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