Monday, October 25, 2010

Of Haymakers and Rainmakers

“We should, I believe, be judged by our compromises more than by our ideals and our norms…Ideals may tell us something important about what we would like to be. But compromises tell us who we are.”

On Compromise and Rotten Compromises, by Avishai Margalit

Recently, I went to a panel discussion on urban agriculture at the Kellen Gallery, part of the Living Concrete/Carrot City exhibition. To anyone tuned into the food debate in the New York area, familiar sentiments were on display: scrappy entrepreneurs with a love for farming and/or eating, nurturing their holistic vision of a just society, itself replete with happy farmers tilling ever-healthier soil, which in turn produces nutritious fare for contented locavores, farmer’s-market enthusiasts, schoolkids, or [insert your constituency here], building greater community while lessening our carbon footprint, etc.

Being the happy curmudgeon, I was glad to sneak in the following during Q&A:

Aerofarm is a startup that is only a few years old. Their model does not have anything to do with creating community, or building soil health, or even encouraging food awareness or organic agriculture. They have developed technology that allows people to grow food in enclosed spaces, without sunlight, without soil, even. They recently received $500,000 in seed funding from several venture capital groups. Is there room for everyone to play in this space, or does Aerofarm, etc represent a threat to the vision of (urban) agriculture as implicitly envisioned by this panel and the food movement as we know it in general?”

It was disappointing to see the panel – or what takers there were – squirm their way through this question. One posited that “hydroponic agriculture” is a tremendous waste of resources. This may be or may not be true, but the fact is that Aerofarm is not a hydroponic operation. Another was concerned with the fact that Aerofarm was going to dilute the nascent “brand” of urban agriculture. No one really understood that my question was about money.

So what, exactly, does $500,000 “mean”? Let’s compare Aerofarm’s seed funding with the MacArthur Genius Grant, which itself is $500,000.

According to the MacArthur Foundation’s website, “MacArthur Fellows Program awards unrestricted fellowships to talented individuals who have shown extraordinary originality and dedication in their creative pursuits and a marked capacity for self-direction.” This essentially means that you have been busting your hump for a good chunk of your life before the Genius Grant smiles on you, eg: Will Allen, MacArthur 2008.

In fact, it was Cheryl Rogowski, not Allen, who was recognized as the first farmer-recipient by MacArthur, and that was in 2004. She has been farming since 1983. Wags might point out that people have been, in fact, farming for quite a bit longer than that. Nevertheless, in business school parlance, 20 years is one hell of a product development cycle.

It’s worth mentioning that the $500,000 is disbursed over five years, whereas it’s not unusual for seed funding to be wired as a lump sum within 24 hours of getting the good news (and signing the contract). Sure, VC funding certainly arrives with conditions, such as equity and/or board seats for the investing firm(s), etc, but this only serves to deepen the relationship between the allocated capital and its intended outcome – that is, a successful business.

The funny thing about money, you see, is that it creates the opportunity for influence and scale. This is not about getting a pat on the back from a foundation. The problem is that awards like the MacArthur grant simply arrive too late – the opportunity for real impact demands investment, not reward. As such, it has to be paid forward, not back. This is the critical difference between something like the old school foundation model, as exemplified by MacArthur, and the aggressive, agile development model perfected in Silicon Valley that is now being exported to the agricultural community under the rubric of Ag 2.0.

Of course, there is no doubt that the organizations created by people like Rogowski and Allen have been going concerns for a long time, are likely profitable, have provided jobs, etc. But this elides the main question, which is: how do we value something, and when is the most effective point in time at which to value it?

A VC – or any investor for that matter – thinks in terms of return on capital over time, which is itself based on the idea of present value. That is, given a future sum and a fixed interest rate, what is the equivalent sum needed today to match that future sum?

Using Rogowski’s career as an example, let’s assume that it takes 20 years of bootstrapping and hard work to get to the point where a foundation is willing to make such a grant. If I know I’m going to give a $500,000 grant in 20 years, and I assume that the risk-free rate of interest will be 5%, I immediately know that I only need invest $188,444.74 to make good 20 years from now, and I put that capital in my endowment and forget about it (here – try it).

Essentially, the VCs funding Aerofarm are making the same basic calculation, that is, a return based on market rates, but they are paying it forward. In this case, let’s call it the same rate as the above discount rate, or 5%. In 20 years they will have a total of $1.3m, of which $825,000 will be profit. This is simply the minimum return required to justify investing in a project, versus letting it sit in their bank account.

So here is the first big difference: MacArthur at some point said, OK, 20 years from now we are going to kick a half million to some worthy soul (maybe a farmer – or maybe not), so we need to sock away $188,444.74 into our endowment to be ready with it when the time comes. The VCs say, we are willing to bet $500,000 right now in anticipation that someone like Aerofarm is going to provide us with at least the market return, and hopefully much, much more.

The other, bigger difference, is what is happening to the capital in the meantime. In the case of Aerofarm, that money is spent – probably quite quickly – on capital equipment, R&D, new hiring, securing of intellectual property, supply chain and sales development, etc. All of the things that you would need to get a business going and growing. In the case of the foundation model, that money is used to hold long-term Treasury bonds until 20 years of the recipient’s business model has already gone by. That is, if MacArthur wanted to see their money better spent, you could argue that they would be better off paying forward Rogowski with the $188,444.74.

But that would only make sense if they could identify Rogowski as a sure bet. This leads to the third, and most important difference, which is how these perspectives influence funding. Since they are risking their own capital, VCs and other investors fund things they understand. The power of the Aerofarm idea comes from its distilled nature, which goes something like this:

Dear Investor: We can grow food pretty much anywhere. Here is our market size projection, here is our roadmap to commercialization, here are the risks and competition, here is where we break even and become profitable. Here is the projected return on your investment. And here is our bank account and routing info for the wire transfer. Thank you.

If you can’t put a dollar number on soil health, or social justice, or employment opportunities for ex-convicts, then almost any VC will refer you to the pet foundation run by his wife, and politely excuse himself to go find someone who will make him some real money.

Of course, none of this mattered when no one gave a shit about agriculture, and the only people sowing oats were folks like MacArthur. But now that agriculture is coming up big bucks and making global headlines, we are going to see plenty more Aerofarms, which will work over our assumptions about the definition of sustainability in a most uncomfortable way.

Unless the food movement as it is currently constituted can figure out how to create valuation that capital can understand, this avenue of funding will be closed to it, and the the future will continue towards a "tiered" sort of sustainability. This means the wealthier among us can afford, Marie Antoinette-style, to go milking in a “real farmer’s” dairy, while the ever-expanding working poor are fed on food grown in utter isolation from the larger values – physical or social – that constitute the food movement’s halo (and its real value). In fact, this is already happening, as Michael Pollan discovered when he was writing The Omnivore’s Dilemma. What he thought was going to be one section on organic food rapidly turned into two – the “industrial organic” of Horizon as compared to the “real organic” of Polyface Farms. The introduction of agile capital will only exacerbate this divide.

Don’t get me wrong – the debates, such as the importance of organic, matter. And it will always be essential to think about food locally. But, at this moment, what is happening in Brazil matters a whole lot more, and the mechanisms that are funding these trends matter most of all. Ignoring the macro, global scene, in favour of what is local and tangible, forces us into the error of proximity – of literally not seeing the forest for the trees. It is a miscalculation that the current food movement makes at its own peril.

At the event mentioned at the start of this post, a panelist contended that “the food revolution will not be funded by foundations”. I don’t think she anticipated the way in which I agree with her.

Thursday, September 30, 2010

A Middling Problem, Part 2

“But all things excellent are as difficult as they are rare.” Spinoza

If the market is great at providing us with the next iWhatever, shouldn’t it also be great at providing us with a better education system? Let’s be blunt: why wouldn’t anyone who remembers that first day of class in a public school want to give privatization a shot?

It’s true that the success of specific charter schools has been trumpeted from the rooftops, especially in total fail, tabula rasa scenarios like New Orleans. As it happens, it’s easy to come up with equally pleasing anecdotes on the other end – the hopeless public school made good, simply through the implacable willpower of its teachers and administrators, a creative and adaptable approach, amenable unions, etc. (That shouldn’t be hard to reproduce and scale, no not at all.)

Charter schools have only been around since 1992, so comparing their record to that of public education may seem a tricky exercise. But Stanford University's Center for Research on Educational Outcomes (CREDO) recently published the most authoritative study done on charter schools thus far, and the verdict is rather qualified:

17 percent of charter schools reported academic gains that were significantly better than traditional public schools, while 37 percent of charter schools showed gains that were worse than their traditional public school counterparts, with 46 percent of charter schools demonstrating no significant difference.

Interestingly, one of the factors affecting charter schools’ results is the fact that it’s much easier to open a new one (ie, procure a new charter) than to shut down a failing one. This leads to diluted results and churns teachers, students and administrators. But who can resist chasing the next great anecdote – or feeding it to the press?

Moderate minds will believe – and doubtless be proven correct – that charter schools will evolve a significant role for a society that is decentralizing and growing ever more complex. Like any other service, education will be sourced from more and different providers than ever before, just like our media or our electricity. This genie doesn’t go back into the bottle, and that’s a good thing. The charter model is moreover certainly not monolithic, and one hopes that success will be recognized, reproduced and scaled. But as implied above, a successful school is a deeply social exercise, and good education is one of those enterprises that seems to resist reproduction at scale remarkably well.

But it’s not high school graduates that get jobs. That was a long time ago. The kind of workforce that we are talking about – agile, productive, well-rounded – requires some kind of post-secondary education. What has been the market’s response?

All Shall Have Prizes

If you live in New York, you’ve seen the subway plastered with advertisements for the University of Phoenix, et al. – pioneers of the brave new world of for-profit education. But beyond such trainspotting, does for-profit really occupy some kind of critical mass in our educational landscape? Well, while post-secondary enrollment has increased by 31% over the decade (1998-2008), for-profit enrollment has skyrocketed by 225%. Whereas in 1990 less than 1% of students enrolled in for-profit schools – which themselves constituted less than 10% of all schools – by 2009 almost 10% of all students were enrolled in for-profits. In same timespan, the sum total of for-profits grew to comprise 25% of all educational institutions (Eisman, p6).

Ok, but didn’t non-profit community colleges fulfill this function until recently? As always, the past proves instructive. I refer the enterprising reader to a fascinating revisionist history of the development of community colleges vis-à-vis four-year institutions. In an essay entitled “Institutional Origins and Transformations: The Case of American Community Colleges,” Steven Brint and Jerome Karabel question the idea that community colleges constitute a “great democratic experiment”. Here is Brint, in a subsequent paraphrasing of that article’s many magnificient provocations (emphasis added):

In addition to our doubts about historical studies based on the responsiveness of community colleges to consumer and employer demand, we raised a number of critical questions about community colleges. We characterized them as the lowest rung in postsecondary education, both in terms of student composition and student life chances, and we raised concerns about the effects of community college entrance on the life chances of students. We saw community colleges as one means by which student ambitions were softly lowered to fit with the opportunities actually available in the labor market. We speculated whether the colleges led to democratization of higher education – by bringing in students who would not otherwise have attended a postsecondary institution – or whether their primary function was to divert students who would otherwise have attended a four-year college. We presented evidence that otherwise comparable students had a better chance of completing their baccalaureate if they started at a four-year college than if they started at a two-year college. We also raised questions about the economic payoffs to vocational programs. We anticipated important differences by field, but we also argued that many vocational students did not obtain jobs in the fields in which they prepared. We found no evidence for a common argument of the time – that rates of return for vocational students were notably higher than for liberal arts transfer students who went on to complete a baccalaureat.

This is not some quote from the 1970s. It is Brint in 2003, reflecting that not much has changed since 1989, when the original article was published (mmm-mm. I do looove me some Institutionalism). If we accept Brint and Karabel’s research as such, you would rightly say that there is a vast market opportunity here. For-profit education will surely rise up, delivering the education and training that ambitious students need to succeed in the employment marketplace.

As the above statistics demonstrate, thanks to a Siren-like mix of convenience, promise and high-powered marketing, those students have been beating the doors down. So what do they get for it? Recently, the GAO, which sometimes seems to be the only effective government agency in operation today, conducted an investigation into for-profit education organizations’ marketing techniques. Among the practices uncovered included coercion and fraud, encouragement to not report income on student loan applications, and such practices that would not be out of place in a pink-slip boiler room or a Florida subprime mortgage broker’s office.

Ok, let’s say there will always be a few bad eggs. It’s not like the GAO would have come up with something all that different, had they investigated the used-car industry. However, what is really at stake is not educating students but making a boatload of money. Obviously, if you’re running an online education service, your marginal costs of adding the next student are pretty minimal, compared to actually having to put some kid’s ass in a seat, feed and house them, clean up after their keggers, etc.

Here is the first indication of trouble: you would think that for-profits would be cheaper than community colleges on a credit-by-credit basis, since they compete with community colleges and their public funding, non-profit tax status, etc? Actually, for-profits are significantly (ie, by multiples) more expensive than community colleges: on average, $100- $300 per course, versus the for-profit price of $900-$1800 per course. (By contrast, Columbia University’s tuition is about $3300 per 3-credit class, so you are pretty much halfway there.)

Much more significantly, “current regulations allow for-profit education companies that participate in Title IV programs to derive up to 90% of income from federal government loans”. Title IV programs are loans that are disbursed by Federal Student Aid, part of the Department of Education, and include such plums as Perkins Loans and direct loans, as well as all kinds of grants. 90% - that’s some gravy train! Now those coercive marketing practices make more sense: the point isn’t to enroll students to get them to pay for their education up front, it’s to get them to take out a raft of loans. Since it’s a loan, it’s that much easier for the borrower to put it out of mind and sign the promissory note. After all, they’ll all be making six-figure salaries once they finish their correspondence courses in nursing or accounting, right? (Someone actually was recorded as saying this during the GAO bust).

So are students finding jobs? I’m sure that some are, but those who aren’t are mad as hell: “At least 750 former students and employees” of some Arcadia of higher learning known as Westwood College are doing what any self-respecting American does when things don’t work out: they’re suing the bastards, alleging, among other things, that “the school failed to give them accurate information about future job prospects or whether their degrees would be recognized by other schools or employers.” (Oh, had I only known that I could sue my alma mater for allowing me to major in some useless liberal arts subject. On the other hand my degree is recognized, so perhaps I shouldn’t be too hasty).

Eat My Short

In fact, this situation is so egregious that the industry has attracted the baleful eye of that implacable financial predator, the short seller. In this case, Steve Eisman, whose FrontPoint Partners hedge fund made accurate calls (and boatloads of money) betting against subprime mortgage securitization, is now smelling blood in the for-profit education sector. (Yes, that Steve Eisman.)

I implore my Gentle Readers to take the time to read Eisman’s entire presentation, which is not too difficult and the very model of a carefully constructed short hypothesis. But the gist of it is this: for-profits got fat feeding off the Title IV trough. In fact, they are crowding out other Title IV participants, hoovering up 25% of Pell Grants, even though they hold only 10% of enrollments. More saliently to Eisman’s short thesis, “at many major for-profit institutions, federal Title IV loan and grant dollars now comprise close to 90% of total revenues”.

It should be clear that students are being used as a conduit to siphon off federal dollars. And the more students the better – dropout rates at many of these “institutions” are over 50%, so they have to keep packing them in. Thus, dropout rates are actually an incentive, since the institution doesn’t need to do any more work, but the loan sticks, and there’s always another sucker ready to be pressganged into the education grinder.

But wouldn’t defaults impact the profitability of these institutions? Not really. In brief, the for-profits’ tuition fees are paid out by Sallie Mae, which originates the loan. In case of default, the Department of Education makes Sallie Mae whole – interest and all – and then proceeds to go after you themselves.

Curiously, the unique nature of student loans is something that Eisman omits, but we shall complete the picture. Mortgages, as we all know, are non-recourse loans – if you default, no collection agency shows up to impound your car and put it up on the auction block. You mail the keys to the bank and walk away from the mess, albeit with a ruined credit rating. Other consumer loans and credit card debt are generally wiped out when an individual declares bankruptcy. Student loans are virtually unique in that they don’t go away. Bankruptcy or no, there is no statute for limitations – you will pay your entire loan, principal and interest, even if it has to come out of your Social Security check. That makes the for-profit gravy train cited above look like peanuts.

To give an idea of the scale of student loans, by this summer household deleveraging had managed to reduce consumer credit card debt to the point where student loan debt overtook it as the largest category of consumer debt, outside of mortgages, at about $830bn. And with rates of defaults surging, there’s plenty of money to be made by everyone involved in making the student loan sausage. In fact, Eisman’s projection is that total outstanding Stafford Loans will hit nearly $500bn by 2020; of those loans, fully $274bn worth are expected to default. But since, according to Eisman, the government collects $1.20 for each $1.00 of loans originated, the total burden on students is estimated to be $330bn (Eisman, p40). Even by today’s standards, that’s a lot of money, especially if you are asking it of underemployed workers, and not the Federal Reserve’s printing presses.

So we are left with a bleak picture. For-profit institutions scam their students on their way in, give them a steaming pile of shit for an education, and then, if those students cannot find employment and begin servicing their debts, condemn them to years of indentured servitude, courtesy of the Federal government. I started out writing this post concerned about how we would address structural unemployment, but this makes the case for ongoing permanent unemployment.

Come to think of it, perhaps I don’t have the faith in Eisman’s short thesis, it being completely against Washington’s interest to regulate more strictly for-profits’ participation in Title IV. But what the heck, since most of these for-profit institutions are corporations that are publicly listed, anyone with a Scottrade account can get out there and do some shorting (APOL, COCO, ESI, EDMC and even WPO, if you’re curious). In the meantime, though, how about microfinance for students? We can at least save a few souls, especially if they’re interested in learning Mandarin.

Monday, September 20, 2010

A Middling Problem, Part 1

"Ford!'' he said, "there's an infinite number of monkeys outside who want to talk to us about this script for Hamlet they've worked out.'' -Douglas Adams

(This post goes out to Bix Santana of How to Cook A Yogi for inspiring me to get back to the blogging life. Thanks, Bix!)

Recently, veteran journalist Simon Head gave an afternoon’s-length workshop at NYU on “A Contrarian View of the American Economy in the Information Age”. This is worth mentioning for several reasons.

The first is found in the workshop’s title. Mr Head’s view, which he has been building on since his 2003 book, The New Ruthless Economy, is that today’s so-called knowledge workers are “de-skilled”, that is, forced by the pursuit of efficiency into ever-narrower, Taylorized categories of workplace behaviour. As a result, their skillsets are increasingly non-transferable. Technology itself – in particular, the IT systems designed to model and enhance complex corporate functions – abets this process by not only boosting productivity and thereby obviating the need for excess human labour, but also by rendering the remaining participants unfit for new employment. Once let go, what else can a call center worker pretend to be, other than a drone who can only follow a scripted decision tree?*

But to get back to the title: What’s so “contrarian” about this view? This is not a new theme for the world, and certainly not for Mr Head, who first deployed his future book’s title in a 1996 article for the NYRB. I was able to catch up with Mr Head during one of the breaks and asked him precisely what was so contrarian about his hypothesis. Mr Head is a Senior Fellow at the Rothermere American Institute at Oxford University, so I thought he was crossing swords with some obtuse mainstream phalanx of sociologists or economists. I was very surprised to hear that, according to him, the prevailing view was represented by the likes of Chris Anderson of Wired, Nicolas Negroponte and Clay Shirky of NYU.

Now, beyond the completely justified drubbing meted out to Negroponte’s One Laptop Per Child project not just by the free market but also by the project’s former employees (I mean this in a purely amoral sense, just as the market itself did), I don’t know much about Negroponte. He just seems naïve, so I’ll leave him out of it. But having waded through more than my share of breathless bullshit propagated solely for the purpose of generating buzzword income for the techno-industrial complex, Wired is justifiably the Omni Magazine of our time. Actually, scratch that, since even Omni had the modesty to label at least part of its content ‘science fiction’.

As for Clay Shirky, I tar him with much the same brush. He belongs to the same cabal of ‘thought leaders’ that will be among the first to be boiled down into Soylent Green by our impending robot overlords. You can grind your teeth through his TEDTalk on ‘cognitive surplus’, or you can read Jonah Lehrer’s very nicely mannered takedown of same, or you can just recall Wilensky’s dictum, that

We've all heard that a million monkeys banging on a million typewriters will eventually reproduce the entire works of Shakespeare. Now, thanks to the Internet, we know this is not true.**

Negroponte’s OLPC project at least spawned the netbook industry, but persuading people that they possess creative prowess that they do not have – or, worse, have no need to cultivate – is the mark of a dilettante and demonstrably harmful to society.

So much for our ‘intellectual mainstream'. I won’t dwell on whether Head actually considers them as necessary ground for his counterpoint, or whether they’re merely fish in a barrel. Let us return to the matter at hand, which is indeed quite serious.

The second item worth mentioning about Head’s workshop is this: at one time, this talk of ‘de-skilling’ might have been dismissed as so much milquetoast Marxist kvetching, but it has been rendered urgent by the appearance of what seems to be, by all accounts, structural unemployment. Is there a connection?

First, let’s be clear about what structural unemployment means. It is, quite simply, a mismatch between the jobs on offer and the skills and/or mobility of the available workforce. It doesn’t matter if the jobs are there, if you don’t know how to do it, or can’t get to it (for example, if your mortgage is so far underwater that you can’t afford to sell your house, hint). The position remains effectively unfilled. You can’t go from being a fashion model to being an art conservator, at least not overnight.

There have been clear traces of structural unemployment in our current situation. What is interesting is that this phenomenon may not just be caused by occupational or mobility issues, but also by technological phenomena (a possibility already noted by other observers). In fact, a recent piece in the Economist bolsters Head’s view nicely. In addition to the ongoing, ever-more-dramatic polarization of income in the United States, we are also witnessing – in both the US and Europe – a ‘hollowing-out’ of middle-skill middle-income occupations, such as “salespeople, machine operators and factory supervisors”. The most important thing to realize here is that we are not talking about the stereotypical 3rd-generation autoworker bathing in entitlement. We are talking about the the middle class that is the aggregate demand in this country.

It should be noted that the studies cited by the Economist article also unfortunately question Mr Head’s prescription of unionization as the answer to this “de-skilling”, as the pattern of joblessness is “similar in countries with very different levels of unionisation, prevalence of collective bargaining and welfare systems”.

Thus, in a supremely ironic gesture, America has just about innovated itself out of existence. Whether it’s moving to the cloud or capitalizing on high-frequency trading algorithms, corporations are putting paid the idea that immunity exists for those who are high enough on the value chain.

But wait, I hear you say, can’t education save us? That’s what we’re supposed to do, right? Re-train and all will be Morning in America again? This will be the subject of my next post.

* Which brings up an interesting point. Head mentions the fact that, at least in the earlier history of manufacturing, when a worker’s machine broke it was not unusual for him (yes, him) to have the skills and tools with which to fix it. One pauses to consider if the advent of microcontroller-driven assembly lines are in fact the material reason why Toyota instituted the ability for its Japanese workers to stop the assembly lines. That is, you didn't have a choice but to stop the line when you noticed something was wrong, since you couldn't fix it yourself. Not even kandan is what it seems.

** It is worth noting that at some point Wired picked up the first half of that quote – which does have a long and interesting history to it – and wrote it up as one of the “best thought experiments”, ascribing its coolness to the fact that “our minds have a hard time grasping the infinite. Mathematically, it's true.” Thanks, Wired!).