Facebook’s 27-year-old founder,Mark Zuckerberg, isn’t usually mentioned in the same breath asBen Bernanke, the 58-year-old head of the Federal Reserve. But Facebook’s early adventures in the money-creating business are going well enough that the central-bank comparison gets tempting.
Everything started quietly, in 2009, with the experimental launch ofFacebook Credits, billed as “the safe and easy way to buy things on Facebook.” Anyone who chipped in $5 from a Paypal account, Visa card or the like, could do the equivalent of changing money on an overseas trip. Voila! — $5 turned into 50 Facebook Credits.
Initially, the Credits-based economy was confined to the virtual world’s trifles. Credits could be spent to buy imaginary gold bars for aficionados of Mafia Wars, or bouquets of virtual flowers for birthday postings on friends’ Facebook accounts. This new form of digital money was cute but essentially useless for mainstream activities.
Lately Credits have become more intriguing. Warner Brothers this summer offered movie-goers a chance to watch “Harry Potter” and “The Dark Knight” for 30 Credits apiece. Miramax and Paramount countered with film-viewing offers, too. In a provocative post this week on Inside Facebook, guest blogger Peter Vogel argues that Credits in the next few years will become more of a true currency. Facebook’s 800 million worldwide users represent a lot of buying power. He figures Credits could evolve into commercial mainstays for digital movies and music.
Vogel has a personal interest in seeing Credits take off. He is co-founder of Plink, a customer-loyalty program in which people earn Facebook Credits by eating at participating restaurants. Plink is just getting started, and no one knows yet how much traction his company ultimately will enjoy. But such uncertainties can’t stifle Vogel’s ebullience. He predicts that the Facebook Credits economy could double every year for the next five years.
Already, Credits looks very rewarding for Facebook, thanks to built-in commissions or transactions fees. Merchants participating in the Credits economy receive 70 cents of every dollar spent on their wares; the other 30% goes to Facebook. That’s in line with the way that Apple Inc. runs its iTunes store. It’s far more lucrative than the 2% to 5% fees associated with credit cards or currency-exchange counters in the traditional economy.
Facebook won’t say how much it’s making from Credits, but the research firm of eMarketer offered up a widely quoted estimate in September. Its tally: $470 million of revenue in 2011, or about 11% of Facebook’s total business. Costs associated with the Credits program are likely to be trivial. So while advertising remains Facebook’s dominant source of revenue, banking looks like an alluring second way of making money — literally.
Edward Castronova, a telecommunications professor at Indiana University, is fascinated by the rise of what he calls “wildcat currencies,” such as Facebook Credits. He has been studying the economics of online games and virtual worlds for the better part of a decade. Right now, he calculates, the Facebook Credits ecosystem can’t be any bigger than Barbados’s economy and might be significantly smaller. If the definition of digital goods keeps widening, though, he says, “this could be the start of something big.”
In the short term, Facebook may choose to move cautiously with its Credits-based economy. Company executives are likely to have their hands full the next few months, trying to manage a successful initial public offering of stock. Moving too aggressively into banking could invite more government regulation than Facebook wants.
Still, Facebook’s buildup of Credits suggests more than just a minor dalliance. Facebook already takes payment for Credits in more than 40 currencies — ranging from the euro to the Vietnamese dong. Exchange rates are adjusted daily. It probably won’t be long until some economist tries to calculate the inflation rate, money-supply velocity or other traditional dimensions of the Facebook economy.
If Facebook at some point is willing to reduce its cut of each Credits transaction, this new form of online liquidity may catch the eye of many more merchants and customers. As Castronova observes: “there’s a dynamic here that the Federal Reserve ought to look at.”
Auction 2012 is a weeklong series in partnership with The Huffington Post and United Republic. Here’s Dylan’s interview with Paul Blumenthal of The Huffington Post kicking off today’s Auction 2012 series.
No money down. A sure thing. No risk loan. Free lunch. Easy money. Can’t lose.
If you’ve heard any of those expressions, a Greedy Bastard has tried to sell you something. Greedy Bastards, as I explain in my book, are the people that run our economy and politics. This week, the Huffington Post, the Dylan Ratigan Show, and United Republic are doing a series to explore corruption in our politics, looking at the various sectors of our economy to see how this impacts us. So this week, watch the Dylan Ratigan Show, read the Huffington Post, or check out CorruptionCostsYou.com to see how political corruption affects your life (for instance, why corruption leads to you paying higher ATM fees). The politicians may want us to obsess over the horse race, but we have a choice not to do so.
I use the term Greedy Bastards to describe the behavior of the corrupt elements in our culture. Greedy Bastards are spread across the economy in different industries and throughout government – in Banking, Oil, Universities, Government, Health, and Trade. While their behavior looks different depending on what industry they are in, the tactic they always use is what I call the “Very Bad Deal” hypothesis.
The essence of a Very Bad Deal is that it looks great on first glance. Someone offers us a low price on something we want or need – say housing – and we accept the deal. But there’s a catch. We have to accept a tiny chance that something terrible will happen. Even though on any given day there is only a tiny chance something very bad will happen, in the long run, that terrible thing is certain. The benefits come upfront and are obvious, while the much larger costs are deferred and hidden.
This framework explains the housing bubble and bust, who won and lost, and why.
From 2003-2007, according to the St. Louis Federal Reserve, Americans took out $4.5 trillion of additional mortgage debt, which is roughly $15,000 per person. You can’t go wrong, went the sales pitch, because housing can only go up in value. And so Americans bought more homes, for higher prices, and it seemed like it was working out. And it was! Debt was up, but housing values were up more. At the peak in late 2006, American residential real estate values were worth nearly $25 trillion, up from $16 trillion just four years earlier.
The big banks were the dealers in this game, extending as much credit as they could with capital requirements. They had used their political power to lift leverage restrictions and expand the derivatives market, which when put together is the equivalent of removing all the stop signs on the road. So onward we went, faster and faster.
And then came the crash. Asset values plunged by about $7 trillion, but debt levels stayed the same. The terrible thing had come to pass. Americans today have lost everything they gained in the bubble, and then some. They effectively gave up fourteen year’s worth of savings, without counting high unemployment and high public debt levels.
The banks who orchestrated this bubble transferred what’s known in technical terms as “tail risk” to the public. Tail risk, as my friend Nassim Taleb explains, is the chance that something extreme but unlikely happens. A chance of a hurricane that causes $100 billion of damage is low, but it’s not nothing. Banks, who are in the risk trading business, think very hard about how to price “tail risk” and who pays. In the case of the housing bubble, the banks transferred their “tail risk” to the public through derivatives. When the music stopped, the banks realized that they could get the government to cover their losses by using AIG as a funnel to suck up taxpayer money. Homeowners however were on their own, and have dealt with underwater mortgages and foreclosures. So now the homeownership rate, when you back out homes in default, is probably lower than it has been since 1962.
This tactic, of transferring tail risk to the public, is conceptually no different in banking than it is in any other arena. I’ll go into other areas in depth in my book and in future blog posts. Briefly, though, when BP cost us hundreds of billions of dollars in pollution costs by dumping oil into the Gulf of Mexico, that was transferring tail risk to the public. It’s all different types of Very Bad Deals, offered to us by Greedy Bastards.
Ultimately it comes down to the expression that if it sounds too good to be true, it probably is. For decades, since the early 1980s, our big banks offered us easy credit in increasingly large amounts. Buy now, pay later. Seemed like a great deal. But a funny thing happened since the time credit became “democratized” – we stopped getting raises. And after the housing bubble collapsed in 2008, we’ve lost our homes and our wealth.
What we’re finding out, now that the terms of the Very Bad Deals are becoming clear, is that an economy based on deals that sound too good to be true is a very unstable place to live.