Outside Observation #3: Bloomington Farmer’s Market

I recently attended the Farmers market in downtown Bloomington for the first time and was really astounded by how much I enjoyed being there.  The combination of real food for sale, community intermingling, music, and being outside was really refreshing.  I liked the market so much that I went back several times and even developed the habit of buying ingredients that I used to actually cook.

Visiting the market made me think about how great it would be if all food markets could exist in a similar fashion.  The pleasant feeling that I get from being at the farmers market could not be any different from the feeling that I get when I walk through the fluorescent aisles of Kroger or Marsh. 

When I’m in Chicago visiting my old neighborhood, my girlfriend will frequently drag me to her closest Whole Foods where she likes to study and do other work.  Upon my first visit, I was surprised to see that the company has adopted a strategy of providing community space.  Equally surprising to me was that the space is typically busy.  The local store contains café’s, bars, large community tables, and other public spaces, which are all typically filled (Although not in this staged picture...)

While I can’t say that I entirely agree with the “organic” movement which seems to be intertwined with the Whole Foods chain, I have to admit that the company does a great job of providing a middle ground between the Krogers of the world and Bloomington’s Farmers Market.  When I first saw it, I could not believe that people were actually hanging out at a bar inside Whole Foods.  Such is the draw of community and the power of building social capital.  Maybe this is the strange beginning of a march towards local sustainability?

Outside Observation #2: Occupy Bloomington Movement

The recent passages in Roseland regarding local governance tie in perfectly with the Occupy Bloomington movement which has sprung to life in recent weeks.  It seems to me that this organization, along with similar organizations that now exist across the country, embodies the “inclusive” decision making process which Roseland advocates as a method for increasing social capital within a community.  In fact, as I drove past the camp site of the movement this afternoon, I noticed a sign which read, “All opinions are welcome.”

Yet, in addition to being an example of an organization which might serve to increase community social capital, I also think the Occupy Bloomington movement is an interesting case study which illustrates the challenges involved with creating a local movement.  I believe that one important challenge involved with creating a movement would be to create a mission statement which encapsulates why the movement exists.  Below is the content within the “ What We Want ” section of the Occupy Bloomington website:

“A better world.  One not ruled by materialism, but by communalism.  Where the goal is not to acquire stuff, but to build community.  Where the pressure isn’t to consume, but to minimize consumption.  Where we don’t have to work ourselves to the bone just to get by, but can pursue our intellectual curiosities at will.  Is this world possible?  Maybe not.  But I’d rather try to build it than continue to suffer in the one we have.  It’s time for something new.”

I was slightly underwhelmed by this statement.  While I appreciated the motivation to create a better world, that motivation alone does not seem helpful to me without a recommendation on how to achieve it.  In addition, this passage has a not so subtle hint of laziness.  Most people would like to pursue their intellectual curiosities without working hard, but unfortunately, the world economy is competitive, and the latter requires the former.  This does not seem like a novel concept to me.

Occupy Bloomington is not alone in its lack of a clear mission.  The first Occupy movement which originated on Wall Street has an “ About Us ” section on its website which is similarly vague and does not advocate for any specific change.  After reading  Ryan Conway's most recent blog  regarding the Occupy movement, I was surprised to discover that these organizations are intentionally remaining goal-less. The members of these movements believe that their organizations can be effective without having a goal.  Moreover, many of these organizations believe that making specific demands “reduces the movement" and “takes the heart out of it.”

To an extent, I agree with this opinion.  Advocating for, say, a change in the laws which govern bank deposit insurance does not sound as emotionally charged as a demand for world peace.  However, I believe that without creating a clear mission, the movement will not absorb enough adopters to create meaningful change.  As is illustrated by the oft-referenced “Human Perspectives” chart, the majority of individuals (including myself) are focused on short term, family-centric problems.  These individuals may desire world peace, but their focus on the everyday tasks of life, as well as more short term, realistic goals, prohibits them from spending time pursuing utopian causes.  A goal-less organization will not appeal to these individuals, and in some cases, will clash with these individuals.

A good example of such a clash occurred last week, during an Occupy Bloomington event at the Kelley School of Business.  At least one protestor at the event accused JP Morgan Chase Bank of being among, “…the major financial institutions that caused the 2008 financial collapse with its criminally greedy, fraudulent lending practices.”  Protestors then blocked the entrance to a JP Morgan Chase recruitment event which was targeted towards Kelley undergraduate students.  This protest, while perhaps well-intentioned, was not well-received by Kelley students.  Many students voiced concerns that it would be themselves, and not JP Morgan Chase, who would be most negatively affected by the protests.

In my view, this is a clash of short-term focused individuals against long-term focused individuals.  Students, as a whole, are a demographic which the Occupy movement would do well to absorb.  However, because the organization is focused on vague, long term goals, the protest actually served to alienate students, who were focused on the more pragmatic, short term goal of finding a job.  If the Occupy movement really wants to change the world, I believe they need to figure out how they want to do so without alienating the majority of individuals who are concerned with the here and now.

Outside Observation 1: Gold Rush Alaska

During thanksgiving break, as I was flipping through the channels one evening, I discovered a TV show with which I had been unfamiliar.  The show is called “Gold Rush Alaska” and it follows a group of Oregonians who have made the trip to Alaska in order to spend the summer mining for gold.  As I watched the show, I became more and more horrified. 

As the cameras move to and from each of the characters’ respective mining sites, the viewer watches as bulldozers tear apart miles upon miles of beautiful, untouched, Alaskan wilderness.  While at this point in the show, most of the characters still have found no gold, at one point there is a small discovery.  As the camera zooms in on the excited miner, there are extremely tiny specs of gold visible in his pan.  The miner declares that the find is at least one ounce of gold and thus worth roughly $1800.

The show has become a hit and Alaskan state officials have become worried about the message that is being sent to the three million viewers that are tuning in each week (http://www.oregonlive.com).  In addition to the seemingly unregulated destruction of virgin forests, the show has aired the killing of a black bear, the diversion of natural streams, and scenes of miners driving heavy machinery across rivers which some concerned environmentalists have claimed to be salmon spawning habitats.

From my point of view, the show embodies many of the flaws in our economic system which we have discussed in class. There can be no question that the environmental services destroyed by the mining by far exceed the value of one ounce of precious metal.  Even worse, gold has no inherent productive value, only subjective monetary value.  Finally, all of these perverted efforts at value creation will be counted as an increase in Gross Domestic Product.  

Monetize the Environment!

Over the past century, economists have taken great lengths to legitimize their field as a true science that is comparable to other sciences like physics and chemistry.  They have done so by applying ever more abstract mathematical equations to what otherwise, in many cases, would be plainly obvious concepts.  For example, when asked to simplify the work that won him the Nobel Prize in 1981, James Tobin said, “I guess I proved:  Don’t put all your eggs in one basket.” (http://www.nber.org/)

Despite the fancy equations, economics is just the study of one, universally understandable, thing: human behavior.  And just like physics, human behavior is bound by natural laws.  One such law says that humans, as investors, will prefer investments with higher expected returns per unit of risk to investments with lower expected returns per unit of risk.  The most efficient investments are located on what is called the efficient frontier (left). Nobody imposed this law on our world, it simply exists and there is nothing we can do about it.  To me, it is as universally true as E=mc^2.

When Tim Jackson spoke about a “paradigm shift” towards a sustainable economic system, he referenced a search engine called Ecosia (http://ecosia.org/faq.php#2) as an example of a new business model which would, along with other similar new models, propel us towards sustainability.  I could not disagree more with Mr. Jackson.  By supporting Ecosia, which gives away more than 80% of its revenues to the World Wildlife Fund, Mr. Jackson is hoping that the natural economic law stated above will cease to exist.  He might as well have said, “Let’s try to forget about gravity and try something new called ‘walking on air.’” 

In fact, there is not much new about Ecosia.  It is a private business that supports a charity.  Many companies support charities.  McDonalds allocates a portion of its revenue towards the Ronald McDonald House.  The only difference between McDonalds and Ecosia is that McDonalds doesn’t allocate 80% of its revenues towards the Ronald McDonald House.  If it did, it would have less capital to allocate towards its primary business, leading to lower business performance.  Its competitors, which would not allocate 80% of their revenue towards the Ronald McDonald House, would have more resources available to out-innovate McDonalds.  Eventually, McDonalds would be driven out of business or, more likely, into a hostile takeover.  After that, the amount of revenue being allocated to the Ronald McDonald House would be 80% of zero.  I predict that ultimately, a similar sequence of events will unfold for Ecosia.  No company can violate the laws which govern human behavior indefinitely.

Try my new paradigm

The readings in Wheeler this week focused on the concept of monetizing the environment.  Over the course of this class, I have become convinced that this is the only viable way to move the world economy towards sustainability.  This is because the concept does not advocate the overturning of the current economic system, which is simply not possible to do with success.  Please reference any communist country for proof of this.  Instead of overturning the system, a monetization of the environment aims to incorporate “externalities” into the system.  This is accomplished, very simply, by placing a price tag on everything that provides an environmental service but is currently regarded as free.  My proposed carbon dioxide emissions allowance futures exchange, for which I recently posted a business plan (http://v515brian.blogspot.com/), is a good example of what I believe must happen in the absence of government action on emissions.  This is just a start.

Personal Project Update: IU Best Competition Concept Submission

Today was the deadline for Round 1 concept submissions to the IU Business Entrepreneurs Software and Technology Competition.  Notifications for advancement to Round 2 will be sent out 12/9.  I've copied my submission form below:

Concept Title: 

Carbon Dioxide Emissions Allowance Futures Contract and Trading Platform

One Sentence Synopsis of Concept: 

Web-based trading platform to facilitate the trading of a new futures contract based on the expected future price of U.S. Carbon Dioxide emissions allowances.

Concept Description (200 Word Maximum): 

Market Need: Futures contract and web-based trading platform will allow firms and investors the opportunity to hedge exposure to, and speculate on, the future price of U.S. Carbon Dioxide emissions allowances.  

Size of Market Opportunity:  According to Commissioner Bart Chilton of the Commodity Futures Trading Commission, “The potential size and scope of a structured carbon emissions market in the U.S. is unequivocally vast.”  However, the size of this new market opportunity will vary based on investors’ expectation of future U.S. cap-and-trade regulations.  Assuming a linear relationship between expectations and transaction commissions, the annual size of the market varies between $274,000 at current expectations of zero and $28,800,000 at 100% expectations.  More details on these estimates are listed in Appendix 3.

This latter estimate is conservative as it assumes that regulations would cap emissions at current levels.  If regulation is approved, emissions will most likely be required to decrease over time, and thus the price of allowances will increase, along with the size of the market and commissions earned. 

Barriers to Entry: The largest barrier to entry will be the creation of a liquid market that will draw market participants. 

Market/Customer(200 Word Maximum):

Users of this futures contract and web-based trading platform will include both firms and investors who are interested in hedging exposure to, and speculating on, the future price of U.S. carbon emission allowances.  Firms are motivated to neutralize themselves from extraneous risks in order to provide certainty to investors regarding overall business performance.  Examples of participating firms would be utilities and manufacturers, or other firms who are highly exposed to carbon allowance price risk and wish to hedge their exposure to future price fluctuations of these allowances.  

Examples of participating investors would include institutional investment funds and retail investors who wish to allocate their capital efficiently in a new asset class and/or speculate on the future price of carbon emissions allowances.

Net buyers of this futures contract would differ from net sellers.  Net buyers would include market participants who believe their future emissions will be higher than their future emissions cap.  Net sellers would be those participants who believe their emissions in the future will be lower than their future cap.

Competition(200 Word Maximum):

There are no competitors in existence which offer a U.S. exchange-traded carbon futures contract.  The Chicago Climate Exchange, which operated from 2003 to 2010, facilitated exchange-based trading for spot carbon emissions contracts, however this market is now defunct.  There are several competitors in existence which provide over-the-counter brokerage services on California carbon futures instruments.  These companies include the Green Exchange and the Chicago Climate Exchange (ICE).  The first California carbon futures contract traded on August 29th, 2011 through the Green Exchange for $17.  

In the past, the successful launch of a futures contract has attracted competitors into the market with similar contracts.   Successful markets are typically the first markets to amass liquidity.  A good example of this pattern is the case of live cattle futures.  These contracts were introduced by the Chicago Mercantile Exchange (MERC) and their success was quickly noticed by the Chicago Board of Trade (CBOT).  The contract eventually launched by CBOT was not successful as liquidity had already attained critical mass at the MERC.  In this way, it is crucial to attain a critical mass of liquidity in this new contract before it is attained by a competitor.  

Sales/Marketing(200 Word Maximum):

In order to attain liquidity in this new contract, it is crucial for investors to not only become aware of the exchange, but also to have confidence in its ability to neutralize credit risk.  In order to accomplish both of these tasks, the web-based trading platform will be launched with the assistance of the CME Group through its Globex trading platform.  The listing of this contract through Globex will provide publicity and credibility for the contract.  Also, because trades will be cleared through the CME Group clearing house, traders can be confident that their exposure to credit risk will be neutralized.

Partnership with the CME group is essential in the race for liquidity, but it is also expensive.  The launch fee for the contract is approximately $100,000 and 50% of the trading commissions will be shared with the CME group.  Further promotion of this contract and trading platform will be through business-to-business sales initiatives.  Larger traders will be offered a percentage discount on trading commissions in exchange for trading volume.

Team (200 Word Maximum):

Brian Kerschner will manage the launch of this new futures contract and web-based trading platform under the guidance of experienced market-makers at the CME group and elsewhere.  Mr. Kerschner’s professional background is ideally suited for this management position due to his extensive experience in the process of new market development.  While working at Sysco Corporation, Mr. Kerschner developed a new geographic market from zero to $2.4 million in annual revenue within one year.  These market development skills are directly applicable to the development of liquidity for the new futures contract and web-based trading platform.

Financial Projection(200 Word Maximum):

The cash flows generated by this futures contract and web-based trading platform will vary based upon investors’ expectations of future U.S. cap-and-trade regulation.  The revenues forecasted within the discounted cash flow analysis within Appendix 1 are based on mean cap-and-trade system passage expectations of 10% in 2012 and 30% thereafter.  These estimates are based on expectations made public through crowdsourcing website Intrade.com.  The distribution of these revenues is assumed to be triangular and the upper and lower revenue limits are listed within Appendix 2.

Operating margins and the corporate tax rate are assumed to be normally distributed and equal to those of the CME Group, with mean rates of 61% and 45%, respectively.  The standard deviation of these rates is assumed to be 1%, and 2%, respectively.  Development costs are assumed to be $125,000, which includes a $100,000 contract launch fee and legal fees of $25,000.  Based on a simulation containing 1000 iterations, the mean NPV generated by this futures contract and web-based trading platform is $12.1 million.  Based on this simulation, this is a positive NPV opportunity with 99% certainty.   

Implementation Plan(200 Word Maximum):

There are several active U.S. patents on file for forward contracts which are similar in structure to the new contract which I plan to introduce.  As a defensive measure, in order to protect myself from legal challenges, the first step I take towards implementation will be to file a patent on the new contract.  Should I be selected as the recipient of a monetary award from the IU Best competition, I will use these funds to immediately begin the patent filing process.  I assume this process will take four years to complete.  During this time, I will move forward with the formation and listing of the new futures contract on the web-based Globex trading platform made available through a partnership with the CME group.  I anticipate that the contract will be launched within eighteen months of the patent filing.

Appendix 1: Discounted Cash Flow Analysis

    Note: Net Present Value listed above is the expected NPV with no randomness.

Appendix 2: Regulation Expectation Forecast Assumptions

Appendix 3: Expectations vs. Contract Trading Commissions Revenue

    Source: Chilton, Bart. (2008). “The Most Important Thing.” New York, New York:       http://www.cftc.gov/PressRoom/SpeechesTestimony/opachilton-14

Detroit: An Extreme Demonstration of the Costs of Urban Sprawl

Detroit, which covers 139 square miles, is a relatively large city by land area.  This land area was not particularly remarkable during the city’s peak economic period in the 1950’s, in which the city was home to a population of almost 2 million people.   However, the subsequent economic decline has resulted in an astounding exodus, leaving the 2010 population at 714,000.  Today, Detroit’s land density more closely resembles the densities of newer, sprawling, Sunbelt cities like Dallas and San Jose, rather than industrial peers like Chicago. 

The economic costs of this degree of sprawl are daunting.  Even as the tax base has declined, government services such as mass transit, lighting for roadways and snow removal are being spread over Detroit’s outsized land area and are thus more expensive than should they be for a city of its current size.   Moreover, as opposed to low-density Sunbelt cities, Detroit’s landscape is populated by approximately 60,000 abandoned properties.  Detroit’s rental and home vacancy rates are the second highest of all U.S. cities, behind only Las Vegas (http://www.forbes.com/2009/02/12/cities-ten-top-lifestyle-real-estate_0212_cities_slide_16.html).  These vacant properties attract crime and simultaneously dampen enthusiasm for economic development while requiring high levels of police services.

These steadily mounting public costs are currently being addressed by Detroit’s mayor, Dave Bing, through an initiative called Detroit Works (http://detroitworksproject.com/).  The goal of the initiative is to provide an incentive for the formation of denser city neighborhoods.  Mayor Bing hopes that this goal can be accomplished by scaling public services according to the economic viability of each city neighborhood.  Demonstration zones are currently being setup in all three neighborhood types, defined as distressed, transitional, and steady, in order to track the effectiveness of the new system.  Large funds are also being put towards the demolition of 10,000 dangerous, abandoned homes by 2013.

In addition to government initiatives, private funds from investors and entrepreneurs are being put towards ventures like Techtown, a business incubator, through Southeast Michigan’s New Economy Initiative (http://neweconomyinitiative.cfsem.org). Interestingly, the same concerns regarding gentrification that were raised during class have been raised by critics of these new programs.  Critics claim that the benefits of these programs are primarily being captured by yuppies coming in from the suburbs and that the needs of the the city’s poorer residents, who make up the majority of the city population, are being overlooked.

Personal Project Blog 2 - Making Progress

Since my last personal project update, I’ve met with several contacts in finance-related job functions in order to get a better understanding of derivatives markets and market making in general.  It was my goal to apply the knowledge obtained through these meetings directly to a financial model of a carbon derivatives exchange.  However, things did not proceed exactly as I had planned and instead of helping me to move forward on my original derivatives exchange plan, these conversations helped to illustrate several obstacles within my plan that would limit its economic feasibility.  The good news is these meetings have led me in some new directions that are more feasible than my original plan.

The first person that I spoke with was a finance professor of mine, Professor Shockley. The reason that I wanted to speak with Professor Shockley was because I wanted to confirm that my hypothetical derivatives contract, of which I know of no currently existing equivalents, was mathematically sound.  I explained to Professor Shockley that even though my contract was based on an underlying asset which had no spot price, I believed that the spot price could be derived through price discovery in the futures market.  Professor Shockley confirmed that the contract made sense and recommended that I talk with the CME Group in Chicago in order to figure out why nobody else was pursing such a contract.

So that’s what I did.  During my meeting with a member of the Research and Product Development Team at the CME Group, I learned about potential methods in which I could partner with their exchange in order to launch my Carbon contract.  By working within an already established exchange, I would instantly have access to a liquid market and a credible clearing house.  In exchange for these services, I would have to pay a launch fee and I would receive only a portion of the commission generated by each trade.

After talking with the CME Group, the next person that I talked with was Michael Greenberg, the founder of the Plastics Exchange in Chicago.  The Plastics Exchange is one of a few, if not the only, truly new markets that has successfully been established in the last thirty years.  Mr. Greenberg told me that I had a clever idea but that a carbon exchange, organized in the way in which I had imagined, would be almost impossible to turn into a viable business.  The reason for this is because the commissions on futures contracts average out to be only about eight cents per contract.  This commission structure is appropriate for contracts like S&P 500 futures, which trade millions of contracts every day.  However, by launching my own exchange, even if I managed to create a market with thousands of contracts in open interest, a number which is similar to that of the Plastics Exchange, I would still be earning very little revenue in the process.  Mr. Greenberg thought that the option of working with the CME group was more realistic.

After hearing this critique, I spoke with another professor of mine in the business school, John Succo, who until recently ran his own hedge fund.  John explained that the lucrative part of making markets was the actual act of matching buyers and sellers.  In this business model, a broker earns a large fee for their match-matching efforts.  The only problem with this model is that it is much less transparent, and as a result, I do not know if such contracts/brokers currently exist.  John suggested that in order to find out, I get touch with the players who would be involved in a carbon market.

So that is the next step.  I need to get in touch with utility companies in order to find out if/how they hedge their carbon risk.