Easy Sunday: Tipping point.

I feel like I have been here before. 

--   This feels like 1999-2000, and the internet bubble is at the top.

--    It feels like 2008, before everything fell apart.

Warning the CEO

"So, what you're telling me is that the music is about to stop."

Artificial intelligence platforms want to charge what it costs them to run their service.  Artificial intelligence users are now treating AI as expensive overhead, not a freebie, and they are starting to shop. 

The era of magical thinking is over.

Friday's Wall Street Journal had this story:

Gifted link to the story

Somebody is going to need to pay for the electricity, the data center construction and operation, all those chips, all the programming and data, and all the investment that has been driving the U.S. economy for this year. Artificial intelligence platforms have initial public offerings ready to launch. Investors buying those IPOs want to see that AI companies make money. 

My $20/month subscription to Claude, an AI platform, is switching to a new payment model, and there is something about "token credits."  Apparently, Claude is going to start charging me what I cost them. I have heard of professional high-volume users of AI who are paying $10,000/month in fees for tokens. Of course, those users are beginning to shop, and China has a much, much cheaper alternative.

I like the price I pay for AI when I use Google, or Apple maps, or when I say, "Hey, Siri." The price is free, or nearly so. That may be the long-term equilibrium price for AI. 

I could see that something was very wrong with the mortgage and housing markets in the several-year buildup to the Great Financial Crisis. TV ads were urging people to buy houses with 110-percent financing. That is, people with no money would be given $50,000 cash to buy a $500,000 home and borrow $550,000 and start making mortgage payments. Once house prices failed to go up, those buyers would not be able to make their payments, nor could they sell their house at a price high enough to pay off the mortgage. The business model for "free money" in mortgages was unrealistic and dangerous. 

The business model for cheap artificial intelligence was unrealistic and dangerous, too. We are entering a period of dislocation where the business needs of providers and users of AI need to come into sync. We are in a mark-to-market moment, that moment when the artificial price ends, and buyers and sellers clear the market by paying the real price for something. 

Today's Easy Sunday post includes a movie clip and transcript from the movie Margin Call. It is the scene where the top executives of the investment bank initiate their own mark-to-market fire-sale of mortgage bonds. The music of magical money built on mispriced mortgages had ended. Click below to see a nine-minute clip. Sit back. Enjoy. This is history. We entered a rough patch in the economy, and people got badly hurt, but most of us survived, and here you are on a mid-summer Sunday.

I have also excerpted a bit of the dialog.

Click here

Sullivan is the quantitative expert who described the precarious situation for the investment bank. 

Tuld is the CEO of the bank.

Sullivan: Well, we have to hold these assets on our books longer than we might ideally like to.

Tuld: Yes.

Sullivan: But the key factor here is, these are essentially just mortgages, so that has allowed us to push the leverage considerably beyond what you might be willing or allowed to do in any other circumstance, thereby pushing the risk profile without raising any red flags. 

Tuld: Now -- thank you, Mr. Sullivan. Sit down. What I'm guessing your report here says -- and give me some rope here -- what I'm guessing it says is that considering the, shall we say, bumpy road we've been on the last week or so, that the figures your brilliant co-workers up the line ahead of you have come up with don't make much sense any more, considering what's taking place today.

Sullivan: Actually, not what's taking place today, but what's already taken place over the last two weeks.

Tuld: So, you're saying this has already happened.

Sullivan: Sort of.

Tuld: Sort of. And, Mr. Sullivan, what does your model say that that means for us here?

Sullivan: Well, that's where it becomes a projection. But, um --

Tuld: You're speaking with me, Mr. Sullivan.

Sullivan: Well, sir, if those assets decrease by just 25%, and remain on our books, that loss would be greater than the current market capitalization of this entire company. 

Tuld: So, what you're telling me is that the music is about to stop, and we're going to be left holding the biggest bag of odorous excrement ever assembled in the history of...capitalism.

Sullivan: Sir, I'm not sure that I would put it that way, but let me clarify. Using your analogy, what this model shows is the music, so to speak -- just slowing. If the music were to stop, as you put it, then this model wouldn't be even close to that scenario. It would be considerably worse. 

Tuld: Let me tell you something, Mr. Sullivan. Do you care to know why I'm in this chair with you all? I mean, why I earn the big bucks?

Sullivan: Yes.

Tuld: I'm here for one reason and one reason alone. I'm here to guess what the music might do a week, a month, a year from now. That's it. Nothing more. And standing here tonight, I'm afraid that I don't hear a thing. Just...silence.

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