San Francisco has always been a beacon for people who want to change the world. From beat poets to hippies to gay activists, each wave of counterculture immigration has put its stamp on the city, creating a unique blend that has set it apart from any other in America.
That culture, in turn, has been a draw for innovators of a different sort—technology workers who began populating the suburbs of the South Bay, which came to be known as Silicon Valley, in the 1970s and ’80s. In recent years, they have increasingly put down roots in San Francisco itself, commuting south to work by day and coming home for restaurants, art, and culture at night. And more and more, tech businesses are locating here.
In doing so, however, technology workers may be threatening the very culture that they came to celebrate. The influx of wealthier professionals has driven up housing costs, increased the pace of gentrification, and threatened the city’s rich racial and socioeconomic diversity. Tensions came to a head in December 2013, when a group of angry protesters stopped a Google commuter bus leaving San Francisco for Silicon Valley, brandishing signs that read “Stop Displacement Now!”
“The incident brought to the surface the values and aspirations of long-standing residents and the challenges they were facing,” says Clayton S. Rose, professor of management practice at Harvard Business School. “There is this real squeeze on certain parts of the community—housing prices are out of sight, the middle class is leaving, and homelessness is a serious problem. This is in the face of great prosperity for many technology workers.”
In addition, San Francisco presents a unique case, says Rose, who grew up in the Bay Area. “People are afraid that this special culture in this special place could get lost.”
Wealth and culture
Rose tackles these tensions in a new case study, San Francisco, 2015 #tech #inequality, cowritten with HBS California Research Center Director Allison Ciechanover (Harvard MBA 2002) and Kunal Modi (Harvard MBA/MPP 2013), a manager at McKinsey & Co. in San Francisco.
At a time when economic inequality is increasing globally, San Francisco may be the proverbial canary in the coal mine, displaying the negative effects of such rapid increases in wealth on a city’s culture.
“This is a place where the effects of inequality appear to be heightened and most palpable,” says Rose. “Even though San Francisco may be ahead of the curve, these same issues could well affect many other cities, from Austin to Atlanta.”
In order to more deeply explore the issues around these issues, Rose and his fellow researchers sought to add a personal perspective to the case. They invited 22 Bay Area-based Harvard MBAs who had graduated as recently as a year ago and as long as 30 years ago to a series of roundtables to discuss their perspectives on inequality and the tension between the community and technology firms and their employees. Far from the unfeeling interlopers depicted by the Google bus protesters, they found a group that cared deeply about preserving the culture of the city, and that wrestled with how they might understand and change the underlying conflicts.
The researchers set out to find out why so many local politicians took out toxic loans in the first place—and whether they understood the stakes.
Political Incentives
To test whether the election cycle affected loan activity, the researchers looked at municipalities that held elections in the first quarter of 2008. They found that structured loan transactions occurred much more frequently shortly before rather than after political elections.
Toxic loan transactions were especially frequent for incumbent politicians running in “swing” areas. Incumbent politicians running in politically contested areas (where the local government had been ruled by the same party for fewer than 10 years) were more inclined to use structured loans than those in political strongholds (where the ruling party had been in power for more than 20 years).
Vallée and Pérignon analyzed how the politicians used the loans—whether they had invested the money in equipment or services for the city, or used the cash to lower taxes for their constituents, or both. It turned out that for the most part, they had used the short-term savings from the loans to lower taxes. “This action is consistent with politicians seeking reelection by catering to taxpayers’ preference for low taxes, which represents a likely channel for the previous result on the effects on reelection,” the researchers write.
The strategy apparently worked. Controlling for potential selection effects, the researchers found that using structured loans led to an increase in the likelihood that a politician was reelected.
“These financial innovative products appear, therefore, to have aligned banks’ incentives, as the transactions were highly profitable, with local politicians [who] had an interest in getting reelected,” Vallée says. “However, this happened at a large cost to the taxpayer, as the positive effects of the loans were short-lived, and interest on toxic loans ballooned when the crisis hit.”
In the wake of the financial crisis, many local politicians filed suits against their banks, claiming that they had not comprehended the risky nature of the loans they undertook.
“Local politicians have been vocal ex post both in the media and in [the] French Congress,” the researchers write. “For instance, in his testimony before the French Congress’s committee on toxic loans, the deputy mayor of the City of Saint-Etienne, who originally decided to take on some toxic loans, stated that ‘[he] was not able to read the information [he] received because [he was] not a financial expert.’ ”
Vallée, who holds a doctorate in finance from HEC Paris, is currently working on a study of byzantine banking behavior toward individual investors. But in the case of structured loans, he argues that a borrower need not be a financial expert to realize the stakes. “
They are not that complex, and after spending 10 minutes on it, someone with a college education will be able to understand the risks,” he says.
They are not that complex, and after spending 10 minutes on it, someone with a college education will be able to understand the risks,” he says.
The Role Of Financial Sophistication
That said, the researchers did assess the role of financial sophistication on the use of structured loans. They considered the size of each municipality, understanding that larger governments were more likely to employ specialized financial advisors. And they obtained the mayors’ current or former occupations, educational backgrounds, and age at the time of election.
The data suggested that mayors with the most-educated backgrounds were actually more likely to take out structured loans than those with less education. Those who took out the most structured (or toxic) loans had worked previously as corporate executives or senior-level civil servants. Former blue-collar workers, farmers, and artists, on the other hand, largely stayed away from these products.
The likelihood to use structured and toxic loans increased with local government size, indicating that bad loan decisions couldn’t be blamed on a lack of staff expertise. Meanwhile, the use of structured loans decreased with the mayors’ ages. “This was not a senility effect,” Vallée says.
Pondering the prevalence of bad loans among French municipalities, the researchers also found evidence that politicians were more likely to enter into toxic loans if their neighbors had recently done the same. “First, there’s the issue of salience—if their neighbors do it, then they know it’s an option,” Vallée explains. “Second, there’s the reassurance factor. If your friend is taking a risk, then you’re more comfortable being in the same boat.”
And while the paper focuses on France, Vallée notes that municipal toxic loans were hardly an exclusive French phenomenon.
“I think it was interesting to look at France because the level of creativity and risk-taking was especially high,” he says. “But this was widespread across Europe, and has been observed in India, China, and the United States to some extent. Politicians are kind of the same all over the world. If you give them an opportunity, I think they will seize it. They seized the opportunity offered by innovative financial products to lower taxes.”
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