POP QUIZ

Sam Altman’s Silicon Valley drama with Microsoft and OpenAI is dominating the news these days, but what did he do before OpenAI? (The answer is at the bottom of this newsletter!)

IN THE NEWS

😬 OpenAI’s Future Hangs in the Balance

Photo by Andrew Neel on Unsplash

“Hey ChatGPT, what’s the best way to save OpenAI after its CEO has been ousted?” We already asked the chatbot, but alas, we got no insider insights — finally, a problem not even ChatGPT can solve.

The saga at OpenAI continued on Tuesday after “extraordinary efforts by employees and investors,” according to the FT, to remove the board that fired Sam Altman.

• But, unlike most companies, the board at OpenAI isn’t beholden to shareholders, nor is it even made up of shareholders with meaningful financial stakes in the company.

OpenAI is weird: OpenAI was created as a non-profit, with a board of independent AI specialists and ethicists to advise the organization. Its “principal beneficiary is humanity, not OpenAI’s investors.”

• But a for-profit subsidiary was established years later, allowing OpenAI to raise funds from Microsoft and venture capitalists to backstop the enormous computing and talent costs of developing world-leading AI.
• The news came as a shock to Microsoft, which learned of the board’s decision to fire Altman only minutes before it happened.

Don’t shed any tears for investors: They knew what they were getting into. In the org chart, the non-profit OpenAI, which the board is tied to, sits above the for-profit OpenAI subsidiary.

So, OpenAI’s non-profit board unilaterally calls the shots, and they aren’t exactly concerned with maximizing investors’ profits.

• In its agreement with investors, it promises no returns on capital and says investments should be made “with the understanding that it may be difficult to know what role money will play in a post-AGI (artificial general intelligence) world.” Wonky stuff…but hey, this is Silicon Valley we’re talking about.
• In other words, OpenAI was established with aspirations to create an AI-powered utopia that may exist in a world not bound by the normal rules of capitalism, or even money, for that matter.

Why it matters:

Aside from Sci-fi and strange corporate structures, OpenAI itself (both the non-profit and for-profit versions) faces its own existential challenges rather than dealing with existential questions about AI and humanity.

• The number of OpenAI employees threatening to quit and join Microsoft if the board doesn’t resign and reverse its Friday decision to remove Altman has reached 95%.

Microsoft wins: If everyone abandons ship to work for Microsoft, you might argue that Microsoft pulled off a full acquisition of OpenAI essentially for free.

• It invested billions to own a share of a for-profit OpenAI subsidiary without power over the non-profit parent organization. Now, it may control OpenAI’s talent and intellectual property without additional investment.
• As Ben Thompson puts it, “You can make the case that Microsoft just acquired OpenAI for $0 and zero risk of an antitrust lawsuit.”

Read more

😅 No More Earnings Recession

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The third-quarter earnings season is (unofficially) over after Walmart’s report last Thursday. Despite worries about an ongoing “earnings recession” — two or more consecutive quarters of falling profits across major companies — the latest round of corporate reports ended the trend.

• Profits had fallen at S&P 500 companies from Q4 2022 through the first two quarters of 2023.

How things shaped out: Consumer discretionary companies held particularly strong, padding the narrative that American shoppers remain resilient, with per-share profits in the sector rising some 40% — driven most by Amazon.

• According to Factset, 82% of S&P 500 companies reported a “positive earning surprise,” meaning their profits exceeded analysts’ estimates.
• This time around, only 276 of S&P 500 firms mentioned “inflation” during their earnings call with investors, marking the fifth straight quarter where fewer companies referenced inflationary challenges.
• Still, the 10-year average for invocations of “inflation” is 173, so inflation concerns remain above average.

Why it matters:

In addition to fewer concerns about inflation, there were fewer mentions of “recession” in this quarter’s calls. Based on the number of S&P 500 companies citing “recession” on calls, recession fears peaked at 237 in the second quarter of 2022 and dropped to just 53 this past quarter.

Eight of the eleven sectors that classify S&P 500 companies reported rising profits since last year, with only Energy, Materials, and Health Care seeing declines.

• As another cause for optimism, this quarter saw the highest percentage of companies beat Wall Street profit projections since Q3 2021, coming in well north of 5-and-10-year averages, too.

In summary: Things were good. Not great, but very, very solid. As always, there are plenty of anecdotes to focus on to find reasons for concern, though the consensus feeling is optimistic.

• Of course, markets remain forward-looking, and changes in projections for next quarter’s earnings will carry far more weight going forward than these recent results.

Read more (Factset earnings report card)

🏠 How Higher Interest Rates Are Crushing Housing Dreams

Photo by Breno Assis on Unsplash

We know that interest rates have slowed the housing market. But how have they specifically impacted prospective buyers worldwide?

For millions of people, homeownership is the primary way they build wealth, especially in countries with less robust stock markets.

• But a shortage of homes and interest rates around 22-year highs have made housing unaffordable to people on average incomes.
• The U.S. market is effectively frozen, as homeowners locked into low-rate mortgages won’t budge. Who could blame them?
• What this means for the middle class: Financial security has become more elusive.

The golden age: There are big winners — longtime owners who have equity from the soaring value of housing. And then there are the losers, stuck grappling with getting by and making monthly payments.

• “The golden age of single-family housing is behind us,” said an economist at Moody’s. “If you bought in the wake of the financial crisis, you built up a lot of equity in most parts of the world, but the next 10 years is going to be more of a slog.”
• Many economists expect the U.S. 30-year mortgage rate to sit around 5% or 6% in the next decade, down from its 7.4% level today but far higher than the 2.65% low in early 2021.

Unaffordable: Commercial properties face much stronger headwinds in the real estate world. But consumers are reckoning with a world where rates and mortgage payments are much higher than they imagined just a couple of years ago, and it’s too hard to ignore.

Low inventory, high prices and rates have made this market the least affordable in four decades: About 40% of the median household income is required to buy a typical home.

From Bloomberg

The impact will play out for years, with transactions falling — some economists believe 2024 could be the worst of the residential real estate market, with fewer transactions next year than at any point since the early 1990s.

Glacial period? “In some ways, we’re in the early stages of this glacial period, and it’s unlikely to thaw anytime soon,” noted a University of Pennsylvania Wharton School professor. “This weirdness can last for a long time.”

• That could mean less job mobility, forcing family and friends to live together, and older Americans staying put rather than selling to younger generations.

Meanwhile, many homeowners are sitting on near-record home equity. Most of them are unaffected by rate hikes.

Bottom line: Affordability may improve as price increases slow down and rates fall, but economists see a “slow puncture” rather than a housing crash. In other words, it’s a relatively calm economic slowdown that doesn’t result in heavy job loss or housing distress.

Read more

TRIVIA ANSWER

Before OpenAI, Sam Altman built a location-based social media app called Loopt at 19 years old. It failed to gain traction, though, and sold for $43.4 million a few years later. After that, he served briefly (8 days) as the CEO of Reddit. And like all great Silicon Valley entrepreneurs, he dropped out of Stanford after just one year.