Oct 15, 2020

Axios Capital

Felix Salmon

Situational awareness: Korean record label Big Hit is worth $7.6 billion, after its IPO. 90% of its revenue comes from one band, BTS.

English auctions play on greed; Dutch auctions play on fear. But most auctions today play on algorithms.

  • In this week's newsletter, I look at the auction design that won this year's economics Nobel. Also: Commercial real estate, bank profits, true unemployment, Biden's stimulus plan, Leon Black's entanglements with Jeffrey Epstein, and much more. All in 1,690 words, a 6-minute read.
1 big thing: Auctions make the world better

Illustration: Sarah Grillo/Axios

Economics is disparaged as "the dismal science" for good reason. And governments are rarely upheld as paragons of efficiency. But Paul Milgrom
and Robert Wilson, the winners of this year's Nobel Prize in economics, have helped governments around the world create hundreds of billions of dollars of value with an astonishing level of sophistication and efficiency.

Why it matters: The auctions designed by the winners of this year's prize were initially used to allocate electromagnetic spectrum for cellphone communication. Since then, they've been used to price everything from airport landing slots to carbon-emission credits, in a manner that is fair, efficient, and effective.

The big picture: While auctions have been around for millennia, the two standard mechanisms — English auctions, where the price rises until there's only one bidder left, and Dutch auctions, where the price falls until a bidder emerges — can sometimes be unfair or inadequate.

  • For example: If two identical items are auctioned successively, they can often sell for very different prices. Or if a certain bidder values a certain combination of items while not particularly wanting any one on its own, it's hard to put together a good bidding strategy.

Between the lines: While nearly all auctions attempt to create as much value as possible by assigning an object to the buyer who can make the best use of it, government auctions also have to ensure they don't create monopolies or other market distortions.

  • The laureates' inventions, including the Simultaneous Multiple Round Auction, helped solve all of these problems — and also raised hundreds of billions of dollars that would otherwise have to have been levied in taxes.

Be smart: You trigger state-of-the-art auctions almost every time you visit a website. Most online advertising these days is sold via real-time bidding, which means that the ad is sold after you navigate to the page in question. Advertisers bid on reaching your particular eyeballs, reading your particular device.

  • Milgrom is involved in those auctions, too, theorizing how best to structure them and proposing a “modified second bid” design as the best way to maximize efficiency.

The bottom line: For most of the Cold War, governments would use game theory mainly for national defense. Auction design and strategy, which is a subset of game theory, is not only more socially useful than mutual assured destruction, it's also more socially useful than nearly everything else in economics.

Bonus: Why you should raise more in poker

Photo: Artur Lebedev/TASS via Getty Images

Poker is a kind of auction, where bidders are bidding on the amount of money in the pot — the blinds and antes to start, plus anything else that has been bid.

  • How it works: The worst kind of auction is the "dollar auction" or "penny auction" — one where you have to pay the amount of your bid whether you win the auction or not. Poker is a bit like that — once you bid on the money in the pot, you have lost that money unless you win the whole pot.

Be smart: The easiest way to win the auction is to enter the winning bid — to bid more than anybody else, and win the pot without having to show your cards. But you can only do that if you raise.

The bottom line: Professional poker players tend to be more aggressive than amateurs. That's because they want to win every auction they participate in.

2. How to unfreeze commercial real estate

Illustration: Sarah Grillo/Axios

One undisputed victim of the pandemic is the commercial real-estate market.

  • Offices and retail have both been hit hard by people working from home and going out less. That reduces the value of commercial real estate, which in turn means that the price should go down, too.

Why it matters: The problem is that commercial real estate prices are sticky: They go up a lot more easily than they come down. If they would come down to a market-clearing level, that would vastly increase economic activity and help cities — New York foremost among them — get back on their feet.

How it works: Columbia University law professor Tim Wu explains in the New York Times just why prices are sticky.

  • Landlords have multiple incentives to keep real estate empty, rather than renting it out at a decreased rent. They range from the tax regime to clauses in mortgage contracts to accounting practices to simple hope that an empty space, kept empty long enough, will eventually find a top-dollar tenant.
  • Those incentives collectively impose a huge negative externality on cities. Empty storefronts help no one.

The solution: Wu suggests that cities should raise property taxes when commercial real estate is empty for more than 90 days, giving landlords a countervailing incentive to rent their property out at lower-than-desired prices.

The bottom line: There's no shortage of potential tenants willing to fill empty spaces — at the right price. Maybe what we need here is an auction mechanism to ensure cities get moving again.

3. There's no financial crisis
Data: Axios research; Chart: Axios Visuals

Banking seems to be doing just fine during the coronavirus pandemic.

Why it matters: America's five biggest banks set aside $24 billion to cover bad loans, but they haven't yet had to dip into any of that money.

By the numbers: JPMorgan, Goldman Sachs, Bank of America and Morgan Stanley all made more money in the third quarter than they did a year previously.

  • Red-hot markets have helped the investment banking and trading divisions, while loan defaults have — so far — failed to materialize in any great volume.

What they're saying: "The consumer is in reasonably good shape for whatever we may face next," JPMorgan CFO Jennifer Piepszak said on the bank's earnings call this week.

Go deeper: What bank's booming profits say about the economy

4. Unemployment is worse than you think
Expand chart
Data: Ludwig Institute for Shared Economic Prosperity; Chart: Axios Visuals

A person who is looking for a full-time job that pays a living wage — but who can't find one — is unemployed. If you accept that definition, the true unemployment rate in the U.S. is a stunning 26.1%, according to an important new dataset.

Why it matters: The official unemployment rate is artificially depressed by excluding people who might be earning only a few dollars a week.

The backstory: The official definition of unemployment can be traced back to the 1870s, when a Massachusetts statistician named Carroll Wright diagnosed what he referred to as "industrial hypochondria."

  • By restricting the "unemployed" label to men who "really want employment," Wright managed to minimize the unemployment figure.
  • Wright went on to found the Bureau of Labor Statistics, and he brought his unemployment definition with him.
  • To this day, to be officially counted as unemployed you need to be earning no money at all, and you need to be actively looking for work.

By the numbers: Even back in January, when the official rate of unemployment was 3.6%, the true rate was seven times greater — 23.4%. That's according to new calculations from the Ludwig Institute for Shared Economic Prosperity, founded by Gene Ludwig, a former U.S. Comptroller of the Currency.

  • "I was shocked," he tells Axios on HBO, "that a quarter of the population that want work can't earn a living wage."

The bottom line: The unemployment catastrophe in America is not new. It's been at crisis levels for decades, but it has been hidden behind the official numbers.

Bonus: The dismal employment figures
Expand chart
Data: Ludwig Institute for Shared Economic Prosperity; Chart: Axios Visuals

Only 46.1% of white Americans over the age of 16 — and a mere 40.8% of Black Americans — now have a full-time job paying more than $20,000 per year.

That's much lower than the official labor force participation rate.

5. Where Biden's stimulus money will go

Photo illustration: Sarah Grillo/Axios. Photo: Drew Angerer/Getty Images

The Biden administration's top priority, after virus control, will be "building a fiscal bridge to the other side of the crisis." That's what Jared Bernstein, a senior Biden economic adviser, told an IIF conference this week.

Why it matters: Biden has a very large and complex Building Back Better agenda, which includes some 800 different policy proposals and will cost some $3 trillion. But before even getting started on that, the Biden team plans to spend a lot of money — probably north of $1 trillion — on a short-term stimulus package.

Between the lines: In the fight over a potential stimulus package, the Trump administration is refusing to funnel money to state and local government. By contrast, says Bernstein, that will be top of the list for a Biden economic stimulus, because it comes with a high "fiscal multiplier."

  • The Biden team is looking at "getting the biggest bang for the buck," says Bernstein. Giving money to state and local governments has a multiplier of about 1.5, according to the San Francisco Fed. In other words, every $1 given to those governments increases GDP by about $1.50.

Other priorities with high multipliers include nutritional support and expanded unemployment benefits.

The bottom line, per Bernstein: The "fiscal bridge" is going to be needed even if a new stimulus package is passed between now and January. So long as the economy is well below potential — which it will be — Biden will want up-front spending in January.

6. Why did Leon Black pay this man $50 million?

Illustration: Sarah Grillo/Axios

Leon Black, the founder and CEO of Apollo Global Management, has 75 million more Epstein-related questions to answer now than he did when he first started stonewalling Axios' Dan Primack in July 2019.

Driving the news: The New York Times has uncovered $50 million in payments from Black to Epstein, all of which were made after Epstein was convicted of sex crimes. Two sources placed the total amount at $75 million.

What they're saying: In the wake of the NYT report, Black released a letter saying that the payments were for "professional services" including "estate planning, tax and philanthropic advice."

  • Be smart: Epstein once cultivated a reputation as a successful investor, even though no one ever saw him in the markets. His reputation as a tax planner is similar.
  • Matthew Goldstein of the Times told Dan on the Axios Re:Cap podcast that there's no evidence Epstein had any particular skills on the tax front.

The bottom line: As I've previously reported, Black played a key role in enabling Epstein to maintain his access to MIT and Harvard. It now seems that Black was also instrumental in funding Epstein's private-jet, private-island post-conviction lifestyle. His limited partners should be asking pointed questions why.

7. Coming up: China's continued growth

Illustration: Rebecca Zisser/Axios

China's Q3 GDP report is out Sunday night.

Why it matters: China was the first major economy to start growing again after imposing economy-crushing lockdowns.

  • China's economy produced 5.2% more in the quarter than it did a year previously, per economists polled by FactSet.
  • China is likely to be the only major economy to show annual growth this year, the IMF said this week.
8. Building of the week: Château de Verteuil

Photo via Patrice Besse

The Château de Verteuil, in Charente, France, dates to 1080 and has been in the Rochefoucauld family ever since.

  • The castle is now for sale, along with 94 acres of land. The asking price: a surprisingly modest €2.8 million, or $3.3 million.
  • "The estate stretches the length of the village," says the official listing, "or perhaps the reverse."

Among the castle's features: Machicolations used to drop burning objects on attackers; chapels; a library; and 14 bedrooms, one of which was slept in by the Holy Roman Emperor Charles V.

Felix Salmon

Yes, I know it's technically the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. Reward me for my perspicacity by subscribing to this newsletter — it's free! — here.