What we need…

Below I will lay out what, in my opinion, would help our market and economy recover in a timely manner. Some of the parts are more critical than others.

We need…
1. The government to buy mortgages- The bill that failed in congress today actually had a decent plan for this. They were giving an unprecedented amount of money to the Secretary of the Treasury, Hank Paulson, with which he was to buy mortgages. The government would then be in a position renegotiate terms with the borrowers, keeping more people in their homes. By buying the mortgages, banks would be able to lend again because they’re already paid back for these loans that they thought were going to go bad, be it at some amount of cents on the dollar.

2. Congress to wake up! The size of this problem should have put politicing at the very, very, very back of anyone’s mind… but it didn’t. The bill, even though it was far from perfect, would have done a lot to help banks be able to lend again, housing prices to slow their fall, and our economy to begin a recovery. Think of anything you need a loan to buy: car, home, tuition, you name it. And do it again for businesses. Right now BANKS CANNOT LEND MONEY, they do not have it, they are just trying to stay afloat and meet their reserve requirements. How much is your house worth if you try to sell it and someone who wants to buy it cannot take out a loan? It’s worth whatever someone can pay in cash. No help will result in real estate values being cut in half, to start with. How many people are going to show up and offer a couple hundred grand in cash for your house? Welcome to a deflationary environment. Seriously, this is the environment we are in RIGHT NOW, and will continue to be in for 4-7 years without some help from the government. Not to mention, with out any help, many of our banks will go under in the next 6-12 months. I hate government intervention as much as anyone. The government being involved with Fannie and Freddie worked out great. But right now, they’re the only friendly balance sheet big enough to help.

3. People to listen to Paulson. Hank is the smartest financial mind in the federal government. He made himself hundreds of millions of dollars, a lot of it off the buildup of this problem. Now let’s let him help us fix it.

4. Minimize moral hazard. This is part of what congress has been complaining about, CEOs getting big severance packages. They think the whole bill was a bailout of financial firms that took on way too much risk. It is, but the people who took on the risk have already been punished, any net worth they accumulated through options is gone. The government can reposses executive shares as part of the deal, I don’t care how we do it, but making sure no current executives walk away with posh deals is important. However, this is not a reason to not pass the bill. The bill is not for the Wall St firms, it’s for every American who owns, or wants to own an asset of significant value. This is closer to an investment than a bailout, and the more our government is willing to invest, the quicker the housing market will turn around, the quicker the economy will turn around and the more money the government will make off their investment.

5. Europe to watch us. They’re next, about 12 months behind. A British lender and a Dutch bank both had to have government rescues over the weekend…

6. People with a backbone in regulatory positions. Fire Christopher Cox. “Naked shorting” is, and has always been illegal. To short you first have to borrow the stock you want to sell. In the past it’s been ok to sell short if you say you’re “in the process” of borrowing the shares. Check the filings, the vast majority of short positions, including ones that have been on for weeks, are still in the process of borrowing the shares. They’re naked shorting (shorting without borrowing the shares) because they know the SEC under Cox’s astute leadership won’t do jack! Pull Elliot Spitzer out of jail and make his sentence house arrest at the SEC for a few years, he’ll slap hundreds of millions of dollars of fines on firms playing games like the one above before they turn around. McCain says he’ll appoint Cuomo, current NY Attorney general, but why not go for the ultimate white collar crime fighter in Spitzer and save the penitentiary system a few bucks, just a thought.

7. People to forget it’s an election year. The most frustrating thing about the bill not passing is because a big reason it didn’t pass was politicing between congressmen. It’s an election year and these guys are going home soon to campaign. Sometimes it’s the role of an elected official to do what’s right even if their constituents don’t immediately agree. In an election year, politicians aren’t willing to do this because they want to be reelected.

What? We can be funny?

Scott Green is the man. Read this article from the DI. Now. That is of course, if you haven't already read it between sudokus while you weren't paying attention in class.

Afterward, check this out. The irony to Scott's story is how much money Nintendo's employees (not even including the Brothers) actually do make for their company. It's even more per capita than Goldman, apparently.

Where are we now?

So what's going on right now? Paulson will be doing his best to fight back the swarms of angry Congressmen, and broker deals with banks left and right... for the moment, the dust is starting to settle, and now we're seeing politicians squabble over power.

Maybe people have a right to be mad. Apparantly, these fallen titans doled out $39 billion in bonuses to their employees in 2007. Talk about a job well done!

If there is any type of article you should be reading, it is this one. Without a doubt, this entire problem occured because people didn't understand risk and statistics, and because of that:

"The banking system (betting AGAINST rare events) just lost > 1 Trillion dollars (so far) on a single error, more than was ever earned in the history of banking. Yet bankers kept their previous bonuses and it looks like citizens have to foot the bills."

You read that correctly. While banks certainly handled more than $1trillion over their collective history, the money they made by handling that money has just been eclipsed by the staggering loss they are now responsible for.

Or are they responsible for it? Could this have been the government's fault? This article insinuates that mark-to-market, or the act of valuing a difficult-to-value asset by matching it to the price it would fetch on the market. An accounting rule called FAS157 was responsible for implementing it, and beyond financial instruments, it is actually a very useful, fair value approach to accounting. I disagree largely with this arguement, because the implementation of FAS157 is a step forward to more accurate accounting.

Whether or not you think this was all the government's fault, it's clear that the government still has a golden opportunity to make a mess of things at this point. I agree with Mean Street, who thinks congress should back off and let Paulson do his thing. However, this is largely becuase I think a speedy solution at this point is more important than a more thought-out one. Waiting too long might do even worse damage around the world to an already broken system. This article does a good job at describing the motivations of the actors in this Greek tragedy. I think their arguement is persuasive as to why Hank needs as much bargaining power as he can get, and why the liberal solution to this problem is nonsensical.

But what can go wrong? Freakenomics, backed with a letter to congress from, literally, hundreds of prestigious economists has this to say: it looks really unfair, we have no idea how this bailout (the government buying up a staggering amount of toxic debt) will be structured (implying that it probably will be structured really poorly), and the effects of this bailout will be felt for ages, as the government's balance sheet tries to accomodate the incredible loss it will most likely incur.

So it is a race against time, and everyone knows it.

Will this solution probably be unfair? Yes. Are we basically forcing the innocent tax-payer to bail out these greedy bankers, who are largely responsible for this whole mess to begin with? Yes. But if we wait too long, then we may be dealing with far too many defaults for society, let alone the capital markets, to sustain.

Greed

We are in a very complex and dire situation. By we, I mean Americans, and I also mean just about ever other developed country. We are growing closer to having a truly global economy, which is great when everything is going well, but it also raises the pain level when we hit rough seas.

How did we get into this mess? That’s a long story. In two words: we’re greedy. I’m not trying to be condescending, I’m a greedy person too. And not everyone is greedy, there are a lot of people living in developed economies that don’t care about material possessions and money, but by and large, we’re greedy people.

Mortgages
In the late ‘80’s “genius” investment bankers started packaging mortgages and reselling them. These investments, called mortgage-backed securities, were fixed income investments very similar to bonds. They were very profitable for the investment banks, but their real benefit was enabling banks to make more loans. For example, after the bank lent someone a mortgage, they would give them the cash and keep a piece of paper that was a promise to pay. In the old days, the bank would have to wait for the mortgage to be paid back before making another loan. Now, as soon as the borrower walked out, the bank would call the investment bank sell them the mortgage for 90 some cents on the dollar. The bank got their money back right away so it could make another mortgage loan and repeat the whole process over again.

The process described above had several effects. It increased leverage (the level of debt) in our society, banks we’re able to lend more, increasing the level of debt in our economy. It also made lending mortgages much more profitable. The increased profitability of mortgage lending led to many more mortgage brokers popping up, and growing much larger. The mortgage brokers were not banks, who relied on customer relationships, they just lent the mortgage, sold it to the investment bank (who sold it to investors) and moved to the next person in line waiting for a mortgage. These brokers (Countrywide e.g.), in many cases, skirted the due diligence they should have done on the person asking the mortgage, such as asking if they had a job, how much money they make, do they have other homes, etc. This is what led to the boom in subprime mortgages, mortgages lent to people in a not-solid financial position.

Why didn’t these brokers care that much about a lenders’ financial position? Well this is in the 2004 - 2006 time frame when it seemed that real estate value went up every single year. Therefore, if someone did not pay, they could foreclose and resell the house for more than the value of the mortgage. In order to entice more people to take out a mortgage, they offered mortgages that started with a very low interest rate for the first 2-5 years, the interest rate would then reset much, much higher, but that was in small print, after all, it was a few years off. Now not only could someone that wasn’t fit to have a mortgage get one, they could afford a really nice house too!

Now, it is unfair to blame the whole mess on the brokers. Many banks did their fair share of this practice too. Overall, however, banks (especially smaller and local ones) did a much better job of sticking to lending standards than mortgage brokers did. All you have to do right now to get a good approximation of how well someone stuck to lending standards and making good loans is to look at a stock chart. Compare U.S. Bank (USB) to Thornburg Mortgage (TMA) since January 2007.

Who helped make sure the whole securitization process ran smoothly? Well that is the job of Fannie Mae and Freddie Mac. Fannie and Freddie were government-sponsored entities that were created to help more people be able to buy a home. Then even Fannie and Freddie got greedy and started keeping some of these mortgages on their balance sheet to boost returns. It’s funny how the ones that didn’t fly off the shelves turned out to be some of the worst loans.

As you can see, our housing market saw quite the bubble form over the prior few years. As more and more people could get loans, they could pay more for housing, making the value of real estate inflate. These increased real estate values were really driven almost entirely by leverage. Leverage was not only at work with people and their homes, it was also at work with corporations.

Investment Banks
In addition to starting the mortgage securitization process and seeing a boon in that business, investment banks were also seeing pressure on their main business model. Investment banks are strategic advisors to companies. They get paid fees for things like: helping a company buy another company, issue stock, buy back their stock, etc. Many of the big banks also have a balance sheet (money to lend to companies). These banks would also make loans to companies to help them achieve their goals. The banks historically made a little by lending, but it was nothing compared to a M&A (buying another company) or IPO (issuing new stock to take a company public) fee.

The investment banking model is entirely dependent on relationships. All the investment banks have basically the same capabilities, with some variation, but that makes the bank getting hired almost entirely dependent on whether the company’s management likes it. Companies and banks acknowledge the give and take relationship. Companies need to borrow money, but banks don’t make a lot on lending money. However, the banks willing to lend money to the company when they need it coincidentally have the best chance to get the big fee engagements when the time is right for the company.

Over the last few years, up through July 2007, debt was readily available. Interest rates were relatively low, banks had lots of cash and companies knew it. If a company needed a loan, it would go to their main bank and say how much they wanted. If the bank said “no”, the company would go down the street to the next bank, the next bank would lend to them no questions asked and in the process put themselves front and center as the main bank ready to reap the big fees when they came along. Therefore, the main bank couldn’t say no. It would lose it’s customer before the “o” in no came out. Banks, like Citi, like JP Morgan, made lots of loans to companies knowing that they were going to lose money on the loan, but that was ok because they would make back way more then they were losing with the next big fee engagement.

Again, this business model, like lending mortgages to anybody works great as long as the economy is going strong. But, when the economy slows down, those big fee engagements don’t come along. This way of conducting business and the mortgage mess drove leverage to unprecedented levels in the history of mankind. Leverage, the level of debt, increases the risk of a firm going bankrupt. Purely looking at leverage, the risk of a going concern going bankrupt had never been higher than it was in summer 2007.

Credit default swaps
Credit default swaps (CDS) are a specialty financial product the essentially provides insurance on an asset defaulting. For example, if you bought a corporate bond you could buy credit default swaps and lock-in a return, albeit a smaller one. Credit default swaps have been used on all types of fixed-income assets, including many mortgage backed securities.

As our economy has levered up for the past several years, more and more companies, including insurance companies like AIG began issuing credit default swaps. It was, after all, a very profitable business. So we have increasing leverage, meaning and increasing risk of bankruptcy, or default, and some of the biggest financial firms are taking positions worth hundreds and hundreds of billions insuring against default.

Credit default swaps have become a favorite gauge of how likely it is that a certain bank will go under in these trying times. As the spread (the premium) on a given bank’s credit default swaps rises, so does the market’s perceived risk that the firm will go under.

Out of bounds
One of the major issues leading to this crisis is firms stepping out of their normal area of business in order to boost profits. AIG, unlike most insurance companies, began doing credit default swaps. Many bond insurers, like MBIA (ticker: MBI) who used to insure municipal bonds, started insuring mortgage-backed securities. The list goes on and on. Why did these firms enter new markets? Simple, there was a lot of money to be made. There is nothing wrong with that, this is capitalism after all. But in true capitalism it’s a live or die world, and if the firms that stepped over their bounds went bankrupt or almost went bankrupt, the next time new opportunities presented themselves, there would be a hell of a lot more due diligence done before those markets were entered.

But we now live in a world where firms can grow to be “too big to fail”. I agree, AIG was too big to fail. There were too many counterparties all over the world who had contracts with AIG, our financial world would be in chaos had the firm gone out of business. How have we not had a problem with this in the past? Is anti-trust growing more and more lax? Probably a little, but that is not the problem, AIG had lots of competition. How do companies like Citi and AIG operate in so many geographies, markets and products yet remain organized, focused and profitable and why wasn’t anyone ever able to do it before? Some would say they don’t, but if you give them the benefit of the doubt, the only answer is technology. We’ve never had a problem this big before because we’ve never had the technology to allow firms to grow as big as they are now. Our own advances in technology gave corporations enough rope to hang themselves, and many of them succeeded. Firms had the capacity to expand product offerings across more markets fast and more efficiently than ever before and handsomely increase profits. Stocks, bonds, all forms of money are not transferred in hard form anymore, they are ones and zeros going from computer to computer.

Firms took full advantage of technology and market conditions (low interest rates and a strong housing market) fill their greedy desires and maximize profits. There is nothing wrong with using technology to get bigger, taking advantage of market conditions or being greedy. This is capitalism.

The hammer
The sledgehammer that broke the proverbial camel’s back was the housing market. When the housing market turned downward in summer 2007, the value of mortgage backed securities went down because the value of mortgages went down. Some people’s mortgages were now worth more than the underlying home. Why pay it off? The economy was starting to weaken. At the same time, lots of those adjustable rate mortgages discussed above were re-setting to higher interest rates, making the interest payment unaffordable to many homeowners, driving more of them closer to defaulting.

As more of the mortgage backed securities weakened, first the mortgage brokers were hit hard, then the insurers. Now, with the credit default swaps through the roof, all the issuers of the credit default swaps are being forced to post cash collateral, driving them to insolvency (they don’t have any more cash)

What needs to happen?
We went through a multi-decade levering process that needs to be at least partially unwound. What does that mean? Profits will go down because businesses can’t finance expansion as regularly. This will drive stock prices down. Academically, as leverage increases, returns on equity increase and with it the firms’ stock price. That unwinding will take equities lower as well.

Am I saying the Dow goes to 8,000? No. But will the recovery be as quick as the drop? Not in my opinion. However, there are, and will continue to be tons for great buying in the stock market.

What will start the turn back towards a more normal state will be when the housing market begins to turn. That will ease some of the stress in the system. However, by that time we may be in a recession. Stay tuned.

...and then there were two

Of the five big stand-alone investment banks, only Goldman Sachs and Morgan Stanley remain. Even these folks have been hit, though. Goldman has shown a 70% drop in third quarter net income. Morgan is looking at Wachovia for a merger, who, interestingly enough, has hired Goldman to look for potential merger partners. How has Goldman done so well? A commentator noted how Goldman mentioned last year that they were net short, effectively shorting indexes of all of the bonds which they were selling. I had mentioned this concept only a few weeks ago, but cited it only as a general business strategy. The commentator in fact saw it as a "predatory" action, due to the fact that Goldman is selling to customers (the bond purchasers) products which they personally don't have faith in.

If we are going to see Morgan and Wachovia merging, and perhaps Goldman at some point down the road, this brief article does a good job at describing the nature of combining investment and commercial banks, as it pertains to risk and loans.

“There’s a prevailing sense that the business model of the free-standing, highly leveraged investment bank that funds itself in the wholesale financial markets is virtually kaput,” Willem H. Buiter, a professor at the London School of Economics, told the New York Times this week.

“The pure investment bank was an American specialty,” he added. “But we’ve now seen three major American investment banks go down, so this model looks like a weakness, not a strength in a down market.”

What is the advantage of a merger with a commercial bank? To cite this article, the large pools of capital that come from retail banking deposits - your and my money. Because there is so much stable money in retail banking, made safe by the FDIC's insurance, retail banks receive greater credit ratings, which makes it easier for them to raise capital. 

Goldman doesn't necessarily need these deposits:

That’s because a large amount of what Goldman Sachs invests in is considered riskier than the bread-and-butter loans that commercial banks make with deposits. If Goldman were to become part of a commercial bank, those deposits couldn’t be used to support the vast majority of its investments.

Meredith Whitney, an analyst from Oppenheimer, was quick to respond on the conference call, telling Mr. Viniar, “Obviously, you can’t fund capital market activities with deposits, but your overall credit rating as seen by the rating agencies would improve because of diversification. So there would be a benefit.”

Whether or not Goldman's shareholders will agree to this when a good purchase offer comes around is a different story.

And finally, this comment comes from Judey, and one which I'm sure we'll be hearing a lot more of, as the fallout of this market tends to lead towards more conservatism.

The Glass Stiegal was put in place during the Depression for a reason. Having banks which have access to low cost federally insured deposit funds is just another way to have a government subsidy for investment banking.Its repeal was dangerous. Merging with banks is another even more insidious way to to subsidize risk taking.We need to learn from history. We must stop and investigate and regulate market manipulation. We must put the brakes on short sellers. The bear raids must be stopped. The uptick rule must be restored in addition to stopping naked shorts. And the uptick should be at least .05.

Most people expect this crisis to take ages to finally erode away, but I have more faith than Judey in the after-shock. People will be looking for a solution, and I'm sure that is going to come from strict regulation changes. Most likely, as the US continues to switch to IFRS accounting standards (a topic that has obviously taken a back seat to the credit crunch and sub-prime write downs), I believe will see a more international standard of regulation as well.

Musings

This is one of the most historic weeks in US financial history. That was a period. And I'm not excluding black monday, the great depression, the S&L crisis, or any of the other monumental events that shaped our financial history. If you're not reading every possible thing you can get your hands on, if you're not reading the Journal and soaking it up, you're an idiot. That was a period.

I'm not going to reiterate everything that's happened over the last few days, if you don't know go read the news paper.

-The housing starts number sucked today. Guess what? That's great news. Housing starts will be the last part of the housing market to recover. Right now the biggest problem in housing is the inventory (the amount of houses on the market). If more homes are being built, that number goes up by more. Starts going down let's us rip through the inventory and go through the price discovery process. Let's not forget what started this shit show, housing. What's going to lead us out? Housing.

-The journal had a phenomenal article on the AIG mess front and center on pg 1. Go steal a journal from the front of an apartment building or go to this thing they call the library. Read the article, study the chart at the top of the second page of the article, it's a great simplification of how AIG got in trouble. AIG got killed by the credit default swaps they helped create, which are basically insurance on banks' debt, or in other words: insurance against a firm going bankrupt. Think about how the value of that has changed over the last few months.

-Barclays got the deal of the century yesterday. They bought the good parts of Lehman for $1.75bn. Included in this is Lehman's main office building which the Journal reported valued at $600-900 million. Essentially, Barclays bought one of America's best financial services institutions and investment bank for $1.15BN max. And they didn't have to tke any of the toxic paper with them because LEH was already in bankruptcy. For comparison purposes, Bank of America paid in the neighborhood of $50BN for Merrill Lynch. In my opinion Barclay's got a much better deal than even JP Morgan did when they were wed with Bear Stearns.

Those are some of my quick musings. I will write another post about the underlying theme of this whole mess, greed, shortly.

What in the world...

I hope you're all turning your attention to the news.

Lehman's finished. Merrill has been bought by BofA. AIG is looking for more capital.

It's recruiting season over here at school, but don't expect to find many finance jobs, considering how many thousands of former Lehman workers are now going to be pushing out new hires for cheap banking jobs.

This was a historic weekend, following a previous historic weekend. I'll be sure to slap something together soon.

Google blows up UAL

Let's avoid the giant elephants in the room for a moment (Fannie Freddie Lehman Merrill), so I can point out another technical folly that has come out of the woodworks.

On Monday, UAL's stock price was essentially wiped out this week by an error in the systems that track news stories on the internet.

Here's a breakdown I'm citing form the LA Times:

Back in 2002, United was verging on bankruptcy, and South-Florida Sun Sentinel newspaper, a subsidiary of Tribune group, published an article about it. The Google News search algorithms came across the article early Sunday, and by opening it, probably pushed it to the "most viewed" section of the webpage. From there, other news aggregators that just search over "most viewed" lists picked up the article and, due to a mis-dating on the original article, presented it as current news to Income Securities Adivsors, inc. Bloomberg news picked up the "story" from there, and automatic trading algorithms that are programmed to respond immediately to certain news events, like bankruptcies, dumped shares, cutting away 75% of UAL's market cap before trading was manually frozen.

Things are back to normal now, but this brings to light some pretty interesting considerations, as the effects that automated information system processes have on our lives increase.

These systems work fine, as long as they are designed perfectly, but when you incorporate human error, like mis-dating an old news article from a tiny newspaper, the shock waves that can be made are staggering. This is especially true in capital markets, due to the affect information has on liquidity. In spite of all of it's value in maintaining fair value, liquidity also has the adverse effect of draining a security of value, whether the information causing the change is accurate or not. 

How will we solve these issues? Insurance first comes to my mind as a "solution," but it exists more to treat the symptoms, not the cause. I imagine that more and more adaptable circuit breakers will need to be put in place. We will need to find innovative new solutions that fight to maintain a fair market value that still has a solid, auditable foundation of value. Perhaps we can use historic data to statistically model past market responses to news items like bankruptcies, and design a circuit breaker that prevents a stock's price from swinging too far past that average?

Maybe such intervention sounds too manipulative, even for these times. Speaking of market manipulation, I'll try to throw something together about the big news stories soon.

The Economics of Crowded Markets

I read a great article on O'Riley Radar about how the big players (read: Google and the New York Times online) on the Internet are behaving like the big banks, who, when facing a turn in the tide against ridiculous growth, used subversive tactics to try to maintain that growth.

What atrocity could golden Google possibly commit? Well, as a high-flying public company with several years of growth, Google started to slow down late last year. That slow down was occurring as the "product life cycle" signaled that web search may have been beginning to mature. Tim O'Reiley, in his infinite wisdom, was able to notice their actions as early as then, and cited another clever clogs called Bill Janeway, who drew parallels to Google with the banks' actions a few years ago.

As Bill explains:

"The price of a trade a generation ago was regulated by the exchanges: it cost approximately 22 cents per share to trade an institutional-size block of stocks on the New York Stock Exchange. The ability to fix commissions reflected the historical fact that the brokers had long been large, relative to their customers. Unable to compete on price, some firms competed on the quality of their investment research, and brokers’ relations to clients were based on the information and insights they could provide (others competed in less respectable ways).

As pension funds, mutual funds, and other institutional investors grew to dominate trading, they successfully broke the NYSE cartel. Once the exchanges no longer regulated the price of a trade, prices fell over time to current levels of a fraction of a cent per share: for large trades, effectively zero. As a result, some sell-side firms tried to charge directly for research and found that their buy-side clients were unwilling to pay. Instead, they were investing money saved from commissions to build their own research staffs. Two other things happened. Seeking an alternative subsidy for sell-side research, most firms repositioned their research staffs as marketing arms of their corporate finance firms, a strategy that blew up spectacularly with the Bubble in 2000–2002. More important, firms began to trade against their clients for their own account, such that now, the direct investment activities of a firm like Goldman Sachs dwarfs its activities on behalf of outside customers."

One thing innovation does is drive out older inefficiencies, and charging someone $.22 to transfer information from one party to the other is the definition of waste. And when a company's means of subsistence proves to be inefficient, and starts to get squeezed, it is only natural for that company to fight back. There are two solutions: fight to maintain the status-quo, or wriggle free through innovation and invention. The latter is of course the harder of the two, and is the reason why entrepreneurs are so successful at being "destructive creators."

Google is responding to their pinch releasing more and more products that maintain focus - and web traffic - on their products:

Google's announcement of Knol shows that they understand some of their key business drivers very well; With as much as 5% of the search result links for popular terms going to Wikipedia pages, a solution to capturing some of that traffic in an environment that Google can control and display ads on makes good business sense...

Now the last thing I want to do is imply that Google doesn't innovate - I think Google is our generation's proudest example for innovation. In fact, I believe that this issue has largely been resolved, thanks to Google's new browser, Chrome. The potential Chrome will realize in freeing up system resources for more advanced web applications is a discussion for a different time.

We can't say the same f0r the New York Times online, which people are complaining about sacrificing their journalistic quality by keeping all of the links in their articles internal. This practice redirects readers to other related articles, which increases web traffic, however at the cost of relevance to the story.

However, I'm more optimistic than O'Reiley. Switching costs are as low on the Internet as they possibly could be - the only thing keeping people looking at the New York Times is the New York Times' brand power. If this practice continues to dilute that brand, then we should see consumers shift to a different service. The same goes for O'Reiley's complaints about other web services that attempt to lock people into their brand - the very nature of search should allow them to seek quality elsewhere.

The web is the most meritocratic economy man has ever developed. This only means good news for us.