework, as one moves down the tail by searching for ever more obscure (ie "un-covered") keywords, one inevitably finds companies like Nextag, Amazon and eBay/Shopping.com as the minimum bidders.  They believe that they have enough liquidity of product opportunities so as to be able to convert any cheap click (ie $.05) into a more qualified activity within their network.  In so far as Amazon sells actual products, its role is as much marketer as anything else.  eBay sells other people’s products and so is one step removed from Amazon (which of course also sells other people’s products through its marketplace).  Nextag and Shopping.com don’t sell anything, but are simply better engines for comparing products and finding the best prices.  Shopping.com is doing more than $100m in annual sales off of these and other techniques leading to their recent acquisition by eBay, while Nextag remains private but purports to be doing just as much revenue.

As we move further beneath the radar, there is another group of companies, mostly emerging from the online direct response agency world, that are generating significant profits by purchasing media, attracting prospects and selling leads to advertisers.  Four companies in particular stand out as the leaders in this space:  Adteractive, Azoogleads, Quin Street and NetBlue.  Together they will generate more than $500 million in 2005 sales with 30%+ profitability.  Yes, $500m.  Adteractive recently sold a minority share for more than $100m to a prestigious private equity firm.  In the next few months one of these will likely be bought or merged with another on the way to one of these going public in early 2006.

While the majority of Internet advertising is paid for on a CPM or CPC basis, the real driver of spending is advertisers’ willingness to pay on a pure Cost Per Lead (CPL), performance basis.  Remember the hand-wringing in 1999, for example, as to the efficacy of online advertising?  Strange isn’t it how we don’t hear much about that anymore. The emergence of pay-for-performance advertising online has effectively transferred the risk away from the medium.  With PPC, Internet media no longer has to convince advertisers to trust its ability to perform as effectively as other media (Cable, TV, Radio, Print…).  The quality of the commercial transaction is self-evident to the online advertiser, who now inherits all the risk from the publishers. 

Just to be clear, the fact that the risk now resides with the advertiser and not the publisher does not a pure market make.  Advertisers are companies in the business of selling things to consumers and other companies.  Their business is not buying advertising. 

Tiny (Internet) Markets

Within these new markets, there are millions of micro markets where a query or a unique user path comes into contact with one of more targeted advertisements.  A constructive tension emerges between the user who intends to find something or do something, and the sponsor of the link who is trying to lure her into their particular commercial environment.  Each one of these tiny interactions feature a buyer (advertiser), seller (publisher) and asset (consumer’s att/intention).

The latest Release 1.0 article on Spyware features a fable that imagines advertisers as merchants at a Bazaar and their various adware proxies as pushy street urchins, “Miss!  Miss! Look here!  Special deal!."   Efficient markets are based on trust.  This relates to markets of any scale, from the NYSE and eBay to my decision whether or not to accept an invitation into somebody else’s LinkedIn network.   

While the modern US interpretation of the Bazaar has been typically pejorative (with a few notable exceptions), there is nonetheless a very useful economic system for transferring value that has emerged in around the Bazaar, namely Hawala.   Hawala is a peer-to-peer payment system that enables any participant to make a decision as to any other participant’s credit worthiness:

The unique feature of the system is that no promissory instruments are exchanged between the hawala brokers; the transaction takes place
entirely on the honor system. (From Wikipedia)

It is unfortunate that Hawala got associated with the terrorist activities of 9/11, since as a structural mechanism it has much to offer us as a model for enabling the liquidity of attention markets that Media Futures require.  It takes courage to create new markets, but in so far as new markets establish new currencies of trust and individual control, then they are well worth the risk.

*

Note:  This is an abridged post.
Transparency finds its limits in posts about arbitrage.  While there is likely long term
benefit in an open exchange of intellectual property, specifically
around the collective invention of an attention marketplace,  the fact remains
that capital is usually created by the introduction of friction and
opacity onto otherwise smooth, transparent surfaces.  So long as I continue to debate the benefits of openness vs the importance of discretion, I will continue to hold certain things back.  In this series on Media Futures,  I have used all sorts of
"A" words to articulate how media
operates on the Internet in 2005.  I am looking forward to synthesizing the Media
Futures series into a book, which will include much that is now only in note form or else is too sensitive to share at this juncture..

Finally, all comments here reflect my
personal opinions and not those of any firm or organization I am associated with.  Specifically, I am proud of what our team has accomplished at Majestic Research in terms
of reinventing investment research in a rigorous, unbiased and
real-time fashion.  Majestic’s insights are driven entirely by data,
carefully interpreted by smart quantitive analysts.  When I
comment on this blog about any public or private company, such comments are entirely distinct from the investment research that
Majestic provides to its clients. 

ATTENTION-BACKED SECURITIES

Want an iPod? Get one free at freeiPods.com

I hate sounding like a crass web promoter but FREE remains the best single response mechanism on the Internet.  We are happy to provide our full attention in exchange for free stuff: iPods, Razrs, Flatscreens, PSP, and more.  And it really works, as people actually do end up with iPods which are free in terms of money but expensive in terms of attention.

It is easy to dismiss the random college student who has nothing better to do with his time than click away on offers he isn’t really interested and sell out his five other college friends as potential online education and auto loan applicants.  It’s similarly easy to dismiss the stretched dad who eagerly clicks on low cost mortgage ads even though he has already borrowed 200% of his income on credit credit cards and usually pays 100% annualized interest on cash advance services to service his debt.  It is scary when you consider how much the Internet advertising economy depends on juicing up consumer credit; as JK suggests at his excellent blog, more than 20% of Google and Yahoo search ad revenue may be dependant on mortgages.  Our research at Majestic suggests that the top paying keywords on paid search have consistently been Home Equity Loan and Refinance purchased by Countrywide and ELoan for over $20 per click.

An enterprising consumer could fabricate her identity and that of her referrals in order to try qualifying for products without ever being contacted again.  But that’s not what happens.  The great majority of America does not subscribe to RSS feeds or use Firefox.  These Americans think a tag sale is a great way to spend a Saturday afternoon, not the next revolution in Internet advertising.

We are an American populus of lazy attention providers who opt in to
elaborate network marketing schemes that resell us multiple times over
and append increasing data about our demographics and purchase
intentions. We would rather not bother
with
multiple email identities with unique passwords; life is too short.

Spitzer may indeed go after freeipod.com once he is done with Intermix.  Consumers who have filled in a lot of data and have yet to see their free iPods arrive in the mail will cry foul.  In the same way that some retail investors cried foul to the Attorney General after losing their 401k money on Internet Capital Group or Infospace.  Mayor Bloomberg was right when he said that people make their own investment decisions and should be held responsible for any losses they incur. 

I wonder if he will say the same thing when consumers begin the witch hunt against any Internet advertising company that sells their attention to advertisers without their explicit permission each step of the way.  The individual’s decision to save time and money in exchange for their passive attention represents our collective failure to imagine a more active Internet lifestyle.  This should come as no surprise in the context of our dependencies on credit, oil, porn, sugar, and gambling.  These industries are not in danger of collapsing anytime soon.

It is ironic how personal technology and the Internet continues to be represented culturally as a source of control; we are everywhere reminded that our browser gives us the ability to establish order on a world of constantly changing information.  When we search for something, we are driving the process of personalized information retrieval

But on the other side of the mirror, we are being watched.  Our queries are being mapped legitimately by companies looking to contact us.  If you are not careful, an errant click will be answered with a telephone call from a sales representative.  And so as we succumb to these performance-based networks, our future purchases, our future media consumption, our lifetime economic value across hundreds of categories and thousands of companies, are all being calculated in real-time.  Not by a single agent, but by multiple agents each trying to evaluate our momentary state of purchase intent in the context of the many monetization levers these advertisers have at their disposal. 

As the Internet medium continues to evolve into a sales channel, the price of advertising is becoming mapped algorithmically to probable outcomes.  Very little is being left to chance, as even the most ephemeral of creative decisions (color of the car in the banner, the choice of text in the link) are immediately evaluated in terms of click-thru rate and ultimate conversion.  As Josh Kopelman, who used the prototypical arbitrage concept of “half” to create a $300m exit for his company half.com to EBay, puts it, “online advertising is just math."

THE COMING INTERNET ADVERTISING CRISIS

Most economic cycles have key protagonists that connect multiple actors and in turn attract legions of capital.  One could argue that one of our most recent cycles, in addition to Housing, Commodities and China has been Google.  Google is the central actor in an Internet Advertising action adventure flick that began in 2002 with the dawn of Overture and AdWords into billion-dollar businesses, and came of age in Overture’s acquisition by Yahoo! and Google’s celebrated IPO.

Now the question is, “what might be the equivalent of the 1998 bond market crisis for Internet media?"

Aug. 29, 1998, Saturday, AP

Russia’s Crisis Reveals the Ugly Side of Globalization

"If the current correction in stock prices turns into a full-scale bear market, meaning a retreat of more than 15 percent in the Dow, historians will almost certainly see Russia as the trigger. The reason, to use the buzzword of the mid-1990s, is globalization: the ugly version.

The good version was peddled right up until the current crisis erupted. It held that capitalism was spreading through the places where socialism once reigned. Tapping new markets and billions of new consumers, multinationals had already begun to earn big money abroad.

The ugly version is of more recent vintage. It goes like this: Currency crises can zip from one changing economy to the next, spreading deflation around the world and leaving recessions in their wake. No one, not the United States or the International Monetary Fund, has the power, or perhaps the will, to do much about it."

Here are two disaster scenarios:

1.  Spitzer continues to focus attention on requiring Internet companies to "issue an accounting of its installation of advertising, adserving, redirecting and toolbar programs."

He has started with Intermix, a relatively minor player in a network of adware companies.  Why is Spitzer tackling this?  Well, it’s a question of legal rights for many of us here in NY, despite the fact that Intermix is Delaware-based and operates in Los Angeles.  According to Spitzer’s office:

"Intermix has spread its advertising programs onto millions of consumers’ hard drives.  According to Intermix’s own figures provided to this office, this includes more than three million installations to New Yorkers."

That has got to be like 1/3 of the population of the entire state!  I am likely one of the victims, as I probably willingly downloaded a "free" Pokemon screensaver in the wake of a powerful affiliate marketing campaign from my 6 year-old son.  The lawsuit continues that,

"Intermix either fails to disclose these additional programs in any manner, or hides mention of them deep within lengthy, legalistic license agreements."

In fact, many of us victims did indeed agree to install something onto our computers; and frankly, speaking for the attention-deprived, overworked NY infoclass, I wouldn’t have bothered to read the disclosures even if they had been at the top of the "click here to download" window in short bold print.

As an injunction, Spitzer has asked [Intermix] "to issue an accounting of its installation of advertising, adserving, redirecting and toolbar programs."  Suffice it to say, these metrics will make for very interesting reading.  Now the real issue will be whether Spitzer stops with Intermix (highly unlikely) or in the spirit of his investigations of conflicted investment banking practices, he subpoenas all Internet companies who are engaged in installing "advertising, adserving, redirecting and toolbar programs." Intermix is such a small player compared to companies such as Google, Yahoo, IAC and others who have more than $5b in advertising revenue combined at stake in precisely these areas.  Gulp.

Kenneth Dreifach, chief of Spitzer’s Internet Bureau, said the office is “limited only by the bounds of creativity and diligence of our investigators which is limitless.”  And don’t expect Spitzer to focus only on companies that make and distribute spyware, Dreifach said…. Spyware legislation typically defines it narrowly as surreptitious downloads that monitor a users’ activity and could steal personal information.  Spitzer goes further–to include downloads of advertising onto hard drives that may or may not extract personal information.  Spitzer’s spyware investigation recalls his successful national crusades against conflicts of interest among Wall Street stock analysts, dealers of mutual funds and insurance companies: A consumer concern is followed by a single lawsuit in an enforcement no man’s land.

(If you haven’t please read David Jackson’s excellent series of posts in the past 2 weeks on implications of Spitzer’s suit on the stocks.)

This is not to suggest that anybody other than Intermix is going to be served, but this does raises the specter that Google and others will be forced to account for how many different programs they have installed on their users’ computers and what data they collect in exchange.

We also provide ways to access all this information without making a special trip to the Google homepage. The Google Toolbar enables you to conduct a Google search from anywhere on the web, while the Google Deskbar (beta) puts a Google search box in the Windows taskbar so you can search from any application you’re using, without opening a browser.

The virulent anti-Google site, Google-watch.org, says the same thing with a different accent:

Google’s toolbar is spyware:
With the advanced features enabled, Google’s free toolbar for Explorer phones home with every page you surf, and yes, it reads your cookie too. Their privacy policy confesses this, but that’s only because Alexa lost a class-action lawsuit when their toolbar did the same thing, and their privacy policy failed to explain this. Worse yet, Google’s toolbar updates to new versions quietly, and without asking. This means that if you have the toolbar installed, Google essentially has complete access to your hard disk every time you connect to Google (which is many times a day). Most software vendors, and even Microsoft, ask if you’d like an updated version. But not Google. Any software that updates automatically presents a massive security risk.

One grows old and poor prognosticating about the imminent collapse of one high flying stock or another.  And so I am not going to predict whether Google will run ashore in the next few months.  What I will go out on a limb with, however, is the forecast that should Google be required to provide an open accounting of their toolbar installations or any other key usage metric, that they will look arrog-awkward.  Remember the very mortal Bill Gates during his testimony during the Antitrust trial?  Do you think that Sergey will charm the judge and jury by bouncing into the courtroom on his gymnastic spring sneakers?

(Please refer to my August 2004 post entitled Google, Show Us Your Clicks!)

2. Justice department investigates Google for monopolistic behavior.

We are constantly reminded of how fickle technology can be and how quickly companies can emerge out of products that can emerge out of features and surprise an incumbent.  Still, Google has established a strangle-hold over key avenues of the information highway:  first and foremost they continue to grow search market share and remain, by far, the greatest source of volume for any advertiser looking to generate qualified clicks.

The power of Google as society’s search engine of choice has already inflicted significant harm on a number of companies, including EBay.  Since January, Google’s stock is up more than 20% while EBay’s is down almost 40%. 

I do not think that this 60% divergence between Google and EBay’s valuation in the past 6 months is independent.  Google has taught consumers that they can find mostly everything they want without using any other Internet service.  Often repeated by Google’s management and the first sentence of its corporate overview,

“Google’s mission is to organize the world’s information and make it universally accessible and useful.”

Why shouldn’t this information include auction listings on EBay?  Actually, EBay buys Google AdWords for the right to bring Google searchers to their sellers.  In a way, EBay pays to get f&%$?ed by Google.

Meg Whitman responded innocently to  Google-as-competitor in 2003:

Right now, we view Google as a very cooperative and helpful partner with us. We are one of Google’s largest advertisers, not only here in the United States but in most of the countries of the world in which they operate. What we do is we buy Google keywords on behalf of our community of sellers. So, in other words, if you are interested in buying the word "surfboard," we can help our buyers get placement on Google by effectively helping them on their behalf buying those keywords.

It would be enough if Google were simply the dominant source of consumer attention on the Internet for global advertisers.  That alone would establish the company as a critical exchange.  But Google set a broader agenda with its AdWords program, which is the only broker authorized to sell access to this liquidity.  Sort of like if Goldman Sachs were the only one authorized the sell stocks on the New York Stock Exchange.  Hmmm… bad example…

Although Google’s hallmark is stupid easy self-service for advertisers, don’t confuse this with a level playing field.  Google limits the information it shares with advertisers, who are entirely dependant upon Google’s own ad brokerage unit for flow (both that of their competitors and that of themselves).

In the past, both Larry and Sergey and the rest of the Google corps have celebrated the elite complexity of their Internet solutions.  As their audience has swelled, they have even managed to hide one bit of information that they need no fancy algorithm for, namely the number of worldwide Google users.  Go ahead, search for “total # google users” and see  what you get in return.
Even if you read through the Google timeline, there is curiously little if anything in the way of the number of users.

I believe that the combination of Google’s massive volume of search queries, combined with the manner in which it hides its metrics, gives it an unfair advantage over potential competitors.  And we haven’t even touched on AdSense, Google’s set of trading technologies for brokering attention on other people’s liquidity pools (in particular AOL).  Many analysts suggested that for 2005 Google will likely represent more than 40% of total Internet advertising revenue.  Do no evil.

And so, the question emerges as to when might the justice department decide to investigate Google for anti-competitive practices. Should this happen, the combination of Google’s misfit clunkiness at being open, combined with the uncertainty of legal proceedings would introduce enormous volatility into its stock.  It would be mild if Google were only to suffer a 50 point drop, followed by a perhaps even larger gain.  We could assume that such extremes would whip the Nasdaq into a frenzy and, for a moment, challenge our own unconscious addiction to the populist, conservative and above all white Google search interface.