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Wall Street and Silicon Valley

Sunday, 16 October 2011 09:48 By James Kwak, Baseline Scenario | News Analysis

Whenever someone criticizes “Wall Street,” someone else tries to defend Wall Street by saying that without it we wouldn’t have Silicon Valley and all of its wonders. Most recently, A.S. at Free Exchange says this:

“What would Silicon Valley have been without venture capital and private equity? Apple’s spectacular growth was made possible by the capital it raised in financial markets (it is a public company).

“Much of Apple’s initial investment came from an angel investor (a relative or friend who provides the start-up capital). But most new companies rely on formal capital markets. In a 2009 working paper, Alicia Robb and David Robinson investigated the capital structure of start-up firms, and found that 75% primarily relied on external financing from formal capital markets, usually credit cards and bank loans in their first year. They also found that firms that used formal credit were more successful.”

As critics of Wall Street go, I probably find this more annoying than most because, well, I worked in Silicon Valley. Most of these comments are obvious, but here goes anyway.

 

  • Venture capital has been around for centuries; in its current form, it dates back to the 1950s. Venture capital is one of the most un-innovative forms of finance around: it’s equity investment in the form of preferred shares, generally without leverage. The skill it requires is the ability to identify companies that will be successful. Venetian bankers were good at it back before the Renaissance.
  • (Private equity? What does private equity have to do with HP, Intel, Apple, Oracle, Sun, etc.? There are technology private equity firms such as Silver Lake, but like most private equity firms they focus on mature companies.)
  • The initial public offering and the secondary public offering (as in “[Apple] is a public company”) have been around for centuries. Yes, they involve Wall Street investment banks, but they worked perfectly well before the modern age of financial innovation.
  • Credit cards have been around since the 1950s. But that’s just when the current technology (plastic) was introduced; as a type of finance, there are just unsecured personal lending, which has been around for millennia. You could try to argue that securitization slightly lowered credit card interest rates, but I don’t think that’s the difference between Google existing and Google not existing.
  • Ditto for bank loans, except that few if any small business loans are securitized (not homogeneous enough).

Obviously technology startups need capital, but they raise capital in ways that have been around for decades or centuries—not ways that were thought up by former physics Ph.D.s since 1980. Simply saying that capital is good isn’t much of a defense of Wall Street, unless you think critics of Wall Street are against capital in all its forms. (A few may be , but many of us are not.) This reminds me of when Ben Bernanke gave a speech praising financial innovation but, as Ryan Avent pointed out, he couldn’t come up with an example more recent than the 1970s.

There are certainly ways you can argue that recent financial innovation (custom derivatives, structured finance, the whole works) is good for the economy. But don’t try to count Silicon Valley as one of them.


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Wall Street and Silicon Valley

Sunday, 16 October 2011 09:48 By James Kwak, Baseline Scenario | News Analysis

Whenever someone criticizes “Wall Street,” someone else tries to defend Wall Street by saying that without it we wouldn’t have Silicon Valley and all of its wonders. Most recently, A.S. at Free Exchange says this:

“What would Silicon Valley have been without venture capital and private equity? Apple’s spectacular growth was made possible by the capital it raised in financial markets (it is a public company).

“Much of Apple’s initial investment came from an angel investor (a relative or friend who provides the start-up capital). But most new companies rely on formal capital markets. In a 2009 working paper, Alicia Robb and David Robinson investigated the capital structure of start-up firms, and found that 75% primarily relied on external financing from formal capital markets, usually credit cards and bank loans in their first year. They also found that firms that used formal credit were more successful.”

As critics of Wall Street go, I probably find this more annoying than most because, well, I worked in Silicon Valley. Most of these comments are obvious, but here goes anyway.

 

  • Venture capital has been around for centuries; in its current form, it dates back to the 1950s. Venture capital is one of the most un-innovative forms of finance around: it’s equity investment in the form of preferred shares, generally without leverage. The skill it requires is the ability to identify companies that will be successful. Venetian bankers were good at it back before the Renaissance.
  • (Private equity? What does private equity have to do with HP, Intel, Apple, Oracle, Sun, etc.? There are technology private equity firms such as Silver Lake, but like most private equity firms they focus on mature companies.)
  • The initial public offering and the secondary public offering (as in “[Apple] is a public company”) have been around for centuries. Yes, they involve Wall Street investment banks, but they worked perfectly well before the modern age of financial innovation.
  • Credit cards have been around since the 1950s. But that’s just when the current technology (plastic) was introduced; as a type of finance, there are just unsecured personal lending, which has been around for millennia. You could try to argue that securitization slightly lowered credit card interest rates, but I don’t think that’s the difference between Google existing and Google not existing.
  • Ditto for bank loans, except that few if any small business loans are securitized (not homogeneous enough).

Obviously technology startups need capital, but they raise capital in ways that have been around for decades or centuries—not ways that were thought up by former physics Ph.D.s since 1980. Simply saying that capital is good isn’t much of a defense of Wall Street, unless you think critics of Wall Street are against capital in all its forms. (A few may be , but many of us are not.) This reminds me of when Ben Bernanke gave a speech praising financial innovation but, as Ryan Avent pointed out, he couldn’t come up with an example more recent than the 1970s.

There are certainly ways you can argue that recent financial innovation (custom derivatives, structured finance, the whole works) is good for the economy. But don’t try to count Silicon Valley as one of them.


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