Friday, September 29, 2017

This Week in Bank Failures, Raccoon Edition

A Royal Bank of Canada branch in Toronto had to close a month ago when a raccoon family was discovered living in the ceiling. [ ] Now the bank says the branch will stay closed for another month. Workers had to build scaffolding to reach the damaged ceiling and, after examining it, found that the damage the raccoons had caused was more extensive than originally thought. The branch will reopen after the raccoon damage has been repaired.

It is likely that the raccoon invasion went undetected for quite some time. Raccoons are nocturnal by nature and would have been sleeping during banking hours when people were in the bank office.

Tuesday, September 26, 2017

After Puerto Rico Disaster, We Know So Little

I’ve been waiting to hear how Puerto Rico fared in a storm that had the potential to be the worst natural disaster in U.S. history. After a week, the mere fact that we have not yet heard from half of the island is a likely indication that things have gone badly.

Weather measures looked grim in the first place. Hurricane conditions covered the entire territory for hours and lasted a whole day. Estimated rainfall totals were possibly as low as 6 inches on the southwest coast, though that is already enough for severe flooding, to 40 inches at higher elevations in the interior. You don’t get that kind of rain along with hurricane-force winds without destroying structures of every kind, and the most prominent casualty has been the Guajataca Lake dam. There is damage to the dam and more prominent damage to its spillway, and though it continues to function approximately as intended, damage has progressed far enough that engineers are telling everyone to stay away.

The Guajataca stories are emblematic of the difficulty in getting accurate information about the state of Puerto Rico. News photos have been few and undated and have not focused on the damage. Early reports were wildly inaccurate, some incorrectly stating that the dam had collapsed and misspelling the name of the river, dam, and lake as “Guatajaca,” others falsely claiming that no dam failure had taken place, and still others incorrectly placing the threat near the major city of San Juan. The faltering dam threatens two towns with populations of 70,000, but what part of that number had to evacuate? Some have said as few as 320, others, all 70,000, and it appears the lower number is closer than the higher number, but we don’t really know.

Looking at the state of the Guajataca Dam is frustrating enough to remind even a philosopher about how little we really know. Experts from the Army Corps of Engineers went to see the dam but even they are not able to add much new information. When a dam is made from compacted earth, the key question is how far into the soil the water has reached, and how much is seeping or flowing through the dam near the top. I don’t know of any direct way to measure the strength of soil buried deep underground, and the challenge is that much harder when it is not safe to walk onto the top of the dam.

The broken dam is not the biggest question now after affected residents have had time to evacuate. How about the question of how many have died? That is a question that obviously can’t be answered when roads are blocked and 100 villages remain isolated, unable to communicate with the outside world. Normally in such a situation, helicopters could land and evacuate the most gravely ill people to hospitals, but even a measure as obvious as that is difficult right now. There aren’t many helicopters, and even if there were dozens available, there isn’t enough fuel on the island. Then, where do you take sick and injured people? With the electrical grid destroyed and fuel running low, hospitals are barely functioning. If the lights and medical equipment at a hospital go out, a very present possibility, the death toll could add up quickly.

One reason the United States does not know how to handle the situation is that a disaster of this size and shape has never occurred in the history of the country. When New Orleans was submerged, Baton Rouge was only moderately damaged. It could serve as a base of operations for the relief of New Orleans. Here the United States faces a disaster five times as large, and there is no undamaged town in Puerto Rico that can serve as a starting point for recovery.

I don’t know what the first steps have to be, but it is obvious that some of the most basic components of economic functioning have to be put in place before even the planners at FEMA can relate to the situation in a constructive way. This list would include ports, roads, water, food, motor fuel, and banks. Even this short list would be obviously beyond the capacity of local authorities anywhere. The largest airport has reopened, at least, and if tourists are stranded in the airport waiting for fares to fall below $2,000 a seat so they can get home, that tells us that the airport is functioning and some supplies are arriving.

With so much at stake, hundreds of people on Twitter wonder why there is no aircraft carrier on the way to help. Or maybe there is. There is so little we really know, but it is clear enough that the crisis in Puerto Rico will get worse before it gets better.

Thursday, September 21, 2017

Disaster and Disruption

It is hard not to think about disasters this morning. At the top of the news I can read about one of the most damaging hurricanes in U.S. history. Frantic search and rescue efforts are underway after an earthquake brought down large buildings in central and southern Mexico. I know of several other disasters across North America, perhaps not to be found in the headlines today, but nevertheless in the early stages of cleanup.

It is important to stay informed, but it is hard to read disaster news and not cross over into simple worry. I can tell I have made that transition if I sift through ten more minutes of news imagining I will find a new update when everything I see just repeats information I have seen already. This is time wasted.

It is one of the old questions in economics whether disasters add to or take away from economic production. Two small examples suffice to illustrate the question. A window broken in a storm has to be replaced. The materials and labor count as new production. A bridge is underwater and workers cannot get to work today. The work they would have done can never quite be made up. Production is lost. The question is about the relative scale of rebuilding and disruption. Which is the larger effect?

In the disasters I am seeing this week, it is clear that disruption weighs heavily. Based on the photos I have seen from Mexico City, my guess is that less than 1 in 100 buildings will be demolished because of earthquake damage, but the disruption affects everyone in the city. Meanwhile, the worry that I described earlier affects a far larger number of people. Worry draws us away from productive work for varying periods of time, but it affects so many people that it adds up to a lot.

There are counterexamples, cases where rebuilding appears to be a larger effect than the disruption of a disaster, and then you can poke holes in the counterexamples. Business gurus insist that you have to shake things up to make progress, and there is more than a grain of truth in that, but merely shaking things is not a strategy. Totalitarian regimes regularly go to war on the theory that the hardship will be good for their respective nations’ fortunes, but unless an exceptionally clean and short war can be arranged, this strategy ends badly. War becomes merely a tool allowing corrupt leaders to cling to power for a few more years at most.

Recent studies in psychology suggest that productivity is improved and individual and organizational progress is faster when everything goes smoothly. There are times when disruptions help people focus, but stability boosts focus more reliably. To put it bluntly, if you want to be successful, good luck is better than bad luck. This is not so hard to believe. On which day are you more likely to do your best work: a day when the hurricane wind sounds like a freight train outside your window, or a day when the loudest sound you hear is a couple of songbirds?

It is beyond any of us as individuals to prevent hurricanes and earthquakes, but we can act to minimize the disruptions they cause. Sometimes we are in a position to make buildings more sturdy so that they are not so readily affected by shaking, pressure, heat, smoke, and water. All of us, though, are in a position to keep disaster news in its proper context. No matter the scale of a disaster, if it does not affect you or your town directly or nearly so, it is only right to set the news aside for hours at a time. You’ll still get all the news, if you choose, and the delay of a few hours costs you nothing. In the meantime, by not being immersed in the disaster, you can carry on with your own work in relative peace and productivity. Of course, the disaster news is still a distraction that can bother you even when you are not looking at it, but by reducing the extent of the distraction, you give yourself the best chance of completing something of value.

Tuesday, September 19, 2017

Trans Fat Bans Set for 2018

Removing trans fat from food turns out to be simpler than it appeared. That’s because the vast majority of trans fat in food is placed there intentionally in artificial ingredients that consist of pure trans fat. Prohibiting these ingredients, partially hydrogenated oil or PHO, is a simple administrative step and does not require any extra diligence or difficult adjustments at food factories, but it is sufficient to take away close to 99 percent of trans fat from food.

The FDA issued its final determination on PHO on June 15, 2015, and it goes into effect on June 15, 2018. As government rules go, this is an unusually simple one, indicating that PHO is not “generally recognized as safe” (GRAS) and therefore cannot be used in food for humans sold in the United States. Exceptions are made when manufacturers do detailed safety studies that are accepted by FDA. The fine print in the rule is used to make sure that fully hydrogenated oil (FHO) is exempt from the rule while not allowing food factories to sneak PHO into our food by disguising it as FHO.

To food manufacturers, though, the more important rule is the one made by Health Canada, finalized last Friday and set to go into effect on September 15, 2018. On the surface, the Canadian rule is compatible with the U.S. rule, but there are two important differences. First, Canada is adding PHO to its list of food contaminants. Unlike the more roundabout FDA rule, this action directly makes it a crime to sell food containing PHO in Canada. Second, Health Canada is not allowing the long list of exceptions for small amounts of PHO that the FDA says it will allow in the United States. My expectation is that food manufacturers will follow the Canadian rule and stop using partially hydrogenated oil completely in order to be able to sell the same product across North America.

It is difficult to overstate the effect on health that removing trans fats will produce. Trans fats are clinically implicated in blood lipid problems, especially those related to cholesterol. These problems often develop into heart attack and stroke. Separately, trans fat is known to weaken cell walls. This reduces cellular functioning and is believed to reduce metabolism, cause generally poor health, and make a person susceptible to bruising, viral infections, and fungal infections. No one should be subject to this kind of ill health as a result of eating an artificial food ingredient that does not even add any useful quality to the food. The health effects of trans fat are not as severe as those of smoking, heavy metal exposure, or chronic dehydration, but are comparable in seriousness to the effects of a sedentary lifestyle. Health will improve across North America as a result of this change.

Monday, September 18, 2017

Toys ‘R’ Us On the Brink

Attention Toys ‘R’ Us gift card holders: now would be a good time to spend those gift cards.

Toys ‘R’ Us is one of the most popular gift cards in the United States, so there must be a good fraction of a billion dollars of them in consumers’ hands. Usually consumers hold on to the gift cards until they have a reason to buy a specific toy. But Toys ‘R’ Us has been living on the edge since the 2007 recession with more debt than it could realistically repay, and now Wall Street Journal says it is preparing for a possible bankruptcy before Christmas.

It is a complicated situation. Toys ‘R’ Us owes so much it needs an above-average shopping season every single Christmas just to carry on into the next year. This is a game that will almost certainly end as soon as the next recession hits. On the other hand, the current complaint at Toys ‘R’ Us is just a repeat of last year. Its limited credit meant it was unable to fill its shelves the way it wanted to. Yet the limited stock might have saved the retailer from a post-Christmas bankruptcy. The 2016 holiday shopping season was muted by a post-election hangover, but Toys ‘R’ Us did not face a crisis of unsold inventory because it had held back on purchases. That’s a strategy it is being forced into again now, and again, it is probably what the retailer should be doing anyway. What is different this year is that Toys ‘R’ Us has a $400 million debt payment due in May 2018 (with more to follow). My guess is that executives are betting big on shoppers being more exuberant than they realistically will be during the upcoming Christmas shopping season, because how else will they meet that payment? Yet the big gamble increases the chances of a sudden collapse. Though it might not sound very businesslike, the best chance for the troubled retailer to survive financially is for it to continue to limp along as efficiently as it can and hope for a miracle. Sometimes the prospect of bankruptcy gives a troubled business more leverage to negotiate, and with luck, in this case that might allow a debt restructuring just large enough to get by.

However, the potential for a bankruptcy is hanging in the air, and for a shopper holding a gift card, the simple thing is to spend the gift card and take delivery of the merchandise before the bankruptcy filing occurs. That is, make those Christmas, Halloween, or party decoration purchases in advance. Usually a bankruptcy court will allow gift cards up to a specific cutoff date, after which they are worth nothing, but the point is, if you’re still holding a gift card on the bankruptcy date, the fate of the gift card is something for the court to decide. That’s a complexity you avoid by spending the gift card sooner. No one knows whether a bankruptcy filing is on the way or what the date might be until the papers are signed and taken to the courthouse, but the people Wall Street Journal talked to were guessing this would happen within the next few weeks.

Most retail bankruptcies happen in January after a lackluster Christmas season, and that is another possibility here. For a retailer to be planning a bankruptcy before Christmas shows how desperate the situation is. That Toys ‘R’ Us’ financial predicament gets tighter every year is a measure of how thin its operating margins are, usually a sign of a business that is trying to do too much. A bankruptcy restructuring plan can correct for that, for example, by closing most locations and shutting down Babies ‘R’ Us.

One reason for doubt about a toy retailer is that more shoppers are doing their Christmas shopping in August and September, either to avoid the seasonal rush or just to get a chore off their to-do lists. The trend toward earlier shopping provides an efficiency gain for retailers but does not help a retailer counting on throngs of shoppers in December to keep the doors open. Another trend is that more toy purchases are being made online. With that trend, it is likely that the web store will remain after it is all over, whether operated by the current company, a successor, or an unrelated company that purchases the brand and domain in liquidation.

If Toys ‘R’ Us goes into bankruptcy in October, it will likely enter with a restructuring plan that does not represent a large enough change for the court to approve. The plan will be scaled up or otherwise refined during the bankruptcy proceedings, a process that could take weeks or months. In the meantime, specific stores might be approved to close. If the court is not convinced of the prospects of the restructured business, it could order a liquidation at any point. There is a possibility, either way, of Toys ‘R’ Us store-closing sales during the Christmas shopping season. That’s a prospect that should give all other U.S. toy retailers pause. Buyers for all U.S. toy retailers might be spending this week dialing back their inventory purchases for the holiday season.

Update, 24 hours later: Toys ‘R’ Us filed its bankruptcy papers Monday night. A public statement indicated that a bankruptcy filing for its Canadian subsidiary only would follow. Based on public statements, Toys ‘R’ Us is expected to remain in bankruptcy beyond the end of 2017. It was not immediately known whether stores would be able to fully stock toys for the holiday season or how many stores would be expected to close before and after Christmas. Statements are consistent with an incomplete restructuring plan that would carry a significant risk of bankruptcy liquidation, though any such move would more likely be decided in 2018. A court decision covering operational issues such as gift cards, payroll, and emergency funding is expected Tuesday.

Friday, September 15, 2017

Speculation on Equifax

I’ve been watching with interest as Equifax unravels. Last week it announced the largest-ever leak of highly confidential personal data. The leak is so large that, for most of us, there is no point in checking to see whether your own data was involved in the leak. Just ask yourself if you have ever, in the United States, applied for a credit card or held a checking account that had overdraft protection. If so, it is more likely than not that your personal information, including Social Security and driver’s license numbers, were part of the leak. The leak is so large that there is now talk about doing away with the use of Social Security numbers for identifying taxpayers and financial accounts. That never happened before except in a very hypothetical way.

It is not just the data that Equifax holds on most U.S. consumers that is at issue. Credit card accounts of the much smaller number of Equifax customers have also been compromised. Other data of significance was included in the leak, too much to list here. Equifax’s public response to the crisis has been marked by the company’s indifference to and suspicion of consumers in a moment when its entire future depends on the goodwill of the public.

Nevertheless, the consensus among financial analysts is that nothing will happen to Equifax. Indeed, the company’s stock value has fallen by only a third. I believe in this case analysts have fallen into the trap of not believing in consequences. I would argue that it makes sense to look at the possibility that there are no consequences in the Equifax case but also at the possibility that there are consequences.

What happens to Equifax depends to a great extent on the facts of the situation, and those are mostly secret at this point. One of the biggest questions is the extent to which Equifax leaked data that it was not legally entitled to hold in the first place. If this is extensive or pervasive, then there is no reason to imagine that the company can continue to operate. Its liabilities in this scenario do not depend on showing a degree of negligence, since the harm would have been caused by intentional actions of the company.

It is useful to consider Equifax’s position as a private investigating business. This is not like the leak at Home Depot or Target, where the company’s customers were the victims of the leak. Consumers are not customers in this case. For the most part, consumers do not directly give Equifax permission to collect and hold their data. So what separates Equifax from the criminal enterprises that obtained the same data? Only subtle legal distinctions make Equifax a legitimate business while others who collect the same data on you are criminals. This separation is based on fine points of the law that only a lawyer would be able to explain. But Equifax is not run by lawyers, so we don’t know how well they were following the laws involved. Not perfectly, it is safe to say, but under the circumstances it is reasonable to ask whether the company had controls in place to ensure that it followed the law in general. Conceivably it did not, and in that scenario, Equifax actually is the “hacker” in this case and is not entitled to any sympathy for having been victimized by another hacker.

In between, of course, there is the question of whether Equifax made commercially reasonable efforts to protect the data it held. This question, it turns out, is also vital to the future of the company. In particular, it is important to know whether Equifax lived up to the standards of care for highly confidential data in the banking industry. Why? If Equifax is not as secure as a bank is supposed to be, then it could effectively be shut down by banking regulators. It doesn’t appear that the Fed or the O.C.C. have the authority to take action directly against Equifax, but it hardly matters. If regulators issue guidance to banks that says that sharing data with Equifax is not consistent with banks’ obligation to keep data secure, banks will be obliged to stop sending Equifax any new data. A bank that violated any such guidance would risk regulatory fines and would face legal liability of its own for any subsequent data leaks. No reputable bank would take on those risks. Similar indirect actions could come from Visa or Mastercard that would prohibit credit card issuers from sharing credit card account data with Equifax. Equifax could not operate in its current form after even one such action against it. It would instantly lose most of its legitimate sources of data and most of its revenue. In all likelihood, it would close its doors for good at the end of the next day.

Even if Equifax were found to have done nothing worse than ordinary negligence, the legal liabilities could sink the company. The financial damage caused to U.S. consumers by the first leak alone is probably between $50 billion and $150 billion — an average of a few hundred dollars per consumer. The company’s total stock market value is only $11 billion. The entire company is not worth enough to pay for the damage. The company would have to dodge liability almost completely to survive financially in the end. I’m not saying that couldn’t happen, but if a horse named Equifax presented that kind of long odds you would not want to bet on it. Imagine just paying the lawyers to defend a company against lawsuits brought by more than 150 million people. A company could claim vindication in such a case and still go under from legal fees and reputational loss.

I must conclude with a reminder that the facts in the case remain secret and that this is all just speculation. The actual facts could be better or worse for the company than they appear at this point. At the same time, when people say that nothing will happen to Equifax, remember that that is a speculative position too.

Monday, September 11, 2017

The Post-Consequence World

Hurricane Harvey was a record-breaker, the rainiest hurricane ever, and now Irma is another, one of the largest hurricanes ever and the most persistent ever recorded in its class. Despite this, the weather deniers have been out trying to debunk both weather events. During the weekend, a right-wing extremist radio host told his audience Hurricane Irma was a fake, before deciding he had better evacuate. Then one of the prominent voices of the killer faction of the Republican Party posted false reports claiming that the storm had not reached the Miami metropolitan area. When Harvey was in the Gulf of Mexico, a larger chorus of voices tried to explain why the storm would be a non-event by the time it reached the shoreline. The common threads here are a disdain for science and its quality of careful observation, and a lack of concern for accountability.

The disdain for science comes with obvious perils, but it hard to make the same claim about accountability. Those who operate under the theory that they can say anything at all regardless of facts or consequences have amply proved that they are able to continue to operate in that fashion for years, simply because the core of American culture no longer quite believes in the idea of consequences.

Consequences do in fact exist, though, and economically, one would expect that believing in consequences would eventually provide a distinct competitive advantage. If there are two parties and one considers consequences while the other acts as if consequences do not exist, you would expect the former to bury the latter eventually. The huge example is the Soviet Union, which collapsed economically in the end mainly because ordinary industrial work and matters of national policy were addressed as if there were no underlying reality to either. Now, though, Russia is on a path to repeat this failure, and the disbelief in consequences has become a global trend affecting countries from Argentina to Bulgaria and businesses from retailers to software companies.

How can this be? There are problems in getting good information, of course, and there are lags, often lasting many years, between an action and a definitive outcome. In between, effects are subject to interpretation, like the smoker who sees the medical image of masses in a blackened lung and says, “That isn’t really cancer.” Making this pattern more likely, we have all been conned. We see someone proceeding with strong confidence and say, “Well, they must know something,” even though from everything we know they are doing exactly the wrong things. We collectively face more time pressure and distractions than ever. It’s no wonder if accountability slips through our fingers.

The lack of belief in consequences now extends to the most reputable business journalism. A business that recently leaked sensitive information about more than half of Americans, most of them not its customers, now faces liabilities that are ten times the total value of the business. Reputable analysts bemoan the errors and deceit but still conclude that nothing will happen to the company or its officers.

If we cannot expect the world to return quickly to a belief in consequences, we must at least be alert to the effects of living in a post-consequence world. We regularly face large amounts of propaganda and other persistent false information. Institutions that seem permanent will vanish with little or no warning. People will present patterns of behavior that would be perilous to imitate. We must expect these things to happen.

One of the defenses against the illusions of a post-consequence world is a sense of proportion. Simply understanding the relative sizes of things can point us toward the possibilities ahead. If we hear that the largest city in Texas got a year’s worth of rain in three days, we should be able to think, “That’s big.” Unfortunately, proportion is not an innate human skill, but requires practice.

Proportion helps us spot where things are out of balance in a big way. In a world were most people aren’t looking for consequences, those are the first places to look.