The case book of Sherlock Holmes
In the two years since Sherlock Holmes opened his pro bono cyber-consultancy on housing finance, he has commented prolifically on topics ranging from World Bank pipelines to the dangers inherent in excessive zoning. So forthcoming has Holmes been, in fact, that Watson as his humble biographer has at times despaired of organizing the Great Detective’s wisdom. As we tuck into our Thanksgiving dinners, among those most grateful is Dr. John H. Watson, for whose relief we present this organized compendium of Holmesiana:
A. Money in all its forms
Along with his monographs on tobacco ash or disquisitions on the shape of the human ear, Holmes has laid out a complete taxonomy of money, starting with:
“Surely this is fascinating,” Watson interposed, “but why the lengthy disquisition, Holmes”?
Watson wondered, Were these new men soft capital sources?
“For a simple two-part reason:
1. Deep affordability requires soft capital.
2. At scale, soft capital requires government.”
“And this, you see, is the absolutely fundamental truth: if you want quality affordable housing at scale (at small scales, foundations play a key role), government must facilitate soft capital.”
“But how do developers use these forms of money in their nefarious plans?”
“That, Watson, is quite a three-pipe problem ….”
Importuned by Watson, after a few months Holmes expanded on the topic, giving each form its own brief case history, as in:
Hard debt, one of the four kinds of money, is an essential element in affordable housing,” said Holmes abruptly, “though the very affordability instincts that induce policymakers to offer favorable terms also substantially increase its potential to do harm.”
“Harmful?” asked Watson. “But are not the Federal government and state agencies replete with low-cost, high-leverage loan programs?”
“And in that lies the danger,” Holmes said, for as Archimedes and Michael Milken demonstrated, ‘Give me a line of credit long enough and I can buy the world.’”
3. Hard equity: the Adventure of the Six Simoleons
Asked Watson, “Isn’t hard equity essentially the same as hard debt?”
“Not at all. Lending is renting money — I let you use it for a while, then you give it back to me, plus a certain agreed rent (interest).
“But the equity investor also lets me use his money for a while.”
“Not for a while,” Holmes replied with some asperity, “indefinitely. An equity investment is selling money. You buy my money from me — I have no means of getting it back. In exchange you give me a financial object — ownership in a venture. So my investment decision is quite different. When I lend, I look at your collateral — the security for my repayment. When I invest — when I sell you my money for stock certificates or other pieces of paper — I have to bet on your venture. I have to believe that the business will be worth more, and if I want to realize cash for my ownership, either it flows from the business’s profits, or I have to on-sell my shares to a greater fool who believes what I no longer do.”
There once was a fellow named Ponzi …
“The irrevocability of the sales bargain inherent in equity investment is a topic I shall take up another day.”
4. Soft debt: the Case of the Kindhearted Banker
“Soft debt, Holmes? What on earth do you mean?”
The great detective smiled. “Debt that is not hard,” he said cryptically.
Watson chafed at the straight lines he was being given.
5. Soft equity: the Banker Street Irregulars
“I have previously elucidated the utility of soft debt. Soft equity is a further refinement. By employing Wiggins and his friends, I transfer risk to them, an example of the benefits of soft equity. I shall now explain, excerpting from an excellent monograph on the subject in a South African context (link in .pdf).”
“The least a fictional character can do is compliment his author.”
6. Income subsidy: the Fifth Kind of Money
Holmes,” began Watson, “I’ve been reading Web Updates about proposed cuts in Section 8 subsidy funding, and I’ve been thinking” — how industrious, thought Holmes — “is not subsidy a form of money? One we have not treated? A fifth kind?”
“A fifth kind of money?”
Is subsidy a kind of money? “Subsidy is not a kind of money,” said Holmes, nettled, looking up from the agony column of the Financial Times, which he had been perusing with the silent glee of a short-selling contrarian.
B. Principles of housing finance
Money has its own economic imperatives, as Holmes catalogued in:
7. Credit decisions: the five denying pips
“But surely it is up to the individual to qualify,” Watson protested. “It is not the lender’s job to make someone creditworthy.”
“It isn’t?” Holmes said with a touch of asperity. “For some lenders, it is. And it is always profitable to do good business. Yet so many lenders, a herd of limited observance, fail to appreciate how they can expand bankability.”
“People are bankable if they are not unbankable,” he went on after seeing Watson’s look of surprise. “So it may be useful to express the bankability frontier by examining the six credit-based reasons — that is, reasons grounded in a logical decision about credit, as opposed to irrational, prejudiced, or racist reasons — why a lender may deny credit.”
The forms of money are raw materials, swatches that are stitched together in an overall financial plan:
8. The capital stack: the missing three-quarter
“Holmes,” began Watson, pushing away the mouse and rubbing the glowing pixels out of his eyes, “you have previously categorized the four kinds of capital financing — hard debt, soft debt, hard equity, and soft equity — but you have yet to articulate how they are combined into a financing plan.
Watson started to reply, then checked himself. “They all are. Each depends on the other.”
9. The financing quilt: the Musgrave Ritual, Part 1 and Part 2
As my Musgrave case preceded Watson, I have had to write it myself.
“My dear Musgrave,” I replied with a touch of asperity, “if that was your dream you were always doomed to fail. No one source will provide all the capital, handing it as on a plate to you, with you having nothing at risk. And the reason is risk-reward ratio. For this investment, from inception to final repayment, which moment in time is the riskiest? Obviously the instant just after initial closing.” I tapped the left-hand line. At that moment, all of the capital is committed, but none of the value has been added. “And which is the riskiest dollar?”
“The last repaid,” Musgrave said, sitting forward. He tapped the uppermost point, labeled TDC for Total Development Cost. “That last pound is always the hardest to find because it has the first loss.” He shook his head. “The puzzle is insoluble.”
“Pshaw. I believe your ancestor solved it. And your ancestor’s ritual is a mnemonic that shows how.”
Holmes then used these principles to deduce another by implication:
10. Affordability implies financial complexity
“Can it not be simplified?”
“I believe not.”
“Doesn’t that make affordable housing finance inefficient?”
“Efficiency is quite a three-pipe problem.”
“Efficiency.” Holmes drew the word out slowly. “A most complex subject, doubtless worthy of a future monogram. Tell me, Watson, about which do you wish to be efficient? The use of capital? The long-term property value? Targeting of the affordability? Transference of risk to the private sector? Compliance with program rules? Enforcement? You know, the absolute most efficient charity is to hand ten dollar bills on the street — but is that the most effective?”
C. Insights and commentary on current events
A lifelong Londoner, Holmes believes in cities:
11. Sherlock Holmes, new urbanist
“It is my belief, Watson, founded upon my experience, that the lowest and vilest alleys in
“You horrify me!”
“But the reason is very obvious. The pressure of public opinion can do in the town what the law cannot accomplish. There is no lane so vile that the scream of a tortured child, or the thud of a drunkard’s blow, does not beget sympathy and indignation among the neighbours, and then the whole machinery of justice is ever so close that a word of complaint can set it going, and there is but a step between the crime and the dock. But look at these lonely houses, each in its own fields, filled for the most part with poor ignorant folk who know little of the law. Think of the deeds of hellish cruelty, the hidden wickedness which may go on, year in, year out, in such places, and none the wiser.”
– The Adventure of the Copper Beeches, page 288
12. Economic hostage: the problem of the noble benefactor
Holmes contributes his talents pro bono to worthy causes:
Paul D. Wolfowitz, read the neat card on Holmes’ salver, Worldly Philosopher. “Sir,” asked the Great Detective over his pince-nez, “how may I help you?”
Our guest was distinguished
“Long have I admired your treatises on the hundred and seventeen types of tobacco,” began our guest, twisting the brim of his brushed black silk top hat. “I have the honor to administer a trust operated by a small philanthropic society,”
“You do yourself too little honor,” murmured Holmes.
“whose funds, raised by subscription, are deployed throughout the world to aid the suffering and encourage the enterprising. My predecessor has placed me in a most untenable situation with an African potentate. Our society, in concert with certain private investors, funded a major pipeline and refinery to extract the potential from a vast oil field that for decades had lain unused while its owners suffered.”
Holmes returned to these principles some months later in an update of the Noble Benefactor’s problems, in:
13. Chad pipeline: who blinked? Part 1 and Part 2
“After his predicament had been reported in two parts (Part 1 and Part 2) on a particularly astute blog — a technological innovation,” he said, seeing Watson’s look of utter incomprehension, “he visited us.” He sighed. “I wish we had been able to do more for him.”
The matter admitted of no easy answer.
“Still, he seems to be managing fairly well on his own. He took our advice and refused to fund the scoundrels.”
The oil royalties have been frozen for five months in a dispute with the World Bank after
That left the malefactors with no alternative but to escalate their threats even as their bluffs were repeatedly called. Progress of a sort has now been made. Consider this brief mention.”
D. Is Holmes retiring to
Have no fear, housing mystery fans: Sherlock Holmes will be back soon, with more baffling financial puzzles explained by his brilliant deductions, including Capital Markets, The Adventure of the Money Store, Part 1 and Part 2; and The value of urban land: Moriarty & Milverton Development Company.
Be careful reading AHI blog posts after dark.