skinnerlayne’s posterous



September 29, 2009

Politics is More Uncivil than you Think

With the intensified rhetoric from both sides of the political aisle in the United States, there have been increasing calls from the punditry for "more civil discourse."  This rhetoric is itself uncivil, since the pundits are not calling for a return to genuine civility (if it ever existed) but rather a return to the niceties and pleasantries of "polite politics."  Genuine civility, as M. Scott Peck defines it in his book about Civility, A World Waiting to be Born, is "consciously motivated organizational behavior in submission to a Higher Power."  

Our politics is, if anything, far from conscious and even farther from being in submission to a Higher Power.  We live in a world that is increasingly predicated on coercion, especially of the State kind.  Ideally of course, the State exists to prevent coercion, whether it comes in the form of force (murder, rape, assault, etc.) or fraud (Madoff).  The State however, has throughout history been at least as guilty of the commission of force and fraud as private citizens have, and in many egregious instances, the results are even more devastating (the Holocaust, Japanese Internment, Nuclear Warfare, The Great Leap Forward, and so on).  

And yet, as much as I like to fantasize about a Stateless society (a world without government), I know that it is but a mere daydream, and highly unlikely to be achieved in my lifetime, if it is even achievable.  Consequently, we must each individually, and within the context of the greater society, decide how we are to make our world function given the constraints as they currently are.  This means that at least for the foreseeable future, the State is here to stay.  Many of my libertarian friends will be aghast to read this proclamation, but we would all do well to accept it and then determine the best course of action for increasing liberty in our own lifetimes.

Few people would contest that American society is fundamentally broken.  The Left believes it is because of too little State intervention.  The Right believes it is because of too little Church intervention, and the Libertarians believe it is because of too much intervention from everybody.  So the fight, rather than being about making society work for everybody, is about who can garner the most votes at the next election to impose their vision on everybody else.  Nothing could be less civil.

Democrats treat the "Rich" as people to be exploited--for noble ends, of course--but exploited nonetheless.  The Rich are a bunch of greedy people who made their money through ill-gotten gain, we are told, and they deserve to "pay their fair share" to everybody else.  Who decides what a "fair share" is?  The Democrats, of course.

The Republicans on the other hand treat the environment, third world labour, and the "masses" as objects for exploitation so that somebody can achieve his Randian vision of shrugging the atlas while at the same time viewing gays and other heteronormative people as deserving of oppression because they are nominally different than they are.

Each election, then, becomes about who gets to punish whom.  This is a broken democracy.

If we are to save ourselves from killing each other, we must forge a new path, one that is based upon genuine civility and value for each other as individuals.  We are not islands unto ourselves--but neither are we communes.  Where we cannot agree, we must seek to find true consensus (not where "all bureaucrats agree" counts as a consensus)  about how to proceed.  Police power cannot and should not be used to enforce ideology, but it is what both sides do anyway.  

In the coming weeks, I hope to write more about this subject, as I believe it is among the most important issues of our day, if not THE issue of our day.  I do not live under any false pretenses that building a more civil society will be easy, or that even once achieved that it will be without significant problems.  Life is about problems, and problem-solving.  But perhaps if we do have a more civil society, we can solve these problems without trying to destroy one another.

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September 28, 2009

When God Tricks Us

Most people lose their Vision by the end of their college years, or at least by the end of the first year of living in the "real world." Certainly I do not mean they have lost their physical ability to see, but rather their ability to see great things and a bright future ahead, a specific one of their own making. Vision is the foremost of prerequisites for successful entrepreneurship--sometimes it is the only thing we entrepreneurs even have. Without it, we are lost at sea, adrift and directionless.

Entrepreneurial vision (which I mean broadly--one can be an entrepreneur in many fields, including law, medicine, education, politics, etc.--it is not limited to people who are in the world of commerce) is the engine that drives the progress of mankind, and although all entrepreneurs have a vision of changing the world, there is always some specific personal gain we all seek. For some, it is money and material possessions, for others, it is the satisfaction gained from the work itself, and for yet others it is leaving a "legacy." For most entrepreneurs it is some combination of all three of these things, but this desire for personal gain does not obliterate the astounding humanitarianism that always accompanies the Ethical Entrepreneur.

I have come to realize, though, that entrepreneurial vision is not something we are born with, but is rather something we are called to. The word "vocation" comes from the same Latin root as the words "voice" and "vocal." It literally means "calling." Some of us are born with a sense of vocation to entrepreneurship generally--to change the world. But coming to and realizing our specific vocation (or, as is often the case, series of vocations) is a winding path with twists and turns that we would never have signed on for if we had known it all at the beginning. But this is one of the mysteries of God--his "trickery." I do not mean this pejoratively. The Divine Person is undoubtedly a witty and creative fellow--how else would we end up with animals as strange as Giraffes and Elephants and simultaneously foods so utilitarian and ordinary as the potato?

As the Old Testament prophet said "[God's] thoughts are not our thoughts, nor his ways our ways. For his thoughts are higher than our thoughts and his ways higher than our ways." Sitting in the midst of the trying times of our vocation, we must all step back and look objectively at the circumstance, marveling at how we got to where we are. Rarely, if ever, the path is not only something we wouldn't have chosen, but it isn't even a path we could have expected or imagined. Sometimes we may even feel that God has tricked us into going down our present path with some short-term taste of the beauty that is life when we answer our calling.

In this way, we must find it in ourselves to detach from our own narcissism and our desire to have accomplished things in our own time and with our own strategy and give Thanks for the mystery of God's methods, which at time may seem to us unorthodox at best, and cruel at worst. But when our calling is clear, it is that we must cling onto, and accept the pathways that are presented to us. There are many lessons to be learned along the paths we wouldn't choose for ourselves, and that is of course why we are called to go down them--so that we are prepared for the next run, whether here on Earth or in the hereafter.

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June 17, 2009

Solving the Economic Crisis

Let the man of learning, the man of lettered leisure, beware of that queer and cheap temptation to pose to himself and to others as the cynic, as the man who has outgrown emotions and beliefs, the man to whom good and evil are as one. The poorest way to face life is to face it with a sneer. There are many men who feel a kind of twisted pride in cynicism; there are many who confine themselves to criticism of the way others do what they themselves dare not even attempt. There is no more unhealthy being, no man less worthy of respect, than he who either really holds, or feigns to hold, an attitude of sneering disbelief toward all that is great and lofty, whether in achievement or in that noble effort which, even if it fails, comes second to achievement. A cynical habit of thought and speech, a readiness to criticise work which the critic himself never tries to perform, an intellectual aloofness which will not accept contact with life's realities—all these are marks, not, as the possessor would fain think, of superiority, but of weakness. They mark the men unfit to bear their part manfully in the stern strife of living, who seek, in the affectation of contempt for the achievements of others, to hide from others and from themselves their own weakness. The rôle is easy; there is none easier, save only the role of the man who sneers alike at both criticism and performance.

-Theodore Roosevelt, "Citizenship in a Republic" (1910)

Entrepreneurs vs. Politicians

The advent of the Internet and the simplicity of blogging have made the role of critic even easier.  Everybody can be an armchair quarterback.  Everybody has a gripe.  But who is going to do something about these things?  Clemenceau once said that "War is far too serious a matter to be entrusted to military men."  Echoing that sentiment, I would argue that society's problems are far too serious to be left to politicians and media talking heads.  They have proven themselves to be the most self-interested, myopic people of all.  For all of the financial community's sins, and they are many, they have not crassly and opportunistically attempted to capitalize on our collective pain on a scale commensurate with our beloved politicians.  The question, for us then, is how do we each, as individual citizens and acting in concert with one another, bring about a quicker end to the carnage surrounding us while at the same time doing so profitably.  

Really, this is simply the eternal question facing the entrepreneur: How do I solve a problem at a profit?  Quite apart from the eternal question facing the politician: How do I solve a problem enough to get sufficient credit to be elected but not too much so that I do not have another problem to solve to continue to justify my existence?  Or worse, the eternal question facing the bureaucrat: How do I keep from solving a problem long enough to not be fired and yet simultaneously increase my budget?  

It is the entrepreneur whose question, although supremely self-motivated, is nevertheless perfectly aligned with the interests of those who supply his profits, for they supply them out of the voluntary desire to purchase whatever it is that he is selling.  That is, the entire transaction is based on non-coercive behavior.  Much unlike that of the politician or the bureaucrat, who use coercion to acquire the resources to perpetuate their own existence while being motivated never to deal honestly or forthrightly about matters in the fear that such transparency might lead to their electoral downfall.  For the politician all calculations are zero sum.  They do not understand opportunity cost precisely because opportunity cost cannot figure into a zero sum equation.  Either they win or they lose.  

For the much-maligned profiteer, there is no dearth of alternatives.  He may choose to produce a few units of one good and a few units of another.  If one does not sell, he has something to fall back on.  Or he may choose to put all of his eggs in one basket but save enough of his resources to start over if he fails.  There are endless combinations of these alternatives.  He may not be motivated toward transparency and forthrightness (and we certainly have too much proof that this can be the case), but it is because he misunderstands the incentives.  Eventually, this will come back to haunt him.  If he deals dishonestly with the people buying his wares, he will be shunned and cut off.  Let us never forget that it was the Stock Market that devalued Enron and Worldcom, not government regulators.  The regulators only stepped in after the markets had massively devalued those companies' stocks.  It was not the SEC that caught Bernie Madoff, it was his sons who turned him in.  

In business if you lie, cheat, and steal, you will one day be broke and destitute.  In politics, if you lie, cheat and steal, you get elected to higher office.

It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, and comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows the great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who know neither victory nor defeat. 

-Theodore Roosevelt, (quote continued from above)

What then, do we do?

Dig In, Accept Reality, and Get to Work

There are solutions within all of our grasps, regardless of the sector of the economy in which we are employed, regardless of our net worths.  

(1) Efficiently allocate capital as wisely as possible given the circumstances that exist.  

(2) Always be willing to adapt and change as circumstances change, including our expectations about risk & reward

(3) Work harder.

Capital Allocation

Much of the blame for our existing financial and economic circumstances stems from the distorted incentives of the cheap credit policies of Alan Greenspan's Federal Reserve followed by the fast breaks applied to that system by Ben Bernanke (before he caught the deflation bug).  This distorted incentive system caused corporations and individuals to mortgage themselves to the hilt under the promise of mega-returns.  Professionals in the fund management industry either had to drink the Leverage Kool-Aid or lose their limited partners to their competitors who produced ridiculous and unsustainable returns in excess of 50% annually.  The entire capital allocation system went haywire because of cheap credit.  

Austrian economist Ludwig von Mises observed in his work Socialism in 1922, "Where there is no market there is no price system, and where there is no price system, there can be no economic calculation."  Arguing a view that was vindicated upon the collapse of the Soviet Union 70 years later, Mises pointed out the ultimate flaw of socialist economics: in the absence of private property (that is, fixed ownership), there can be no accurately determined pricing mechanism.  It is all otherwise artificial.  Mechanisms of relative exchange (which is just another name for prices) could not be determined through bureaucratic decision-making and rationing because there is no accurate or readily adjustable means to determine the needs of the consumer en masse.  Private ownership of property is a necessary condition for markets, which are necessary conditions for pricing systems.

What we have witnessed in America since Nixon unilaterally ended the Bretton Woods System and untethered the dollar from the gold altogether is that Mises's observations about full socialism can be accurately modified to reflect partial-socialism, or as Harvard economists like to euphemistically call our economics, a "mixed system."  Let us look at this revised version of Mises's statement:

"Where there is a distorted market, there is a distorted price system, and where there is a distorted price system, there can be only distorted economic calculation."  The statement is prima facie valid, its soundness confirmed by our recent experience.  The policy of continuously manipulating money and credit through the Federal Reserve System as it presently exists serves to distort the market of the most central good in our economy: money itself.  It does so by artificially manipulating its supply and thereby its price (the interest rate).  This is not something that can be fixed or remedied overnight.  It is a system we must for now live with and deal with accordingly.  Yet it is vital that we understand the nature of the system, and how it works in order that we might not fall victim to is machinations.

Consequently, the work of allocating capital efficiently must take into account the contingencies of government intervention in our markets, distorting our pricing systems in one manner one day, and in another manner the next day.  The philosophy of leveraged investing takes advantage of money manipulation when that manipulation is expansionary, but it forgets to respond when it is contractionary.  When the Federal Reserve began raising interest rates in 2006 and the Inverted Yield Curve reared its head again, the financial pundits on CNBC said that the era of Inverted Yield Curves portending recessions was long behind us, and there would be bull markets from here to eternity.  We ought not have needed hindsight to recognize the vacuous nature of those claims.  Yet Lehman Brothers, Bear Stearns, and AIG ignored the market's warnings, they ignored the data.  This is not evidence of market failure, but human failure.  The markets worked as they are meant to.  They bankrupted the people who made unwise decisions.  They took capital from those who had allocated it unwisely and inefficiently.  The market-mechanism picked the winners and losers based upon their wisdom.  Government intervention picks winners and losers based upon the political constituencies the party in power must help.  Not exactly a harbinger for the long-term efficient allocation of capital.

As a result, we must all now make our economic calculations and our decision about how to allocate our capital in light of the actual economic and political realities.  We must do so not only as a means to spur on recovery, but also out of our innate need to turn a profit.  Not only are these two principles NOT mutually exclusive, they are actually necessarily intertwined, for it is turning profits that grows the economy.  Recognizing that the Federal Reserve, the European Central Bank, and the Bank of England are all pursuing monetary policies that will either lead to a future withdrawl of liquidity from the system (the kind that caused the present crisis) or else will be left in the system and necessarily lead to inflation, then we must take care (in absence of a certainty as to which of these eventualities will occur) to invest our capital in producing assets (stocks or corporate bonds, not metals and commodities) denominated in stable currencies (not the Dollar, Pound, or Euro), avoiding leverage (so as not to find ourselves in the position of Lehman, Bear, and AIG).  

Outflows of capital to stable currencies will force the hand of both the Fed and Congress, forcing them to pursue economically sustainable public policy.  It simultaneously positions the investor to take advantage of profits in stable markets.  Profit and Policy change wrapped up into one.  Market forces work, and each individual can make a difference.

Adaptation

Adapt or perish, now as ever, is nature's inexorable imperative. -H.G. Wells

We are fortunate to live in a world of rapid information and rapid travel.  A mere hundred years ago, the vast majority of the people in the world, and even in the United States, had no viable mechanism to get from one town to another except by horseback or foot.  The train was convenient for those who lived in areas where there were trains, but they were the exceptions rather than the rules (by global standards at least).  The telegraph, a dramatic improvement over Pony Express, was nevertheless a severely limited communication tool.  A truncated, several line text message was expensive and cumbersome to send, and not accessible to constant use.  Today, however, a couple thousand dollars can get you from San Francisco to Sydney in less than 24 hours.  Iranian revolutionaries use proxy servers in the United States to upload videos to YouTube which they then broadcast using Twitter.  Last night I looked at the Twitter stream for the #IranElection hashtag.  I watched my clock.  From 9:14pm to 9:15pm there were an additional 97 Twitter messages that included the hashtag #IranElection.  The Iranian government has been unable to keep up.  Subversive and non-traditional communication has always been an integral component of successful guerrilla warfare.  We are just in another major phase of breakthroughs in that area.

For business, this means the markets are unforgivingly current.  Business, sales, product research & development, marketing, partnering, and trading all happen in real-time.  Just as there is no longer a news cycle, traditional cycles in the life of an enterprise now take place on a radically shortened timeframe.  Adaptation is not just something we have to do in response to all of these changes, it must become a way of life, a modus operandi for business decision-makers both global and local.  The world has always changed rapidly, but now we have the tools for those changes to take place rapidly and in synchronization with all of the other changes taking place, and all of the players involved.  The increasing cost-effectiveness of on-demand manufacturing will catapult us to even greater heights of real-time business.  

Yet there is incredible inertia in the business world, and in the world of investing.  People are allowing fear to replace legitimate risk aversion.  Because of the "innovation" in the financial markets that gave us such beautiful (I use that term sarcastically) tools as Credit Default Swaps, there is a fear of innovation and newness in its entirety.  But what we need is innovation predicated on timeless wisdom, an understanding of the broader subject of economics, and innovation that is responsive to the conditions we face today.  We do not need more geeky calculus formulas.  We need more hard work and problem solving of actual real-world, hard-hat business problems.  We need people who want to take their innovation into the board room and the engineering departments and out of the financial analysis department.  We don't need numerical wizardry, we need strong balance sheets and good business strategies that change with the markets.  

Mathematical formulas are predicated upon sets of assumptions.  In order for the formulas to work (and in the context of business, "working" means they are making money), the assumptions have to hold true.  Although I thoroughly enjoyed my academic study of economics, the whole field requires the ability to assume things that simply aren't true or that we can't possibly know are true.  We say, ceteris paribus, as if it magically excuses us from reality where there is no ceteris paribus.  In the ivory tower of academia, this may work charmingly, but when setting a business's strategy that means success or failure, it is useless.  We must never forget that the assumptions mathematical formulas rely upon are assumptions about human behavior, which is constantly changing, constantly adapting.  The Fund Management industry in particular has failed time and time again to learn this lesson.  Those of us who build strategies of adaptation, of constantly checking our assumptions, it is we who will survive.  

Work

Ultimately, all of the philosophizing, strategizing, and organizing must culminate in action.  That action is the hard work of Doing in a world of thinking, talking, and wishing.  The private sector has outpaced the public sector in Doing for all of their respective histories because the incentives for Doing in business stand in contrast to the disincentives for Doing in politics.  But there is no lack of hand-wringers and flapping-jawed pundits in business, too.  CNBC's professional punditry can shout and announce their buys and sells, their holds, and their dumps, but they aren't the people out there Doing.  They make "stock" recommendations when investors really ought to be thinking about the life and health of the businesses whose stocks they own.  

Doers start businesses, they tackle hard problems.  In their existing positions, they do not rest on their laurels, they are not satisfied with the status quo.  Doers pull more than their own weight.  They do work nobody else wants to do.  They don't give up when they see that all of the low-hanging fruit has already been picked.  Instead, they look for new and innovative ways to pick the fruit that is more difficult to get to, but may be just as sweet and ripe, if not more so.  It means taking risks for which one bears the consequences of the results, not simply taking risks on other people's behalves.  

When I moved to Santiago de Chile, with barely more than "hola" and "gracias" in my Spanish vocabulary, it was to learn more about an oft-forgotten little free market country with an amazing economic history and to build relationships, on-the-ground, with the business and political community here in order to do my part to be part of creative problem-solving in the midst of the ongoing global financial crisis.  A year in, the real work is just beginning, the real problem-solving only now starting.  Yet there is a real sense in which it is all for something greater than just profits.  The profits are without question an important motivator, but if one reflects on his work, and it is work worth doing, he realizes that there are other, more ethereal goals achieved in the process of an honest day's work of solving problems in the real world.  

Conclusion

The work we do in the private sector does matter--it does make a difference.  One need not go into the ministry or the peace corps to make a difference in the developing world.  In fact, the real, the lasting work, is often done in the unromantic world of commerce, buying, selling, and trading which results in building a foundation for future generations to engage in the economic activity necessary for the survival, perpetuation, and progress of the human race.  We must all be part of this solution and make our contributions in the areas where our skill sets lie.  

I will leave you with a few more words from Teddy Roosevelt from his speech to the Sorbonne about Citizenship:

Shame on the man of cultivated taste who permits refinement to develop into a fastidiousness that unfits him for doing the rough work of a workaday world. Among the free peoples who govern themselves there is but a small field of usefulness open for the men of cloistered life who shrink from contact with their fellows. Still less room is there for those who deride or slight what is done by those who actually bear the brunt of the day; nor yet for those others who always profess that they would like to take action, if only the conditions of life were not what they actually are. The man who does nothing cuts the same sordid figure in the pages of history, whether he be cynic, or fop, or voluptuary. There is little use for the being whose tepid soul knows nothing of the great and generous emotion, of the high pride, the stern belief, the lofty enthusiasm, of the men who quell the storm and ride the thunder. Well for these men if they succeed; well also, though not so well, if they fail, given only that they have nobly ventured, and have put forth all their heart and strength. It is war-worn Hotspur, spent with hard fighting, he of the many errors and the valiant end, over whose memory we love to linger, not over the memory of the young lord who "but for the vile guns would have been a soldier." 

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June 16, 2009

Honesty & Optimism

I've gotten a lot of feedback so far on my post from earlier today on The Quadruple Down Recession, and one of the interesting things about the feedback is that there is on the one hand an objection to the "negativism" of my outlook on the other hand to its honesty.  It confirmed an important tenet of my business philosophy (which developed as I witnessed the consequences of its inverse) that in our imperfect world, most optimism is simply not based on Truth.  If there is one thing we must all cling to, it is Truth, no matter how unpleasant it might be.  For if we avoid Truth in favor of our own concocted reality, then we will suffer significant psychological (and in the context of business, economic) pain.  


Over the last few weeks I have been doing a slow re-read of M. Scott Peck's masterpiece The Road Less Traveled, which continues to rank as one of the most influential books on my life and philosophy.  In the first section of his book, the one dedicated to Discipline, he discusses several techniques of dealing with the pain of problem-solving "which must continually be employed if our lives are to be healthy and our spirits are to grow."  One of those tools he terms "dedication to reality."  

Peck writes:

Superfically, this should be obvious.  For truth is reality.  That which is false is unreal.  The more clearly we see the reality of the world, the better equipped we are to deal with the world.  The less clearly we see the reality of the world--the more our minds are befuddled by falsehood, misperceptions and illusions--the less able we will be to determine correct courses of action and make wise decisions.  Our view of reality is like a map with which to negotiate the terrain of life.  If the map is true and accurate, we will generally know where we are, and if we have decided where we want to go, we will generally know how to get there.  If the map is false and inaccurate, we will generally be lost.  While this is obvious, it is something that most people to a greater or lesser degree chose to ignore.  They ignore it because our route to reality is not easy. 
 
How timelessly true this is, not only in our individual lives but in our corporate life  also (I use this term in its original meaning, not in its modern economic context, though it certainly applies to that context as well) .  Collectively, corporately, whether it is in our public policy-making for society as a whole or in our investment strategies, or our capital allocation strategies, we must be dedicated to reality, no matter how painful it is.  Many people are much happier with living in a fantasy land.  They want life to be as myopically twisted as Michael Jackson's Neverland Ranch.

These are the people, however, who bear the blame for the irresponsibility of the boom years.  They were the Federal Reserve analysts and policy-makers who advocated continuing to hold interest rates artificially low in the aftermath of 9/11.  They were the CEOs of Lehman Brothers, Bear Stearns, and AIG, who either willfully or negligently believed that unbridled debt could propel their firms to historic prosperity in perpetuity.  They were the realtors who sold houses to unwitting homebuyers with the promise of flipping the house for a mega-profit in only a few months.  They were the homebuyers who left their common sense at the door and bought the snake oil the realtors were peddling.  They were the investors in Bernie Madoff's ponzi scheme who never bothered to ask questions when their returns were too good to be true. They were the SEC investigators who ignored warnings that Madoff was a bad guy.

Unfortunately these people are not gone, they are simply with us in a new form today.  They are the politicians promising us pain-free government panaceas to our economic woes.  They are the Federal Reserve policy-makers who are repeating the mistakes that led to the 2001 tech bubble burst and the 2008 credit crisis.  Yet the mistakes are simply being repeated on a much larger scale.  They are the politicians promising "free" government health care with no cost to 98% of Americans.  They are the people who are buying into this false promise.  

How can we be so quickly forgetful?  Rudyard Kipling, in his timeless poem, "The Gods of the Copybook Headings" observed this phenomenon thusly--

As it will be in the future, it was at the birth of man,
There are only four things certain since social progress began:
That the dog returns to his vomit, and the sow returns to her mire,
And the burnt fool's finger goes wobbling back to the fire.

There can be no optimism without brutal, transparent honesty.  Optimism should arise out of a confidence in what we are going to do in response to our own problems, and how we will respond to the world's problems.  That is warranted optimism, for it is something that is within our control.  When our map reflects the way the world actually is, then we can respond accordingly.  We do not have to worry about disappointment, because when we are dedicated to reality, there will be fewer unforeseen obstacles.  What You See Is What You Get.  Even when what you see is not what you like.

I am most optimistic when I am most real.  Real about the present and about the future.  

Is it pessimistic to say that the European Banks are insolvent?  Is it pessimistic to discuss the $1.6 Trillion price tag of President Obama's health care plan?  Is it pessimistic to acknowledge the prospects of inflation?

Not if these are the realities.  And in acknowledging these realities we can find a source for warranted optimism: coming up with the alternatives and solutions to the negative reality we may face.  I am not filled with hope when I hear a political speech full of empty promises and meaningless rhetoric.  I am filled with hope when I spend an hour with my white board solving the next facet of the problems I face.  That means acknowledging the problems I can't solve and coming up with a way to work around them, rather than locking myself in my room and crying because I can't wave a magic wand and make the problem go away.

I will close tonight with a final thought from Peck.  It should be etched in our consciousnesses, both individually and collectively.  It should guide our policy-makers, our business leaders, our voters, our households, our private equity & hedge fund managers, our bankers, and everybody else.  It should also motivate us not only to dedicate ourselves to reality, but also to transparency about reality with all around us.  This transparency, predicated on honest reality, is the source of trust, whether in a marriage or in a business partnership.  If we all take Peck's counsel to heart, our world will be a far better place:

Truth or reality is avoided when it is painful.  We can revise our maps only when we have the discipline to overcome that pain.  To have such discipline, we must be totally dedicated to truth.  That is to say that we must always hold truth, as best we can determine it, to be more important, more vital to our self-interest, than our comfort.  Conversely, we must always consider our personal discomfort relatively unimportant and, indeed, even welcome it in the service of the search for truth.  Mental health is an ongoing process of dedication to reality at all costs.

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June 16, 2009

The Quadruple-Down?

With all of this talk about green shoots and recovery, you'd think that Ben Bernanke, Barack Obama, and Tim Geithner were living in a different reality.  Just that they happen to be living in the same alternate reality as Mr. Market  who seems to have infected Wall Street yet again.  We are living in the midst of another bubble.  The MSM in the United States has turned to happy talk, primarily out of their sworn duty to keep Barack Obama's popularity rating high, while neglecting their ethical responsibility to the Truth.  The bubble this time is what I'd like to call the Recovery Bubble.  It is built on hype, a lot of government spending, and a lot more fiat money created by the Federal Reserve.  Incidentally it bears a close resemblance to the last bubble in all of those respects.  But underneath the surface (even apart from the long-term implications of the U.S. government's unfunded liabilities in social security and medicare) there are several looming collapses that could trigger the next domino effect.  


We looked at one of them yesterday in my article entitled Private Equity Hit & Run, where I analyzed a recent article from TheDeal.com discussing the maturation of more than $400 billion in senior debt in the Private Equity Market.  

Today I'd like to discuss a few others.  Nobody I have read so far in either the U.S. media or the foreign press has put all of the pieces of the defaults puzzle together, so I want to do that today.  

(1) Insolvent European Banks

(2) Credit Card Debt Defaults

(3) U.S. Sovereign Debt Rating

(4) Inflation (The UK is our Canary in the Coal Mine)

Insolvent European Banks

It [European Central Bank] said it is expecting fresh bank writedowns to hit $283bn (£173bn) by the end of next year..."The deterioration in the macro-financial environment has continued to test the shock-absorption capacity of the euro-area financial system. Prospects for a significant turnaround in the short term are not promising," it said.  In a ghastly day for Europe's lenders, Moody's downgraded 25 Spanish banks as rising defaults eat into reserves...The ECB's report said eurozone bank losses would reach $649bn by late 2010: split between $218bn on securities, largely written down already; and $431bn on loans, where the real damage lies. The banks have written down $150bn of loan losses so far.  The report said accounting rules were lax in some countries and there may be "under-reporting". There is a risk that "write-off rates could increase by more than currently anticipated".

In what is another prooftext for the argument that no amount of regulation can prevent financial crises, the highly regulated banking system on the Continent, seems to be in even worse a position than the U.S. banks, including several that have been taken over by the FDIC.  Western Europe is reeling from the near-default status of several Eurozone countries (Greece, Ireland, and Spain), while Northern Europe and Switzerland are on the hook for the now out of control downward spiral in Eastern Europe, especially Latvia.  Sweden, which had previously been insulated from many of the problems besetting the rest of Continental Europe, is now acutely endangered by virtue of its disproportionate share of Latvia's consumer debt orgy.  The Kronor's independence of the Euro had been one of the strengths of the Swedish economy.  It could quickly turn into its Achilles' heel.  

Assuming these write-downs are only as bad as projected, the situation looks grim, not only for a recovery in Europe, but in the United States as well.  Europe's spuriously perceived resilience (particularly Germany, in light of its dogged refusal to engage in the government spending binge advocated by Gordon Brown and Barack Obama) was, if not a silver lining around the storm-clouds, at least a candle in the midst of pitch-darkness.  Those ill-conceived notions are all but abandoned today, yet the American financial press and Mr. Market seem to ignore this fact regularly.

Massive write-downs in Europe can lead to only three outcomes:
(a) Government-bailouts
(b) Capital markets crowd-outs
(c) Defaults

(a) At least in Germany (assuming Angela Merkel's government is returned to power in the Autumn elections), the prospect of bailouts seems slim.  However, Germany is in a classic catch-22.  If they do not assist in preventing defaults in the rest of the Eurozone, they risk a severe devaluation of the Euro, hurting German purchasing power, and significantly altering the realities surrounding existing German industrial policy.  If they do assist, however, they will only undermine their own national fiscal policy efforts to maintain a disciplined and reasonable approach to the situation in addition to the prospects of inflation that would be raised in light of massive pan-European bank bailouts (see #4 below for the implications of quantitative easing as a means for bank bailouts with the UK as our shining example).  

(b) The European banks can of course go to the capital markets like the U.S. banks have, and raise additional capital.  Investors in U.S. banks did not have the benefit of watching this process, and if they had, the banks would have either had greater difficulty in raising capital or else would have been forced to raise it at far less desirable valuations.  European banks now must go to investors who have watched the continued drag on U.S. bank investors and consider the prospects of good returns in light of the foregoing reality.  In my view, at least, this is why the European banks have not raised more capital from the private sector.  Sovereign investors from Asia and the Middle East are shying away from the risk currently surrounding the developed world's banking system.  Even if the Euro banks can raise capital in the private sector, the amount needed to sustain themselves through the next round of the crisis is likely to be so substantial that it will adversely affect other private sector enterprise on the Continent, forestalling recovery even longer.

(c) The specter of default must still loom on the horizon.  Though the EU finance quango will not allow outright defaults, we must monitor the "behind the scenes" actions of the Eurocrats to discern when these pseudo-defaults are occurring.  We will likely see some forced M&A activity tantamount to the BofA and JPM deals arranged by the Federal Reserve.  Then there will be most likely a couple of "credit lifelines" tossed to then-Too Big To Fail banks rather than dozens of smaller bailouts.  I do not expect honest outright defaults and bankruptcy proceedings simply because it will be too politically damaging for the Eurocrats who were drubbed in the recent European Parliament elections and who are scrambling to save face and stave off their doomsday scenario of a Referendum on the European Constitution Lisbon Treaty in the UK.

Given that there are no pain-free options here, it seems that the insolvency of Europe's banks poses an indeed significant barrier to the Developed World's recovery, and even more likely will contribute to a second crisis.

Credit Card Defaults

The troubles sound familiar.  Borrowers falling behind on their payments.  Defaults rising. Huge swaths of loans souring.  Investors getting burned.  But forget the now-familiar tales of mortgages gone bad.  The next horror for the beaten-down financial firms is the $950 billion worth of outstanding credit-card debt--much of it toxic.  That's bad news for players like JPMorgan Chase and Bank of America that have largely sidestepped--and even benefited from--the mortgage mess but have major credit-card operations.  They're hardly alone.  The consumer debt bomb is already beginning to spray shrapnel throughout the financial markets, further weakening the U.S. economy.  "The next meltdown will be in credit cards," says Gregory Larkin, senior analyst at research firm Innovest Strategic Value Advisors.  Adss William Black, senior vice-president of Moody's Investors Service's structured finance team: "We still haven't hit the post-recessionary peaks [in credit-card losses], so things will get worse before they get better."  What's more, the U.S. Treasury Department's $700 billion mortgage bailout won't be a lifeline for credit-card issuers.

This would be bad enough under normal conditions, or even in a situation we are facing today on its face, but there is another layer of complexity that will make this segment of the crisis even more difficult to handle.  Unlike the mortgage market, where there are assets (although devalued ones) to back up the bad debt, the revolving credit market does not benefit from simply repossessing the property the loans were used to acquire, since in many cases these revolving credit lines weren't used to buy any durable property at all.  The cost of litigation is high, and not only is it not scalable, it suffers from the truth of the old adage about getting blood from a turnip.  Suing consumers with no net worth is a losing prospect for everybody.  So the financial institutions are going to have to absorb the losses and write them down.  Market forces are cleaning out all of the misallocated capital in the economy, even as the government and the Federal Reserve system are trying to infuse more capital to prop up the malinvestment.  

Furthermore, under normal circumstances, the credit card companies would have the ability to adjust the prices, terms, and conditions in order to recover some of their losses.  Higher fees, higher interest rates, etc., could normally be employed to limit their damage.  But Capitol Hill and the Obama Administration have made it clear that they will not allow this to happen, and are in the process of passing a series of new regulations under the guise of consumer protection that will only complicate matters further.  

We should expect the Credit Card tailspin to double down the U.S. economy independent of any Hail Mary the Europeans can achieve with their banks.

U.S. Sovereign Debt Rating

Technical analyst Robert Prechter on Monday said he sees the United States losing its top AAA credit rating by the end of 2010, as he stuck by a deeply bearish outlook on the U.S. economy and stock market.  Prechter, known for predicting the 1987 stock market crash, joins a growing coterie of market heavyweights in forecasting the United States will lose its top credit rating as the government issues trillions of dollars in debt to fund efforts to bail out the economy.  Fears about the long-term vulnerability of the prized U.S. credit rating came to the fore after Standard & Poor's in May lowered its outlook on Britain, threatening the UK's top AAA rating. That move raised fears that the United States could face a similar risk, with the hefty amounts of government debt issued in both countries to pay for financial rescues causing budget deficits to swell...Despite the government and Federal Reserve's massive rescues for financial companies and securities markets, Prechter expects credit markets to clam up again as they did in the first phase of the global financial crisis and for the U.S. economy to sink into a depression.  Although U.S. banks' recently passed government "stress tests" that assessed the adequacy of their capital levels to absorb losses and have been able to raise some capital in debt and equity markets, "the banking sector is in severe trouble," as more loans turn bad, he said.  The economy "is obviously heading toward a depression," despite the government's efforts to dodge one, said Prechter.  Federal Reserve Chairman Ben Bernanke has not averted a re-run of the 1930s Great Depression, even though investors are becoming firmly convinced that the Fed has avoided disaster and that the economy has hit bottom.  "It's the next leg down (in stocks) that will make it clear that these things are not true," Prechter said.
The implications of the U.S. government's sovereign debt rating being downgraded cannot be underestimated.  Even if the ratings agencies shift their "outlook" to negative, the consequences could be severe.  We should pay careful attention as the next several months unfold to see if there is any appearance of political pressure on the independent ratings agencies to maintain both the AAA rating and a Positive Outlook for U.S. sovereign debt.  It will be ironic, considering the fact that the present administration has levied substantial criticism against the ratings agencies for playing favorites and turning a blind eye on corporate credit ratings in the past.  But nobody has ever accused politicians of being above some good old fashioned hypocrisy.  

So when the credit rating is cut, interest rates will skyrocket.  There will be major crowding-out as the Treasury tries to keep itself afloat in the private debt market.  There will be increasing pressure on the Federal Reserve (and increasingly will call its independence into question) to engage in yet more quantitative easing, which can and will only lead to inflation.  There is no other course.  The only other alternative is for the current Congress and Administration to radically reverse course on spending policy, something that has about as small a chance of happening as Mahmoud Ahmadinejad voluntarily stepping down as President of Iran.

Higher rates or inflation (or both, which is what is most likely), far from boding well for a recovery, are merely further circumstances that call into doubt these fantasy claims of recovery.

Inflation / Staglation & the British Canary

The Consumer Prices Index (CPI) - the Government's preferred measure of inflation - fell to a 16-month low of 2.2pc from 2.3pc in April, but it was a smaller fall than City economists had predicted.  However, that had been anticipated and factored into economists' forecasts, and it was the so-called discretionary spending categories which prevented the expected fall in inflation..."We continue to see upward pressure in 'high street' prices and we continue to attribute this in part to the sharp depreciation in sterling seen over the past quarters, notwithstanding the significant rally posted in recent weeks," said David Page, economist at Investec.  Inflation has now come in above economists' expectations in five of the past seven months.

It should be noted that it was the Bank of England that first embarked on the policy of quantitative easing in the Developed World.  That inflation has now several times surprised economists' expectations in the UK should not surprise those of us who believe in sound money.  It is almost humorous that these economists are baffled by the twin prospects of inflation and economic contraction, as if they have a completely blocked out the lessons of 1970s stagflation.  For Gordon Brown and the already beleaguered Labour Party, the Winter of Discontent should haunt their dreams.  Nevertheless, the rest of the world, at least those whose futures are tied to the Dollar, should take note: quantitative easing has consequences.  Either we will sustain severe stagflation or else the Federal Reserve will be forced to abandon its easy money policies once again to tame the inflation beast, thrusting the American economy directly back into the throes of recession.  Recession of course is the best medicine for malinvestments, and had the government permitted the recession to run its course, we would at least be closer to the path to recovery.  Instead, government and Federal Reserve policies tried to avoid the pain of recession by manipulating the markets with massive infusions of cash which will either have to be pulled out or allowed to run their course.

The further problem we should observe in this situation is that avoiding a further massive contraction becomes ever-more costly.  For it is not only a matter of leaving the current inflationary dollars in the system that is required to keep the economy on life support, it is the need to continually feed the monster with more and more newly-minted money.  Virtually any policy pursued by the Federal Reserve at this point will have adverse circumstances.

Conclusion

So what's an investor/entrepreneur to do?  The answer is to look to the handful of countries pursuing responsible economic policies.  The trouble is, you won't find many.  The Developed World has gotten itself into a position where it bet everything on Red 15 and the roulette ball landed on Black 7.  Doubling down on its debts in the hope that the new bets would pay off has only doubled downed the consequences (both immediate and long-term) of our current unpleasantness.  There is plenty of capital sitting on the sidelines today, and it has to have a place to go.  Developing Countries with stable monetary systems offer some haven for investors looking to escape the uneasiness of the over-leveraged developed world.  Emerging market equities in Asia, and Latin America's stable countries have a far greater chance of holding the value and outperforming investments in the developed world not only in the short-term, but over time.  

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June 15, 2009

Private Equity Hit & Run

An excellent article on TheDeal.com [ http://bit.ly/AN1D5 ] validates my view that leverage is a speculative tool that endangers not only the long-term health of companies, but of the Private Equity industry itself.  The article doesn't make these conclusions, but they do follow from the observations the author makes.  Let's look at them one at a time.


(1) Deleveraging Changes the Landscape: "The deleveraging of the economy in the wake of the economic crisis has dealt an especially crippling blow to private equity, an industry long as reliant on debt as candy makers are on sugar.  For a blissful four-year span that lasted into 2007, leveraged buyout sponsors raked in vast profits fueled by oceans of cheap debt and by soaring asset valuations and a booming economy that were debt-propelled.  Today that golden age seems as remote as the lost empire of the Incas."

Indeed, it was private equity firms, far more than the much demonized hedge funds, that were responsible for much of the leverage bubble that tipped off the financial crisis when the game of Hot Potato ended.  Private Equity now must forge a new existence (a more responsible existence) in an era where their favorite food has been taken away from them.  Imagine Michael Moore without his Ben & Jerry's, that's where Private Equity is without cheap debt.

(2) Bright, but Dim Future: "In one key area, it turns out, private equity is sitting pretty.  Before the economy worsened drastically last fall, the industry replenished its coffers, drawing more than $550 Billion in pledges from institutional investors in 2008, a near record...But for now, that alluring prospect is vying for sponsors' attention with a worrisome, brewing development that could lay waste private equity returns and foster an industry shakeout.  Though previous downturns have forced slews of poor performers, including some well-known names, from the business, the body count this time could be great.  The problem lies in the staggering amounts of equity and debt capital that poured into LBOs from 2004-2007.  From 2012 to 2014, about $430 Billion of senior debt tied to that deal spree is set to come due.  And unless the leveraged loan market roars back to life by then--something experts consider doubtful [Skinner: I concur]--an avalanche of defaults could wipe out much of the equity the buyout industry wagered on scores of deals."

Casino capitalism strikes again.  This is the problem with leveraged deals in the first place.  Saddling good companies with a lot of debt for a quick turn sure made the gamblers a lot of profits, but those who were caught at the end of this game of Hot Potato are getting their hands burned, and they are going to have to make a choice between survival (read: burn through all that cash they have sitting around) or doubling down on sure losses by letting it ride.  There is a time and place for debt capital: financing the purchase of new equipment, expanding the operations of a company buy acquiring a smaller competitor with an innovative product offering, financing additional inventory to open up a new export market, etc.  But the time and place for debt capital is not leveraging the lifeblood of a company on 15 Red.  

Before we move on to (3), some math is in order.  PE funds have raised $550 Billion in pledges, but there is $430 Billion in Senior debt coming due.  So that's a net of only $120 Billion.  Not as much capital on the sidelines after all.  As I have stated before on this blog and elsewhere, there is another wave of defaults coming anyway, assuredly from the even-more insolvent European banks, and people are naive if they think it won't further ripple across the Atlantic.

(3) Big Deals Go Bust: "'There will be a lot of RJRs,' one buyout specialist predicts, alluding to KKR's $31.3 Billion buyout of RJR Nabisco in 1989, which held the size record for an LBO for 16 years and which lost money for KKR.  'Not bad companies, necessarily, but companies with capital structures the sponsors can't extricate themselves from and that can't be refinance.'  This investor says he expects one-quarter of the megadeals to be total busts, another quarter to make a profit and half to post a partial loss. 'But that's only if the economy recovers,' he adds. 'If it doesn't, those deals are all toast.'"

Notice that the problem isn't that they invested in bad companies; it's that they invested in bad deals.  There is a difference.  There is also such a thing as a good deal in a bad company.  I threw together a quick color-coded visual to help us understand the differences.

Private Equity's future no doubt must focus on Value Plays and Turnarounds rathe than chasing the biggest, sexiest headline-making deals.


(4) The Interest Rate Storm Cloud: "One top LBO banker calls even that scenario too bullish. 'If we do have capital markets in, say, 2012, sponsors could have to refinance at grotesquely high interest rates, and that will permanently impair their equity,' he says. 'That's the good case.'  If, on the other hand, credit is scarce, sponsors may have to sell stock in their albatross deals to pay off debt, massively diluting their own stakes.  Weak performers may end up being sold at a loss to deep-pocketed corporations or broken up and sold in pieces.  Creditors would recover of what they lent, and sponsors would get zilch."

Debt-heavy Private Equity can't operate in vacuum.  It is going to be subject to the topsy-turvy nature of an unstable bond market over the next several years.  For firms operating primarily in the U.S. market, this means interest rates that are only going to increase in the next few years (whether to tame inflation, or as the markets revolt against it), with the less probable, though still possible apocalyptic prospect of being forced to take out future debts in Yuan or IMF SDR-denominated bonds in order to refinance their investments.  

This data all points toward a leverage-free approach as the optimal way not only to preserve wealth for investors, but to create more of it--just on a less aggressive timeline than the speculators can traditionally "promise" (the problem with debt-driven speculation is that it always collapses.  It is a universal truth that is ignored when everybody gets bubble fever.  Investing with managers who maintain active awareness of these dangers will help investors protect their capital in the future).  

(5) Debt + Excessive Valuation = Low or Negative Returns: "Nevertheless, the returns that LBOs done at the market's peak ultimately deliver, many say, are apt to be skimpy at best, and not solely because of the colossal debt.  Another drag on returns will be the bloated LBO valuations of that era.  With money now tight, sponsors have little chance of selling their holdings for close to the valuations they paid.  'My prediction is that many private equity funds of that vintage won't return capital, won't break even.  Those that do will be top-quartile [performers],' says an executive at a mayor buyout house.  'The industry will be challenged and tested in a way it never has before.'"

Or, as Warren Buffett once said "When you combine ignorance and leverage, you get some pretty interesting results."  

(6) Will Private Equity Learn? "'What's more, there will likely be a drastic overhaul of how private equity operates, some sponsors say.  Many expect the hefty transaction fees firms have collected, which in some megadeals topped $200 million, to be reined in.  Megadeals themselves will be a casualty, and buyout funds will be scaled back to reflect the downshift in debt financing. 'A lot of people now are talking about a new alignment of financial incentives for private equity and hedge funds,' a buyout sponsor observes. 'The incentives to do deals were skewed by the fees that sponsors and bankers were pocketing.' Likening the deal binge to a hamster running furiously on a wheel, he says: 'People will look back and ask, Why did the hamster run like that? It was because of the food it saw in front of it. 'That kind of incentive makes sense for a hamster, but it led to the insanity' that gripped the buyout market, he says."

"He and others argue that when LBO activity revives, banks and sponsors alike, chastened by the pain they caused themselves in the mid-2000s, will keep a lid on leverage and structure deals prudently. 'It will be like what happened to venture capital' after the bursting of the tech and telecom bubble in 2001, he argues. 'People didn't dispose of the VC model,' but overhauled it.  Others aren't so sanguine about private equity's ability to learn. 'At some point the competition for deals will heat back up,' says UBS's Smith, 'People's memories fade.  I'm highly confident that we will overcook the market again.  It happens every 20 or 30 years."


Conclusion

Private Equity needs to be overhauled.  The inertia in the industry, however, will make it slow-going.  The guys with 20 years of experience in private equity will continue to long for the "good 'ol days," and will have the play book to prove it.  Like the music industry with the advent of online music downloads, like the telegraph industry when the telephone came along, like the American automotive industry in the face of Asian competition, most private equity managers will keep up their old ways in an era where they are archaic, outmoded, and useless.  

Out-sized returns are possible in a world without massive leverage and disproportionate debt levels, but they simply require more hard work.  It takes the full-court press.  

[To read about how David defeats Goliath with the Full Court Press, read this great article in the New Yorker by Malcolm Gladwell, Author of The Tipping Point http://bit.ly/m9zFn ]

The future of Private Equity will be mixed.  For those who respond to the changing times, who are willing to invest more in adding value than flipping for a quick profit, for those who are willing to invest in companies that they would be happy owning even if the stock markets were shut down for 10 years (to borrow again from Buffett), and that big IPO simply were never possible, for those managers, the future is bright.  But those who cling to the past will be eaten up by the mountains of debt that they once thought were their road to riches.

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June 15, 2009

National CFOs

Yesterday, I was reading an article that quoted the head of Iceland's Central Bank as saying that they would soon be joining the Euro because Iceland might know a lot about fisheries but maybe they didn't have specialized knowledge about monetary policy. This was interesting enough (though I tend to think the European Union is an undemocratic bureaucracy that is expanding, destroying every economy in its path, but that is a topic for another day).
 
So it got me to thinking--why do some countries so consistently make bad economic and governing decisions? I look at my current neighboring country, Argentina, and the case is simply puzzling. I travel to Argentina with relative frequency, and have collectively spent several months in the country. The people I encounter there are intelligent, many are well-traveled, and they all recognize Argentina's caricature government and economy. The 10-year boom/bust cycle is accepted as an unalterable fact of life.
 
Economic policies in many countries are dictated from the top of the executive branch, since it is the economic health of a country that usually makes or breaks an executive's popularity. The Finance Minister is one of the most coveted jobs in a government, and it carries tremendous prestige. As a result, it is a tremendous political reward to the chief executive's most loyal constituencies. Or else it is given to somebody who can "tow the line" appropriately. Rarely are the finance ministers, who are in fact the CFO of the country, chosen on the basis of providing quality, independent counsel and direction on finance and economics matters. Instead, the tail always wags the dog. Economic policy is made out of political needs, rather than out of economic realities. This is no less true in the United States than it is in Argentina.
 
In the world of international business, CFOs are often accountable to the Board of Directors, not to the CEO. Perhaps Finance Ministers should be too--either accountable directly to the voters or else to the Legislative authority of the country. Greater independence could prevent election year business cycles from propping up otherwise weak executives. Since their own job wouldn't be on the line if the chief executive loses the election, the Finance Minister could make decisions that are wholly independent of their desire to "get the boss re-elected." Imagine the radical shift in government economic policy that could result from this relatively minor change.
 
It's at least worth considering.

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June 14, 2009

Rhetorical Lesson for the Republicans

I woke up this morning and began perusing the news, as I do most every morning, and the Daily Telegraph www.telegraph.co.uk is always one of my first stops, along with the Drudge Report.  I am increasingly finding that the British press is simply more insightful and well-rounded than the filth that passes for journalism in the United States these days.  Indeed, one can still distinguish between the News and Opinion sections of even the more partisan British papers--something that can hardly be said of the New York Times or Washington Post.  But I won't explore that issue today.  Today I wanted to make an important rhetorical observation that the Republicans would be wise to heed.  Here is the quote from the Telegraph article:


In Friday's Financial Times, Alistair Darling, who saw off Brown's attempt to replace him with Ed Balls, sounded a quite different note to the PM on Labour's spending plans. Gordon clings to the tired old formula that the Tories will "cut", while Labour will "invest". Mr Darling's position is altogether more nuanced. "I have always been clear," the still-Chancellor told the FT, "that, just as we support the economy now, in the medium term we have got to live within our means and I set out a clear commitment to halve the deficit over a five-year period."

The Socialist Left loves to use the word "invest" to describe their own hair-brained political constituency-appeasing largesse that they are permitted to pass off as "economic policy."  And they are equally apt to enjoy hurling the "cut" accusation across the aisle.  The Republicans need to turn the tables.  They need to say "every time you hear a Democrat say they are going to 'invest in education' or 'invest in healthcare' or 'invest in the economy' what they are saying is that they want to raise your taxes, take bonds out in the names of your children, and destroy America's standard of living.  What they really want you to invest in is a government-run version of Enron."  

This will be far more politically effective than "spending is out of control."  I don't think the current Republican leadership in Congress or at the RNC is smart enough to pull this off, but there's a new generation of Republicans brewing out there.  They are Ron Paul-supporting, little "L" libertarians who see America's promise of "the land of the free" as a lie, and who see the Republican and Democrat establishment as virtually one and the same.  If this new generation of Republicans will rise up, kick the Establishment out, and put together their own manifesto for decentralizing power, non-interventionist foreign policy, and a less intrusive, less paternalistic police state, they will win allies on the Left, the Right, and in the Center.  

This is what the Republican Party needs--not a bunch of wishy washy moderates--not a crowd of gay-hating evangelicals--but firmly committed, principled advocates of freedom and of a government that does not wreck our economy in pursuit of its ivory tower social agenda.  Not only does the Republican Party need this, but America needs this, badly.

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June 13, 2009

Skyscraper Capitalism has Killed the Free Market

Skyscraper Capitalism (which is hardly capitalism at all) is the real culprit in the waning affection for free markets in North America. The big banking interests, who utilized their political clout during both boom and bust, who abuse the average person through the manipulation of the credit systems and take advantage of their plutocratic connection to the Federal Reserve System--the big automotive industry that the government has been propping up for nearly 30 years now that had also been the beneficiary of three decades of loose credit and easy money (who buys a car with cash anymore? and that's precisely the reason car prices have so radically inflated compared to other consumer goods)--all of these and more have created a murky debate around "free markets" versus "state intervention." The reality is that for the entirety of American history since the New Deal, we have had far more of the latter than the former.

Much of the state intervention in the last 30 years has been to aid private sector interests, especially the interests of the major players (and therefore major campaign contributors). The development of bloated securities regulations has been a boon not just to law firms, but to investment banking, and created an entire industry around broker-dealerships with significant barriers to entry, not just for people wanting to get into that business, but for people who have to pass through those businesses in order to finance any nascent enterprise. Indeed, the state-interventionists have created the very financial services monster they now decry. The average guy wanting to start a business either has to get a bank loan (and pay interest to the banking plutocracy) or else go through the nearly insurmountable trouble of raising equity capital for his business, involving at least two attorneys and likely a couple of financial services providers. Now the state-interventionists want to implement price controls on the industry they created, meaning there will be a bigger black market in financial services, more of the business will move overseas, and there will be all kinds of other externalities to the proposed new policies that the policy-makers and politicians haven't even bothered to consider.
 
Far from being a defender of the Skyscraper Capitalists, I view them as the root cause not only of many of our political problems, but our business problems as well. These are the corporations that want to keep their shareholders at arms-length, who view the Board Room as their provincial palace where only their chosen insiders who have "played the game" are permitted to enter. It is the Skyscraper Capitalists whose abuses have turned people from free markets, and have instigated a massive rise in support for not merely a bit more state intervention, but the radical takeover of entire private sector industries by governments in the United States and abroad.
 
Ian Brown, writing in The Globe and Mail, discusses the new interest in Marxism that has been precipitated by the financial crisis. Those who care about the future not only of capitalism but liberty itself will be wise to read this article and consider its implications. http://bit.ly/bFYNq
 
What we need is a new generation of capitalists: Hard Hat Capitalists who are willing to get their hands dirty, who are willing to create long-standing partnerships and relationships with their shareholders, whose communication with their investors is more personal than an annual report. We need people who are willing to leave their ivory towers and go to where everyday commerce happens. Sam Walton and Warren Buffett are shining examples of Hard Hat Capitalists--men who did not allow their wealth or position to lead them to obsession about tall shiny buildings and New York cocktail dinners.
 
This week, I read that more college graduates are looking for work as government bureaucrats (the article termed it "public service," but we all know what that is a euphemism for) than ever before, and that there has been a substantial drop in college grads seeking jobs in business--even Business school graduates. We should not underestimate the long-term impact this will have on the efficiency of our economy. Our best and brightest should be engaged not in economic policy-making but in actual economic decision-making--ensuring capital is allocated most effectively with a profit motive, and their shareholders in mind. If not, we face a steady decline of our economic output, consumer demand being met less and less efficiently over time, and with all of our smart people in government, they will surely not be content to sit by and do nothing. They will use the force of law to try to "fix" things. America's status as the world's economic engine will go out (to borrow T.S. Eliot's words), "not with a bang, but a whimper."
 
A new generation of capitalists could not come along too soon, not simply to restore faith in free markets, but to be genuinely good stewards of our society's resources, invested with self-interest, but not greed, seeking returns for shareholders year after year, not a big bonus at the end of this one. There is no autopilot in the history of progress. We must all work hard to keep the faith in our values of liberty strong. The alternative is not so pretty.

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June 12, 2009

Pay Attention Private Equity: Enterprise 2.0

Andrew McAfee's blog today contains superb insight into the pattern language of Enterprise 2.0, and it is well worth a read for anybody involved in private equity trying to improve their portfolio companies using technology.  The framework McAfee outlines is really golden.  For those of us working in emerging markets, the question of being able to "leap-frog" a decade of technology advances cheaply is an attractive value proposition of Enterprise 2.0.  It also means we face less internal opposition from those who have spent millions of dollars already on now antiquated technologies.  The closer the starting point is to "zero" the better, when it comes to Enterprise IT.  Aggressive, but judicious implementation of Enterprise 2.0 methods and practices can really jump start an ailing project and open up new worlds of possibilities, not only in terms of efficiency, but creativity too.  And it is the creativity deficit that is usually so hard to overcome.  Unfortunately most of "high finance" is stuck in the dark ages when it comes to collaboration, openness, and the other things that characterize Enterprise Web 2.0.  Those of us who have caught on to it have an advantage facing off against the "big boys."  Let the full court press begin.

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