Atlantic, a monthly magazine, has a fascinating article this month in which they compare U.S. economic behavior over the last few years to the behavior of emerging markets. The basic premise is that the Wall Street elite have taken control of the government in much the same way that economic oligarchies in emerging markets control their governments. In the article the key question for the future of the U.S. economy is whether the government has the resolve to break the control of Wall Street over the economy.
The author of the story is Simon Johnson, the former chief economist at the IMF, which makes the analysis and the proposed solution more meaningful. I am not prepared to agree that Wall Street controls the U.S. economy, but the article is well worth reading.
Note: I found the story through a post by Umair Haique at HarvardBusiness.org.
I worked in Japan for ten years and during that time I was forced to learn as much about Japanese culture as possible to be effective. Of the 50 or 60 countries where I have worked, Japan is the most different from the U.S. or western cultures. The reasons for this are multiple--religion, history, folklore, etc. Trying to understand the Japanese better led me to a realization about learning complex subjects. There are three stages to learning:
I don't know anything
I know everything
I have a lot more to learn
I was always amazed at the number of foreigners in Japan who were stuck in stage 2. Recently I realized that a lot of failing entrepreneurs are stuck in stage 2. Areas where failing entrepreneurs are prone to claim complete knowledge typically include:
Financing (because they have had to raise so much capital)
Competitive landscape (because the competition is not very good)
Legal agreements (because they have read so many agreements)
If you find yourself frequently saying "I know that" or "I know all about that" you may be stuck in phase 2.
A recent example may make the point clear. An entrepreneur had raised $20 million in debt and equity over the years to keep his business afloat. A NY investment bank offered him a convertible bond financing. When I started asking him questions, he responded "I know all that". Convertible bonds (bonds that convert into equity at the option of the bond holder) are some of the most complex securities I have seen and this entrepreneur who had never issued them knew all about them.
Albert Einstein said,"Wisdom is not a product of schooling but of the lifelong attempt to acquire it." Knowledge and wisdom are different, but I think that Einstein would agree that knowledge is also a life long process.
I am completely intrigued by the massive amounts of new data that are being captured on the Web and easily manipulated to draw interesting conclusions. While some think about the evolution of Facebook and Twitter as Web 3.0, I think that developing simple, user friendly tools for the analysis of large amounts of data is a more likely direction of the Web.
Amazon Web Services already has started to build up huge publicly available databases for analysts to use. Google search statistics and the development of their mapping applications suggests that Google is moving in the same direction but with a different business model than Amazon. Also, researchers are just beginning to understand the novel ways that search term statistics can be used. Some academics recently published a paper that showed a correlation in upward stock price and the increase in company specific search term queries.
Steve Wozniak, a founder of Apple, is an investor in DeepDyve, which is a search engine but focused on finding less commonly available data and databases. DeepDyve describes itself as follows:
"DeepDyve is
jumping into the fray by offering publishers other ways to “repackage”
their content that are very easy and inexpensive to implement.Similar to the features at the music sites, DeepDyve’s More Like This technology enables a user to discover related articles.The
technology takes the contents from a single article and uses it to
reach deep into a publisher’s archives to find additional articles that
represent a more complete offering of the publisher’s work on the topic.Publishers benefit when more of the right content is presented to a prospective customer.More Like This
can also be used across whole collections of journals, and often
enables users to discover otherwise hidden relationships between
subjects in different disciplines."
Note; Loyal reader @Johnfleming sent me the heads up on DD.
I expect data sets, databases on the web and tools to manipulate data to be popular themes in upcoming posts. As I have mentioned before, Flowing Data is another blog to read if the evolution of data on the Web is of interest.
Now, if I could just find a free database with updated statistics on cellular subscribers by country in Latin America.
I have always believed that an early indicator of the economy starting to improve would be a large acquisition by a Fortune 500 company or one of the large private equity firms.
Today the NYT and WSJ announced that IBM is in discussions to buy Sun Microsystems for a 100% premium to the current Sun stock price. The obvious strategic benefit to IBM is that it would strengthen their market position in servers.
Now, if CISCO, who announced last week that they are entering the server market, was to enter the bidding for Sun, that would be very encouraging. CISCO has a long history of acquisitions, which I discussed in this post.
Let's hope I am right and that this is an early indicator that the economy is turning up.
Jack Welch, the former CEO of GE, is credited with this wisdom--"Deal with the world as it is, not how you’d like it to be". (Personally, I think Aristotle should get the credit, but I digress.)
This is great advice for any part of your life and particularly appropriate in a start up. Of course the challenge is in being able to identify when you have fallen into the trap of "how you would like it to be". A few key indicators follow:
If you are constantly chasing deals that never close, you have fallen into the trap
If you are constantly raising capital because you did not make plan, you have fallen into the trap
If you did not make plan because of external factors beyond your control, you have fallen ....
If you answer yes-no questions with more than a 1-2 sentence response, you have fallen ....
If people say "you did not answer my question", .....
What's interesting about these leading indicators, they are almost never present in just one form. They almost always show up in multiple forms. Should be easy to spot if you are looking for it.
The New York Times reported Sunday that AIG will be paying bonuses of $165 million to executives in their derivatives unit and another $121 million to other executives in the insurance part of the company. Why is this happening after a government bailout of $170 billion? Supposedly, the answer is that AIG is contractually obligated to make the payments.
Now let's review a few facts:
AIG can not sell its traditional insurance units because of massive unresolved tax issues. If these tax issues flowed through the 2008 income statement would the insurance executives still be entitled to bonuses. Also, is anybody looking at whether these executives are guilty of tax fraud?
The government could have invalidated the bonus agreements for the derivatives unit as a condition for the bailout. Why was this small item overlooked?
The Board of AIG has a fiduciary responsibility to shareholders. Obviously in developing the bonus systems there was some horrendously poor judgement exercised. For example, the $170 billion dollars in unhedged derivative contracts that AIG kept on its books. When will someone bring suit against the directors of AIG for failure to exercise fiduciary responsibility?
Rather than pay a dime in bonuses, I would bring every criminal charge I could against management at AIG. The bonus agreement payouts would be staid until the "fruits of the criminal act" issues were resolved. With the DOJ proceeding deliberately, some of the executives would be bankrupted by legal fees and others might not see their bonuses for 5-10 years.
I have nothing against executive bonuses, but without the availability of the death penalty I would be bringing criminal charges as a way to stop bonus payments at AIG, Citi, BofA, etc. Such poor management does not deserve bonuses.
As long time readers of this blog will know, I am a big believer in a "business model" as a means to develop a new business concept, evaluate an existing business or manage an operating company. This is the main theme in HUTM--the Hacker Universal Theory of Management, which simply put says "focus on the growth drivers in the revenue model of the business".
To achieve a well developed business model, one needs to articulate the assumptions that underlie the business model in three areas:
the Revenue Model
the Pricing Model
the Sales and Distribution Strategy
(More background on these three key concepts is here.)
Steve Barsh, a professor at Wharton, has a good post-- "Want A Better Valuation? Decrease Your Assumptions"--which ties in well with my own thinking on business model. Barsh states:
"I generally find that most businesses / ideas are based on 3 - 7 key assumptions that represent the highest risk factors that will determine the likelihood of success. This applies to both new and ongoing businesses."
His advice to business managers:
"As you are thinking through your business, business model, new product, or new service, make sure to ask yourself and your team:
* What key assumptions are we making? * How can we figure out if our key assumptions are correct and do it quickly and in a capital efficient manner?"
The points to take away from Barsh are:
You have to identify the key assumptions in the business model
The assumptions represent the risk in the model
The more confirmation of the assumptions the better the valuation of the business...(Hacker--AND THE MORE LIKELY YOU WILL BE FUNDED)
Spend intellectual capital to confirm assumptions before you spend cash!
Go HUTM!! If you need a good laugh, read this post--HUTM Goes Viral--from October 2007.
The Merriam-Webster dictionary defines a pundit as "a person who gives opinions in an authoritative manner usually through the mass media". In contrast, an expert is defined as "having, involving, or displaying special skill or knowledge derived from training or experience". In summary, pundits are "form" and experts are "substance". This distinction is beautifully illustrated by this Comedy Central excerpt.
After reading 50 blog posts this morning about the end of the economic world being near, I have had enough. Time to propose a solution.
First we should restate the problem, which I have done as recently as last week. The current problems have been brought on by issues of liquidity, leverage, transparency....and confidence. The status of each factor is shown below.
Liquidity--the situation has improved significantly in the last few months
Leverage--improving, particularly as the government invests in the troubled companies and lenders become more conservative in their lending practices
Transparency--not likely to improve until the SEC stops thinking like lawyers (who have to win court cases) and starts to proactively investigate bums, con men and avaricious corporate types. However, at this point, transparency is the least of the problems except as it affects government bailouts, e.g. AIG. More on this below.
Confidence--there is none and therein lies the real problem. When Warren Buffett is confused, suffice it to say there is no confidence left in markets and particularly stock markets.
To understand the lack of confidence look at the 30 day volatility index, VIX, which is shown below. As you may recall from Finance 101, volatility is the measure of the standard deviation in the compounded returns of a financial instrument. As volatility increases, the risk increases and the price of the underlying financial instrument declines. The VIX is based on the S&P 500, so it is a measure of the volatility in equities for the next 30 days. The VIX 52 week trading range is 15.82--89.53 with a current price at about 50. Anything above 30 is considered unusually volatile. The last time it traded below 30 was September 2008. The last time it touched 40 was in January 2009 when the market rallied. Therein lies the first clue to how to get the economy back on track. Reduce perceived risk in the stock market.
The second factor that needs to be addressed is the short sellers, particularly in equities and equity indexes. Every pundit, expert and honest man has been on television or the Internet calling the bottom of the stock market ("buy") or saying the world is ending ('sell"). Nearly everybody advocating for a bottom, cheap stocks or some positive economic indicator is long equities, such as Mr. Buffett. Nearly everybody saying that the DJIA is going to 5000 is short equities (probably Soros). Logic would indicate that short positions are at an all time high (although it might be hard to prove given the low per share prices). So, the second clue we have is that we need to squeeze the shorts in order for the market to rebound and for some confidence to return. (When the shorts are squeezed they have to buy stocks to cover their position and prices go up.)
To summarize my argument so far, I think we need to see a rally in the stock market to restore confidence in the economy and we need to squeeze the short sellers in order to have a sustained rally. Yes--I am saying rally the equity markets and that will restore confidence--and not restore confidence and the markets will rally. Therein lies the magic in my plan, which has two parts:
First, we need to get all the bad news out. Whatever the total amount of the bailout is for AIG needs to come out. No more piece meal information or partial investments. Whatever the capital requirement for Citibank and/or B of A or any other institution we can not let fail, figure out the numbers, disclose them and fund the problem--now. Every time there is an announcement on AIG or Citibank the VIX spikes. The government's poor management of the information/problem is exacerbating the market risk and leading to a decline in investor confidence. Do not tell me you can not price the securities. If that were the case then maybe the mark to market or fair market value is zero. Deal with it.
Now for the outrageous original part!! Drum roll. The U.S. government should announce a plan to purchase up to $1 trillion in exchange traded U.S. equities, beginning in 90 days, over the next year (or two). Exchange traded equities would exclude bulletin board stocks, indexes (which the shorts like) and options (also liked by shorts). For clarity, the government could also trade the positions or in other words be a seller. To pay for this, we could cut back on the economic stimulus package (which will not work), forget about health care reform for another four years or economize on military spending, just to name three obvious alternatives.
The benefits to the plan are as follows:
By announcing it in advance, everybody will start buying before the U.S. government. In fact, everybody jumping into the market might actually not require the government to buy much equity in order to sustain a rally. A few token purchases to make the program look real may be all that is required.
Such an announcement/rally will draw many foreign investors, strengthening the U.S. Dollar and making imports here much cheaper. Cheaper imports could kick start some other economies like China or Mexico, who would then start buying U.S. exports.
Consumer demand would return with a better stock market and consumers have lead the U.S. economy out of the last several recessions.
Capital gains tax revenue would increase as long equity holders took some hopefully taxable gains in the rally, in a small way helping to pay for the program.
The short sellers of equity would have to cover their positions by buying stocks quickly, which would greatly contribute to the rally. They would also be somewhat timid about going short again for fear the government might re-enter the market as a buyer.
The equity markets might have enough life in them to support some IPOs or secondary issues by listed companies that need equity capital. Some people might even buy bank stocks.
In pondering my outrageous idea I realize that everybody will hate it. The Republicans because it is another government stimulus but.... a lot of Republicans are still long equities. The Democrats will hate it because it does nothing for the foreclosure problem but....I think it would create jobs more quickly than infrastructure investment.
Unless Obama calls me this week while I am in Washington, I do not expect my idea to get much traction. However, I am reasonably certain that confidence in the markets is a key stumbling block to economic recovery and we need some new ideas for how to restore confidence. I am going to continue to think about the current problems but the next proposal will probably be equally outrageous. Maybe Mr. Buffett will come up with something in the mean time.
