Coin Appears to Be Headed toward Failure

Remember Coin? They caused a stir last year with a video about how their device could replace all of your wallet's credit cards. You could bring the George Costanza wallet into the digital age.

Reading over the FAQ section, either the company is running out of money or has a fundamentally flawed understanding of how customers behave. Companies that can appease customers' risk aversion can go far; look at how reassuring Zappos's return policy is.

I've launched a pretend conversation below.

FAQ section: How much does a Coin cost? Each Coin costs $100. For you early adopters there is a very limited quantity that can be purchased for $50.

Risk-averse consumer: I have the choice of buying now and getting an as-yet unfinished product at an unknown time, or waiting and feeling a loss of paying nearly double.

FAQ: How many cards can a Coin hold? A. The Coin mobile app can store an unlimited number of cards, however, a Coin can hold up to 8 cards at a time.

RAC: I'm probably one of the 90+% of people who can get by with only eight cards, but this limit is freaking me out! I hate this just like how I hate cellphone companies limit my monthly data usage, and how I worried about my download limit with my cable provider until they caved.

FAQ: Why do I have to buy a new Coin when my battery runs out? A. Coin is the size of a typical credit card and we were not able to fit a replaceable battery nor recharging components into this form factor. Coin is an electronic device, not a plastic card. We must charge for each device to cover the costs of research and development, manufacturing, and support.

RAC: This is another thing for me to stress about. Why won't you let me charge it? How can I believe your claims about the typical battery life? What if it runs out at an inopportune time (after all, I will have left all of my other cards at home and have no way to settle my bill)? Can't this come with some sort of warranty? I would feel terrible about buying something that I already bought.

FAQ: How do I get help or support? A. Please email us at help@onlycoin.com. We currently only offer email support. Our support hours are 8 am-5 pm PT Monday-Friday.

RAC: That sounds vaguely uninspiring.

In Defense of Adjustable Rate Mortgages

"No!!! We are not getting an ARM! If you want to get an ARM, I am done looking at condos with you!"

"Haven't you read about those people in the newspaper? It's worth it for peace of mind!"

"If you want to get an ARM, I'm not giving you any of the blanket!"

Normal people, like my fiancee, tend to say that they don't want X, no matter what. Economists, in contrast, tend to say that they might want X, if the price was Y.

To see if an adjustable rate mortgage would be right for us, we have to estimate a few parameters. For instance, consider a 5-1 adjustable rate mortgage, where the interest rate is fixed for the first five years. If an ARM offers a rate that's 1 percentage point lower than a fixed-rate loan, that's quite a bit of money: for instance, 1% of $300,000 is $3,000--per year.

If there's a 100% chance (or something close to it) that interest rates won't rise during the duration of our loan, then an ARM is a great deal. But it's very hard to make this assumption. More realistically, if there's a 100% chance (or something close to it) that we'll move to another house within the first five years, then an ARM is a great deal. Neither of these conditions is necessarily true, but we should at least consider if they might be.

But one meta parameter trumps everything else: my spouse's happiness is worth more than potentially saving some money by "gambling" on the mortgage.

More on the Exponential Discount Rate

Yesterday, I wrote about the wonderful application of economic theory to a dilemma from Seinfeld. The paper I mentioned uses an exponential discount factor to model how people value pleasure today versus pleasure in the far future.

I came across another example of this concept in a passage from a paper on the food stamp nutrition cycle. The author's first paragraph, copied below (emphasis mine), discussed the implications of the exponential model, before quickly abandoning it for alternative approaches:

Consider a consumer who is indifferent between enjoying one additional dollar of consumption today and 99.6 additional cents of consumption tomorrow. Such an individual has a daily discount factor of 0.996, and if she is an exponential discounter her annual discount factor will be about 0.23 (corresponding to an annual discount rate of about 146 percent). She would therefore strictly prefer 24 dollars of additional consumption today to 100 dollars of additional consumption one year from now, and would happily accept seven cents today in exchange for 100 dollars in five years.

If you ever so slightly prefer consumption today over consumption tomorrow, you'll prefer pennies today over huge amount of money in the far future, according to the model.

What should economists do in the face of such a surprising result? It's a tough question. We could call the conclusion absurd and modify the model until it produces an alternative conclusion that sounds more reasonably. Or we could go against our intuition and attempt to test this result empirically.

Why Are Cash Advances so Expensive?

My primary credit card charges 24.99% APR for cash advances and 9.99% APR for purchases. Unlike purchases, cash advances have no "grace period," meaning customers are still charged interest even if they pay off their bill in full every month.

Both transactions involve borrowing money from the credit card companies: one for purchases and the other for cash. Yet the companies encourage the former while strongly discouraging the latter. Why?

When consumers swipe their cards at stores, the credit card companies charge the merchants an interchange fee, typically 2% of the value of the transaction. When someone gets a cash advance, there is no merchant to pay the fee. The credit card company needs to make up this money somehow to remain profitable; thus, they charge a higher interest rate.

If there were a grace period for cash advances, they would amount to interest-free loans. Customers could deposit their cash advances into interest-earning saving accounts and then return the money before the end of the month. Many customers would max out their credit to take advantage of this risk-free profit opportunity (also known as arbitrage), as credit card companies watched their losses mount. Eliminating the grace period for cash advances is one way to prevent such behavior.

Invest in Stocks or Housing?

This is an oldie but goodie, pointed out by many other economists.

Which investment performs better over the long run, housing or the stock market?

Without even looking at the data, the answer has to be the stock market. That's because a home provides you a place to live, or a place that you can rent out to other people, earning rental income.

Stock ownership has no such auxiliary benefits. If the average annual rate of return for housing was, say, 5%, then the average return for stock ownership must be higher, to compensate for the fact that it doesn't directly provide you warmth and shelter. If the average return to stocks were lower decade after decade, there would be no point in investing in them.

(Of course, sometimes the whole thing gets blown out of whack, as it has the past few years. But over the long haul, the above holds true.)

Snow Storm Approaching! Time to Hit Up ... the Bank?

So reports the Washington Post.

In my prior post, I discussed how there's been stampedes at the local supermarkets. But why this happens at the banks is more puzzling. If most people are going to be trapped in their homes this weekend, why bother getting money from the bank if they can't spend it anywhere?

One woman is quoted as saying:

"I am just taking care of bills before the snow hits."

Well, doesn't that just involve signing checks?

HT to Sharon.

When to Buy a House?

Another in my series on "Buy Ketchup in May and Fly at Noon":

WHEN IS THE BEST TIME TO STOP RENTING AND BUY A HOUSE? When it costs less to buy than to rent. And how do you figure that out? Find two similar houses—one for sale and one for rent—and divide the asking price by the annual rent. The answer is the rent ratio. During the 1970s, 1980s, and 1990s, the nationwide rent ratio stayed between 10 and 14, then rose to nearly 19 in 2006, when the housing market topped out. (The rent ratio neared 35 in San Francisco and San Jose in 2006, among the highest in the nation back then.) A rent ratio of 20 or more usually means that it costs considerably more to own than to rent, once you factor in the mortgage, taxes, insurance, repairs, and other expenses. Ideally, you’ll buy when the rent ratio is a lot closer to 10 than to 20.

(Read all of my posts on this book here.)

While the rent ratio may be a good rule of thumb, it is not the only factor a potential homebuyer should consider. Interest rates are also important, as a few percentage points can mean thousands of dollars over the course of a 30-year mortgage.

More importantly, although owning a home builds equity, it can also be a very dangerous investment, as evidenced by the recent housing debacle. Many homeowners are now underwater, owing more money on their homes than they can sell them for. They can't afford to leave, and they can't afford to stay; they wouldn't run this risk as renters.

Buying Horses With Gold?

Once again from "Buy Ketchup in May":

WHEN IS THE BEST TIME TO BUY GOLD? When the economy is stable. That’s when gold prices are lower. During a recession or a period of economic instability, the dollar decreases in value, and people tend to look to gold as an investment. The demand for gold drives up the price, and it’s not as good a deal then. Some gold investors point out that the value, or buying power, of gold hasn’t changed in more than 200 years. That means if you paid for a horse in the year 1809 with an ounce of gold, you could buy a horse in 2009 with an ounce of gold. (Gold price in 1808: $19 an ounce; in 2009: about $900 an ounce.)

(Read all of my posts on this book here.)

The best time to buy gold is not the focus of this post (though people often flock to gold during recessions because it is a "safe" asset, driving up the price). I was more interested in the comment about how much gold is required to buy a horse. Gold is indeed a stable asset. As a counterexample, if you held all of your money in dollars, you risk devaluation through inflation; if the government prints a lot more money, your dollars can't buy as much as they could before. Because we can't create more gold, there is no inflation risk. In fact, much of monetary history has revolved around the gold standard.

The nominal value of gold has risen about 4,600% in that 200-year span, according to the book. That sure sounds impressive, but the price level has also risen at a similar rate. So now your ounce of gold can get you $900 instead of $19, but that amount of money can still only buy one horse. It has the same "purchasing power."

Gold is indeed cheaper in a booming economy, but it is a poor bet for long-term economic growth, as it foregos any interest you could have made had you invested the money elsewhere. If you invest in other assets, such as stocks and bonds, you can expect a substantial real interest rate over such a long period. The average annual real interest rate from 1950 to 2008 was 6.8%. Assuming that this was about the same over the 200-year period, $19 invested in stocks in 1808 would be worth $9.8 million today, through the magic of compound interest. Now that could pay for quite a few horses.

Why Is Filing Taxes Still So Hard in the Internet Age?

The New York Times has an interesting column arguing that because the federal government already has a lot of information about your earnings (through W-2's and the like filed by employers), why can't it fill in some of (or all) the blanks on your online tax return? The columnist argues:

Requiring taxpayers to file returns without being told what the government already knows makes as much sense “as if Visa sent customers a blank piece of paper, requiring that they assemble their receipts, list their purchases — and pay a fine if they forget one,” said Joseph Bankman, a professor at the Stanford Law School.

Indeed, such a system would save substantial headache for millions of taxpayers every year. Why doesn't it already exist? Maybe it is the result of a lack of innovation on the government's part. Or maybe the tax preparation industry has sufficient lobbying clout to discourage such efforts; after all, the harder and more inconvenient it is to file taxes, the more profit these firms can expect to earn, as taxpayers turn to them for help.

However, I can think of two legitimate reasons this is not done:

(1) For the conscientious taxpayer, a form that is already filled out may lead to oversights. Because I have to start from scratch every year, I make myself a list of the jobs I've had in the past year, the interest income I've earned, my charitable giving, etc. If the norm were for taxpayers to glance over a prefilled form every year, many of these things may be overlooked.

(2) More importantly, many people are tempted to evade taxes. Taxable income falls into two categories: things the IRS knows about, and things that it doesn't. Under the current system, the taxpayer isn't sure what the government knows, so he should err on the side of reporting everything. If he omits some income that he doesn't think the government knows about, and he's wrong, he could be subject to hefty fines if this is discovered in an audit. This threat of being caught is enough to keep many people honest, even if the odds of punishment are low. However, if the government prefills a tax return, it is showing its hand. If the taxpayer notices that certain income has been omitted, what incentive does he have to report it? The government has admitted that it does not know about this income, and it likely never will. Therefore, the government collects more money under the current system than it would if tax returns were prefilled. However, the magnitude of the collection is important: if the current system collects only an additional $1 million in tax a year, the cost to taxpayers is not justified. H&R Block has an annual income of around $4 billion a year; this number is just for one firm, and all of that money wouldn't be saved under the proposed system, but it helps us understand how many resources are required to sustain the current tax filing system. Clearly, the increase in tax receipts as compared to the proposed system would have to be substantial to justify the additional expenses on tax preparation services. It is unclear how the IRS's budget would be affected under either scenario.

Unintended Consequences: Free Checking and Overdraft Fees

From the New York Times:

Banks earn billions in overdraft fees, money that helps pay for free checking.

A chunk of that revenue will disappear when some consumers elect not to sign up for the opportunity to spend more than they have. This week, Bank of America said that $160 million in overdraft fee revenue had already disappeared, because of changes it made in its policies ahead of the new federal rules.

Yesterday, I briefly mentioned loss leaders—or products that business lose money on in hopes of making it back somewhere else. Free checking is a good example. A checking account costs the bank money (they have to process your transactions, provide ATMs and banking centers, allow you online account access or mail you statements, etc.), but they are willing to give these services away because it may lead to you becoming a customer for more lucrative products. Maybe you'll take out a mortgage with the same bank, generating thousands of dollars in interest payments. You might stay at your current bank out of sheer convenience or laziness instead of shopping around for a better interest rate.


For many low-income customers, the banks relied on a significant percentage of them occasionally spending more money than they had, triggering hefty overdraft fees. Recent legislation would require customers to opt into overdraft protection (otherwise, their transactions will be denied if they don't have enough money). When the government makes it impossible for a business model to profit, it ceases to exist. Without those overdraft fees, free checking is likely to become a thing of the past.