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 practice of transmuting base metals into precious metals.

In considering Alchemy as it relates to the Internet, I have been spending my time trying to reconstruct my college readings of Walter Benjamin, the beautifully melancholy German essayist from the 30’s.  I took a class on the Frankfurt School, a group of intellectuals who distinguished themselves with their critique of the emerging modern consumer culture and the technology that enabled it.  Benjamin was the imaginative outlier of the bunch, writing about "Hash in Marseille," the psychology of the collector and the shopping arcades of Paris at the turn of the century.   I cannot recall an instance of Benjamin discussing computers, although his commentary on art in the age of mechanical reproduction as well as his citation of Kempelen’s chess-playing dwarf machine, the Turk, in important ways pre-figured our contemporary situation of extreme automation. 

The reason I have been rummaging through college essays and running down to St Mark’s Bookshop at 11p on Sunday night is because I have this quote stuck in my head like a persistent Hall & Oates tune.  I remember Benjamin stating that "Great categories are monuments in the history of civilization" and I thought that this perfectly summed up the alchemical act that relates to everything from my decision to describe a link with a certain tag on del.icio.us to the broader power of naming markets and establishing value.  For the life of me, I could not confirm the quote online, and so I located the original source, which was the dense prologue that Benjamin wrote to the only book he was able to publish when alive, the Origin of German Tragic Drama.  The introduction is less about any particular subject (ie Trauerspiel) than it is about the theory of knowledge in general, and the specific powers of naming.  When I found the text, it actually read as follows:

The great categories which determine not only the shape of the systems, but also philosophical terminology- logic, ethics, and aesthetics, to mention the most general- do not acquire their significance as the names of special disciplines, but as monuments in the discontinuous structure of the world of ideas.

Not quite as catchy as what I remembered, but it does get the same point across:  how we describe something is in itself an act of creation, beyond simply representing some external object.  Something happens during the act of naming.  It could be a company, an index, a domain, a category, or a database class.  This is the modern alchemist, consistent with the history of the solitary materials scientist who mixed various elements into something whose value was far more than the sum of the parts. 

*

A fine example of the Internet alchemist is Joshua Schachter, the inventor of del.icio.us.  The seed of his idea, like that of many of his peers, was simple enough: I have a problem, nobody else has solved it to my satisfaction, and so I might as well figure it out and share the solution with others.    As he commented to a blogger:

I started a website in 1998 or so; that kind of thing would later get named a "blog."  Anyway, in the running of this site, I collected a lot of links so I could hopefully organize and post them.  So I started keeping them in a file, which grew and grew. To be able to quickly find things, I started leaving one-word notes at the end.  Tags.  I later built a system, around 2002, that was a web-based database for storing my bookmarks.  It also had tags, but was not multiuser.  I’m not sure if it was 2002 or 2001, anyway. It first shows up in archive.org at 2002 though.  Then later, I rewrote it multiuser, as del.icio.us.  That was 2003 or so.  So the motivation was mostly because I was solving a problem I had, and then I solved it for everyone."

The burning question for me in understanding Josh’s unique contribution, and by extension the art of Web alchemists in general, is to what extent he figured "multiuser" behavior into his initial system?  I doubt he consciously imagined a service that would feature thousands of simultaneous users posting links.  Still, few developers have been able to create such a massive self-organizing with total focus and deep resources, much less when working on it part-time while employed as a developer of trading systems on Wall Street.

Ironically, Josh’s citizenship in finance is useful here as it relates to the experience of George Soros, who almost 20 years ago wrote about his concept of reflexivity in the Alchemy of Finance.  Soros claims that one’s understanding of a situation changes the situation, and that the secret to his investing success was understanding his (and other investors’) impact on what had otherwise been seen to be efficient markets.

This is consistent with what I see happening online, where meta-data (information about information) is creating significant economic value, from the many millions of Google and Overture keywords to the emerging class of Flickr, Del.icio.us and other tag-driven systems.  Our browsing, clicking, searching and tagging behavior are the base metals which alchemists like Josh are turning into precious datastors.  Rather than perform this magic in some sort of black box (ie like our friends in the Googleplex), Josh is transparent about his agenda:

Hmm. Mostly right now I have a big deck of cards with all the todos ("hipster pda") which I need to move to some sort of online thingy. I’d set up a tadalist with RSS feed, but it appears that the RSS feed is empty.

Mostly there’s three major categories of stuff to do; Server Architecture, Things Involving Schema Changes, and Other Stuff.

For those of us living on the West side of Manhattan, Josh is our (mostly) friendly neighborhood Internet architect.  He has the vision (and the perfectionism) of Louis Kahn and does not suffer fools lightly.  Little is important to Josh other than preserving the simple scalability of del.icio.us as a system of collective meaning.  In the spirit of my incantation of Benjamin, when I first met Josh late last year (through another emerging Internet alchemist and pal Mike Frumin) he described his project as "crystallized attention."  What is del.icio.us after all but the traces of what people do with their time?  These memory links, and the tags that go with them, are themselves a form of media.   For me, this is the essence of Internet alchemy, and relates the complementary functions of automata, algorithms and APIs.  It is also the reason why I took to Josh, encouraged him to take friendly venture money so that he could quit his job, and recently became involved in del.icio.us as an angel investor and advisor. 

*

If we look back over the past ten years, there are handful of similar alchemical moments in the history of the World Wide Web (and many other minor moments that may have generated significant financial profit but were otherwise inconsequential in terms of establishing long term structural value such as Broadcast.com).  The most memorable are probably Andreesen’s browser at University of Illinois, Yang and Filo’s "Yet Another Hierarchical Official Oracle" at akebono.standford.edu, Bezos’ online bookstore, Omidyar’s Pez-trading application, and Page and Brin’s simple search box.  (It is strange, no, that Andreesen and Bezos are direct investors in del.icio.us?). 

In his 2002 commencement address at Tufts, EBay founder Pierre Omidyar, described what he considered to be the secret of EBay’s success:

I can tell you, without the ability to prepare for the unexpected… …There wouldn’t be an eBay today. The key is recognizing that no matter how convinced you are in the power of your own ideas… …Sometimes, ideas have ideas of their own.

That’s certainly true in terms of system design. Almost every industry analyst and business reporter I talk to observes that eBay’s strength is that its system is self-sustaining — able to adapt to user needs, without any heavy intervention from a central authority of some sort.

So people often say to me - "when you built the system, you must have known that making it self-sustainable was the only way eBay could grow to serve 40 million users a day." Well… nope. I made the system self-sustaining for one reason: Back when I launched eBay on Labor Day 1995, eBay wasn’t my business - it was my hobby. I had to build a system that was self-sustaining… …Because I had a real job to go to every morning.

I was working as a software engineer from 10 to 7, and I wanted to have a life on the weekends. So I built a system that could keep working - catching complaints and capturing feedback — even when Pam and I were out mountain-biking, and the only one home was our cat.

If I had had a blank check from a big VC, and a big staff running around - things might have gone much worse. I would have probably put together a very complex, elaborate system - something that justified all the investment. But because I had to operate on a tight budget - tight in terms of money and tight in terms of time - necessity focused me on simplicity: So I built a system simple enough to sustain itself.

By building a simple system, with just a few guiding principles, eBay was open to organic growth - it could achieve a certain degree of self-organization. So I guess what I’m trying to tell you is: Whatever future you’re building… Don’t try to program everything. 5 Year Plans never worked for the Soviet Union - in fact, if anything, central planning contributed to its fall. Chances are, central planning won’t work any better for any of us.

Build a platform - prepare for the unexpected… …And you’ll know you’re successful when the platform you’ve built serves you in unexpected ways. That’s certainly true of the lessons I’ve learned in the process of building eBay. Because in the deepest sense, eBay wasn’t a hobby. And it wasn’t a business. It was - and is - a community: An organic, evolving, self-organizing web of individual relationships, formed around shared interests. 

Clearly, Omidyar created EBay within an architecture of public participation.  Listening to him, as well as to Josh, it would seem that there is simply no way to create long term sustainable value online without engaging consumers in the act of media production.  And yet one could argue that Yahoo! and Amazon do not necessarily do this.  Yahoo! is working hard to incorporate community production and meta data into their core platform (cf. Flickr acquisition, Yahoo360, etc) and Amazon leverages ratings, reviews, wish lists, associates and other community features to create a richer experience for users.  Still, these are not as fundamental to the browsing and shopping experience respectively. 

With regard to Google, it is hard to figure out exactly to what extent they leverage the community at large and and to what extent they are simply providing this community with cheaper storage, better tools and faster search.  Community in Google is not Orkut, their attempt to compete with Friendster which was aborted mid-stream when the threat evaporated.  Rather, the Google community folds in on itself as user search behavior drives keyword purchases by advertisers (AdWords), which suggests which content offers the highest effective value  in the form of context-sensitive ads (AdSense) which users can leverage profitably for their own blogs (Blogger).  One of the first examples of this was Michael Buffington’s Asbestos Blog.  I have not met Michael, although from reading his blog I have a lot of respect for his alchemical curiosity and ability to execute interesting tests.  He expresses melancholy with the knowledge that these strategies are, as in any advanced liquid market, moving into the hands of speculators who are far more focused on the gold than they are on the magic of base metal transformation. 

As Scott Eagle, the SVP of Marketing at reformed spyware company and current behavioral marketing firm Claria  told the New York Times last month: 

"We’ll take ad inventory that costs 50 or 75 cents, buy it in bulk, and turn it into gold by targeting $6 or $15 precision ads there," he said. "We’ll be the alchemists."

Without further commentary, this is the natural segue into a discussion of Arbitrage which will complete the Media Futures series.