Speaker 1: Ze Media, Hello, and welcome to this week's Better Offline Monologue.
Speaker 1: I'm your host ed Ze tron. That's right, it's your
Speaker 1: second damn monologue this week. But next week we're going
Speaker 1: to have an awesome guest economist Paul Kajowski, and no
Speaker 1: doubt some sort of us will break that will make
Speaker 1: next week's monologue even spicier than this one. And man
Speaker 1: is this spicy anyway. Earlier this week, I put out
Speaker 1: a free newsletter about the SUBPRIMEI crisis. My ongoing theory
Speaker 1: that as AI companies strive to try and make their
Speaker 1: rotten economics work, they'll left to start cranking up the
Speaker 1: price and making rate limits worse and generally trying to
Speaker 1: move things around to make these products anything close to profitable.
Speaker 1: But they won't even get close.
Speaker 2: Now take a.
Speaker 1: Little history trip. That's how I'm going to That's what
Speaker 1: I'm calling it. When the subprime crisis happened, the subcrime
Speaker 1: mortgage crisis, of course, millions of people built their lives
Speaker 1: around the idea that easy money would always be available
Speaker 1: and that anyone could get a mortgage, and that housing
Speaker 1: would only ever increase in value. In reality, the value
Speaker 1: of housing was massively overinflated by the lacks standards of
Speaker 1: a mortgage industry incentivized the sign as many people as
Speaker 1: possible thanks to a lack of regulation and easily available funding,
Speaker 1: the value of housing and indeed the larger housing and
Speaker 1: construction boom was of mirage. In reality, housing wasn't worth
Speaker 1: anywhere near what it was being sold for, and the
Speaker 1: massive demand for housing was only possible with unlimited resources
Speaker 1: and lacks well underwriting. So that which is the process
Speaker 1: of evaluating whether someone can get a house. You might
Speaker 1: know that, but I've been encouraged by Robert and Sourphy
Speaker 1: to be obvious with things. Those buying houses they couldn't
Speaker 1: afford with adjustable rate mortgages either didn't understand the terms
Speaker 1: or believed members of the media and government officials that
Speaker 1: suggested housing prices would never decrease and that one could
Speaker 1: easily refinance the mortgage in question. You know, kind of
Speaker 1: like saying things like, you know, AI is always getting
Speaker 1: more efficient, the values always going up, and venture capital
Speaker 1: will always invest in that.
Speaker 2: This is the new hypergrowth era.
Speaker 1: Similarly, AI startups products are all subsidized by venture capital
Speaker 1: and must in literally every case allow users to burn
Speaker 1: tokens far and excess of their subscription fees. A business
Speaker 1: that only works, and I put that in quotation marks
Speaker 1: as long as venture capital continues to fund it. And
Speaker 1: when I say that, I'm being quite literal. If you
Speaker 1: go and use Perplexity, you're comfortably able to even on
Speaker 1: a twenty dollars plan, burn thirty forty to fifty one
Speaker 1: hundred dollars worth of tokens within account a month. Anthropic
Speaker 1: allowed you, until very recently, to burn anywhere between eight
Speaker 1: to thirteen and a half dollars per dollar of subscription revenue.
Speaker 1: While from the outside these may seem like these are
Speaker 1: functional businesses with paying users. Without the hype cycle justifying
Speaker 1: the endless capital, these businesses wouldn't be possible, let alone
Speaker 1: viable in any way, shape or form, And indeed they
Speaker 1: wouldn't have any customers. My evidence being if they could
Speaker 1: get customers by charging their actual rates and offering a
Speaker 1: non subsidized product, they'd have them, and they would have
Speaker 1: had them from the beginning. Let me give you an example.
Speaker 1: Harvey is an AI tool for lawyers that just raised
Speaker 1: two hundred million dollars at an astonishing eleven billion dollar
Speaker 1: valuation or while having an equally astonishingly small one hundred
Speaker 1: ninety million dollars in AR or fifteen point eight million
Speaker 1: dollars a month. It raised another one hundred and sixty
Speaker 1: million dollars in December twenty twenty five, after raising three
Speaker 1: hundred million dollars in June twenty twenty five. After raising
Speaker 1: three hundred million dollars in February twenty twenty five, where's
Speaker 1: the fucking money, Harvey? Were you putting it?
Speaker 2: Harvey?
Speaker 1: Mister Harvey has been very unfair to the venture capitalists.
Speaker 1: Actually they're fueling I can't even say that. Remove even
Speaker 1: one of those venture capital rounds and Harvey coughs up
Speaker 1: blood and dies. Much like subprime loans allowed borrowers to
Speaker 1: get mortgages they had no hope of paying, hype cycles
Speaker 1: create the illusion of viable businesses that cannot and will
Speaker 1: never survive without the subsidies. The same does for companies
Speaker 1: like open Ai and Anthropic, both of whom created priority
Speaker 1: processing tiers for their enterprise customers in the middle of
Speaker 1: twenty twenty five, and the latter of which, just as
Speaker 1: I discussed in my last monologue, added peak rate limits
Speaker 1: from five am to eleven pm Pacific time, you know,
Speaker 1: just the entire day, and that was after they created
Speaker 1: weekly limits late last year. The customers are the subprime
Speaker 1: borrowers too. They built workflows around using these products that
Speaker 1: may or may not be possible with new rate limits.
Speaker 2: Think about it.
Speaker 1: If your whole business, the whole reason you use this
Speaker 1: software subscription is to do tasks, and suddenly the amount
Speaker 1: of tasks you can do is limited. Is this really
Speaker 1: is anything tenable anymore? Especially if you're one of those
Speaker 1: people who can't actually code and using this to vibe code.
Speaker 2: I'm not really sure this works.
Speaker 1: But in the case of the enterprise customers using Priority processing,
Speaker 1: their costs massively spiked, which is why Cursor and Replet
Speaker 1: and several other AI startups suddenly made their products worse
Speaker 1: in the middle of twenty twenty five, adding their own
Speaker 1: rate limits and changing their pricing. In reality, none of
Speaker 1: this ever made sense. None of this was actually possible
Speaker 1: outside of endless resources. Now traveling back in time, by
Speaker 1: November twenty nine, twenty three percent of US consumer mortgages
Speaker 1: were underwater, meaning that they were worth less than their loans.
Speaker 1: And I think we're eventually going to see that specifically
Speaker 1: with venture capital valuations. By the way, I think there's
Speaker 1: going to be a point when it's like ninety percent
Speaker 1: of AI startup valuations are going to be way lower
Speaker 1: or nil actually, and I truly think the subprime AI
Speaker 1: crisis will be much much worse for the value is
Speaker 1: AI companies made up more than fifty percent of venture
Speaker 1: capital investments in twenty twenty five. I actually don't know
Speaker 1: how any of them make it. This is something that
Speaker 1: I think about a lot. My thesis basically says, these
Speaker 1: companies are all dying. I don't see how it works out.
Speaker 1: They're not getting acquired. They can't go public because they
Speaker 1: have the worst economics of all time. In the moment
Speaker 1: you show the markets that it looks real bad. Minimax
Speaker 1: AI company in China that went public, I think it's
Speaker 1: fifty something billion dollars of revenue and like two hundred
Speaker 1: and something million and losses a little bit like that
Speaker 1: make the real money. Nevertheless, I really don't know how
Speaker 1: that works. I truly don't. I didn't think about it.
Speaker 1: I'm like, is there a way they could get acquired?
Speaker 1: Is there something else they could do? There really isn't
Speaker 1: all they can do is check up their prices and
Speaker 1: hope that people don't leave. And I think that's what's
Speaker 1: gonna happen, if they even bother, and if they can
Speaker 1: even get that far. Now, I know what you're all thinking,
Speaker 1: and I hear this a lot. I'm kind of died
Speaker 1: of hearing it, but I'm honest and I get why
Speaker 1: people do it. But despite the subprime comparison, this is
Speaker 1: not a too big to fail situation. And in this
Speaker 1: week's premium newsletter, I'm going to dig into that question
Speaker 1: in depth. Please do subscribe. If the money goes directly
Speaker 1: to me, it's a main source of income now that
Speaker 1: it's very.
Speaker 2: Important to me.
Speaker 1: But nevertheless, I'm going to give you a sizeable preview
Speaker 1: here because I want this information out there. So too
Speaker 1: Big to Fail refers to the Troubled Asset Relief Program
Speaker 1: TOP over four hundred billion dollars and specifically the bailouts
Speaker 1: of AIG in the surrounding finance industry, mostly focused on
Speaker 1: the commercial paper loan industry that kept major banks and
Speaker 1: financial institutions going as well as fucking ge capital. Oh
Speaker 1: and also the PDCF and ts LF finance systems that
Speaker 1: kept them going to I'll get to that.
Speaker 2: In a bit, but the bailout was in the trillions.
Speaker 1: Like I don't think people realize how and why it happened,
Speaker 1: so I'm going to tell you. Anyway, AIG was too
Speaker 1: big to fail because it had twenty billion dollars in
Speaker 1: outstanding commercial paper and several life insurance subsidiaries that were
Speaker 1: billions of dollars in the hole thanks to AIG literally
Speaker 1: gambling with the money, not actually at casinos, on cds's
Speaker 1: CDOs and the like. The knock on effects of AIG's
Speaker 1: collapse would have been catastrophic for the money market funds
Speaker 1: that held commercial paper from multiple companies. And commercial paper
Speaker 1: is a short term loan type thing, anywhere from one
Speaker 1: to four days to like I think two hundred and
Speaker 1: something days, but most of it was either very short
Speaker 1: term and in AIG's case, was also without any collateral
Speaker 1: in any way. In any case, that used to be
Speaker 1: the primary way that banks and finance institutions g capital
Speaker 1: actually used to be able to fund their businesses. They
Speaker 1: would go to the market and go, hey, well, why
Speaker 1: you lend us some money just for like a few days,
Speaker 1: and we'll get right back to you, and for the
Speaker 1: most part. It worked right up until it didn't. I
Speaker 1: also want to be clear about what the bailout actually
Speaker 1: bailed out, because I think people here too big to
Speaker 1: fail and they're like, right, they bought the houses that
Speaker 1: were being foreclosed. No, no, no, that's not what they did.
Speaker 1: It was like forty something billion dollars that was meant
Speaker 1: to go to stop foreclosures. No one really knows what
Speaker 1: happened to it, which is cool. No, the vast majority
Speaker 1: of the bailouts were for financial instruments, not houses, not apartments,
Speaker 1: not helping regular people, but making sure that the toxic
Speaker 1: financial products associated with the finance industry were absorbed and
Speaker 1: bought off and that liquidity remained in the market via
Speaker 1: the primary dealer credit and term securities lending facilities that
Speaker 1: provided as much as one hundred billion dollars to banks
Speaker 1: and financial institutions a day. Now.
Speaker 2: These still exist.
Speaker 1: The repo facilities still exists, but are not used at
Speaker 1: the same scale. But this, I want you to think
Speaker 1: about this, like every day, fifty one hundred billion dollars
Speaker 1: was just used to keep the to give them short
Speaker 1: term funding to just get through the day. People should
Speaker 1: have been in fucking prison to be clear, people should
Speaker 1: have gone to jail for this, but this was necessary
Speaker 1: to stop the financial system crashing to actually falling apart.
Speaker 1: Lending insurance would not have got funded in the same way.
Speaker 1: There was basically a credit freeze anyway, but I'm talking
Speaker 1: nothing would have happened. And even during the Great Financial Crisis,
Speaker 1: mortgages still were getting written, loans were still getting rerint.
Speaker 1: Things still happened, and the financial system is a confidence game,
Speaker 1: and the PDCF and TSLF existed to stop everything from
Speaker 1: actually going to zero. And like I said, those few
Speaker 1: loans were still being written and funded, and they needed
Speaker 1: to make sure that insurance and borrowing they still actually
Speaker 1: had happened because the world runs on debt and insurance.
Speaker 1: And oh my god, this really reading about the finance
Speaker 1: the Great Financial Crisis really did blackpilm me all over
Speaker 1: again though, because you read what these fuck nuts did.
Speaker 1: They were just they were like, yeah, we're gonna hedge
Speaker 1: our bets on the on the mortgages by buying credit
Speaker 1: default swaps that were not that we assume that aig
Speaker 1: will be able to pay. Don't need to check. Well
Speaker 1: they should have checked. They can fucking bet anyway. Some
Speaker 1: estimate the true size of the bailout when you account
Speaker 1: for that liquidity, to be over ten trillion dollars. Because
Speaker 1: the underdiscussed part of the AIG bailout was that commercial paper,
Speaker 1: the commercial paper lending industry that funded most of the
Speaker 1: finance industry kind of broke.
Speaker 2: It took years.
Speaker 1: The finance industry actually had to undwind their dependence on it.
Speaker 1: Colgate used to use commercial paper. It's fucking weird. In
Speaker 1: any case, there really aren't any comparables to the AI bubble.
Speaker 1: While open AI and Anthropic might be very prominent and
Speaker 1: very annoying, their actual economic existence is relatively small. And
Speaker 1: the overall AI in industry barely had sixty five billion
Speaker 1: dollars in revenue last year, with much of that flowing
Speaker 1: between a few counterparties and funded by venture capital dollars.
Speaker 1: And also we don't know if all of that was cash.
Speaker 1: By the way, a chunk of that is the inference
Speaker 1: spend with Microsoft. That if that still tokens. If you
Speaker 1: work at Microsoft and you want to talk to me
Speaker 1: about the finances or any of these companies, please please
Speaker 1: hit me up. I would love to hear from you.
Speaker 1: Easy at Better Offline dot Com. Nevertheless, had AIG defaulted,
Speaker 1: it would have left multiple banks without the funds to
Speaker 1: continue functioning and killed its insurance companies in the process,
Speaker 1: sending them into government receivership that wouldn't have guaranteed the
Speaker 1: policies had the same value even have been fulfilled. Even
Speaker 1: with that bailout, the government had to plug a hole
Speaker 1: in the side of the finance industry for several years,
Speaker 1: and they ended up bring it back during COVID as well.
Speaker 1: While the collapse of open AI and Anthropic might tank
Speaker 1: parts of the market, too big to fail is a
Speaker 1: term that refers to something that has systemic risk to
Speaker 1: the economy, and these are two very different things. Because
Speaker 1: the market still shat its pants during the great financial
Speaker 1: crisis that happened. The government wasn't stopping the markets from
Speaker 1: collapsing by funding the markets. They were keeping the banking
Speaker 1: system alive, so the markets just functioned at all. And
Speaker 1: I really need you to know that difference, because it's
Speaker 1: not the same thing. The collapse of AIG would have
Speaker 1: quickly ripped through the funding mechanisms of most of the
Speaker 1: US finance industry, and it's collapse still materially harmed one
Speaker 1: of the main funding mechanisms of the US economy. There
Speaker 1: is no such comparison with AI. AI is not producing
Speaker 1: productivity benefits at scale. It is not replacing jobs at scale,
Speaker 1: not that I want that to happen, of course, It's
Speaker 1: not load bearing in an economic sense, in that the
Speaker 1: flow of money in the US economy would collapse if
Speaker 1: open AI or Anthropic did, and a bailout in general
Speaker 1: exists to solve a problem rather than pass the bug.
Speaker 1: And I also want to be clear if that if
Speaker 1: they were truly too big to fail, Ah, no, and no,
Speaker 1: wouldn't it wouldn't it be that when Anthropic goes down
Speaker 1: or chat GPT goes down, the economy would stop, because
Speaker 1: that's what would have happened if AIG died.
Speaker 2: Goddamn have I nearly said AGI like five times? Anyway.
Speaker 1: I also want to address that Fanny May and Freddie
Speaker 1: Mack massive mortgage companies that were absorbed by the US government.
Speaker 1: They're not a comparison as the deaths of though those
Speaker 1: companies would have actually destroyed the US housing market like
Speaker 1: they were like sixty five billion dollars in the whole.
Speaker 2: It was very very very.
Speaker 1: Bad, Like they I need you like The Big Short
Speaker 1: is a great movie, it does not do justice to
Speaker 1: how fucked things would have been. I also want to
Speaker 1: be clear that none of these companies should have been
Speaker 1: allowed to function in the same way, like any of
Speaker 1: the banks involved in this should have like none of
Speaker 1: the executives in questions should be allowed to work in
Speaker 1: finance anymore. I think that it was genuinely evil and
Speaker 1: the whole situation was caused by an industry wide just
Speaker 1: gambling industry.
Speaker 2: That's what it was.
Speaker 1: It would It was truly horrifying, and everyone involved should
Speaker 1: be in jail or jobless.
Speaker 2: I think they're fucking awful. Nevertheles less.
Speaker 1: It was necessary to do because of the fuck with
Speaker 1: nature of the whole thing, because of the stupid gambling
Speaker 1: they did, because of the low reserves they had, and
Speaker 1: how brittle everything was, which is their fault. That's very
Speaker 1: different to the bailout not being necessary. Though, now getting
Speaker 1: back to AI. Without open AI and anthropic the AI
Speaker 1: industry would disappear, as with the demand for AI compume.
Speaker 1: It would lead to billions of dollars of loans going unpaid,
Speaker 1: and the value of venture capital would probably be cut
Speaker 1: in half or as much as eighty or ninety percent
Speaker 1: has happened with the dot com bubble.
Speaker 2: It'd be horrible for the markets core.
Speaker 1: We would die, iron would die, and heaviest would die.
Speaker 1: I think the open A and anthropics death would end
Speaker 1: up ripping through the entirety of silicon value. I think
Speaker 1: that it would be a payback for years of focusing
Speaker 1: on growth rather than creating anything. On the banking side,
Speaker 1: I do think we are somewhat safer. I think while
Speaker 1: there aren't heavy reserve requirements, there are actual regulations around
Speaker 1: high risk speculation. And the scale of speculation here is
Speaker 1: ten tiny compared to I think it's like five trillion
Speaker 1: and synthetic CEOs or something of that nature. There aren't
Speaker 1: trillions of dollars of speculation here, billions, hundreds of billions. Sure,
Speaker 1: And I'm fairly sure, fairly confident that a lot of
Speaker 1: these banks and private equity firms and private credit firms
Speaker 1: have some degree of reserves built in for these loans
Speaker 1: going tits up. In the case of AI Data centers,
Speaker 1: their debts, these AI companies debts wouldn't create a calamity
Speaker 1: that would stop loans in general, or insurance in general
Speaker 1: from being collateralized or any other basic functions of the
Speaker 1: US economy. I'll also add the Nvidia and the rest
Speaker 1: of the Magnificent Seven are going to die as a
Speaker 1: result of the AI bubble bursting. They're not going to
Speaker 1: need bailouts. I think oracles bailout chances are there, But
Speaker 1: even then I'm kind of hesitant to say so, because
Speaker 1: I don't know what they'd be better. Maybe bailing out
Speaker 1: the loans they create a little Larry Ellison's shaped top
Speaker 1: just for that fuck nut, But I actually don't know
Speaker 1: if that would happen. Top was deeply unprop it was
Speaker 1: deeply unpopular, deeply deeply unpopular. And Trump's already having enough.
Speaker 1: I'm sure he's doing that. We're touching the stove competition.
Speaker 1: But at the same time, I just don't see it
Speaker 1: happening in the same way. And even then, I still
Speaker 1: think Oracle would die and get absorbed into another company,
Speaker 1: probably Microsoft. Wouldn't that be funny, man? The anti trust
Speaker 1: would be crazy. That being set, I think that the
Speaker 1: AI bubble will eventually be seen as a smaller precursor,
Speaker 1: much like the dot com bubble was to the Great
Speaker 1: Financial Crisis, to a larger financial crisis created by private
Speaker 1: credit and private equity, and there are hundreds of billions
Speaker 1: of dodgy investments in software and random companies. I am
Speaker 1: still working out how bad this would be, and I
Speaker 1: don't want to be an alarmist. I actually don't think
Speaker 1: it will be as bad as the Great Financial Crisis,
Speaker 1: but that is a question I'm going to try and
Speaker 1: answer in the future. An open AI and anthropic aren't
Speaker 1: getting bailed out. It's not happening. I don't care if
Speaker 1: you think, oh, the Department of Events uses them, They're
Speaker 1: not going to bail them out for that reason, They're
Speaker 1: not going to put them into conservativeship. It's not going
Speaker 1: to happen. It's not It would be deeply unpopular, and
Speaker 1: also to what end a festering hole in the side
Speaker 1: of the government. You already have Congress anyway. AI data
Speaker 1: centers aren't getting bailed out either. I really need to
Speaker 1: be clear about that. Houses were not bailed out for
Speaker 1: closures will not bailed out. Perhaps the ABSs might have
Speaker 1: some hope the asset back securities, but even then I
Speaker 1: don't think the scale of those is anywhere close to
Speaker 1: the Great Financial Crisis. And to be clear, the collapse
Speaker 1: of the AI industry will fucking hurt. It will brutalize
Speaker 1: the banks in private credit firms involved. It will fuck
Speaker 1: venture capital for years, if not over a decade. Earning
Speaker 1: seasons are going to look like the dog from John
Speaker 1: Carpenter's The Thing. It's going to be horrible for them
Speaker 1: and horrible for people invested in the market. It's not
Speaker 1: going to be nice. I am not saying that it's
Speaker 1: not going to hurt, but that is meaningfully different to
Speaker 1: anything being too big to fail. And I'm tired of
Speaker 1: people saying things without actually bothering to understand what they mean.