The past year has been tough for small businesses, particularly in the UK. The dramatic fall in the value of sterling, the increased cost of borrowing and the reluctance of banks to lend to SMEs (small and medium sized enterprises) have all hit firms hard. There are three million family-run businesses in the UK, employing 9.5million people and contributing to more than 30 per cent of GDP and with many facing a white knuckle ride into 2009 there has been an understandable focus on how to ensure the survival of this part of the economy. If unemployment is to be kept to somewhat manageable levels next year this is seen as a key area to target. Small businesses cannot protect themselves from clients, suppliers and bankers in the same way that big companies can, so the speed with which they can run into difficulties when sailing through the current storm is very much heightened.
The British Chambers of Commerce has warned that many small firms will struggle to survive in the coming months, with access to finance and cash flow likely to be major issues. BCC Policy Adviser Steve Hughes says: 'The Government's stimulus failed to help smaller businesses. Many will be forced to lay off staff and in some cases businesses will go to the wall. We must do all we can to help small firms survive, not only because they will get us out of this downturn but because the businesses we lose will never return". One certain opportunity that will come as a consequence is that anyone who is good at running real business is going to become a valuable commodity. If you can manage your way through this and keep people employed the government is likely to be very much "on your side".
Private equity companies, I believe, have a great opportunity in this area. They will quickly need to transfer their focus away from the financial engineering approach of the past five years to a focus on sales growth and productivity gains; i.e. doing something "real". The true secret of private equity performance in the past five years was recapitalisations and pass the parcel secondary buyouts which led to ever more leveraged companies, and unbelievable returns during the good times. Now that the world has turned, there has to be real value added - which is much harder work. Nonetheless, given the likely purchase prices that will be available for the next rounds of private equity deals, the opportunity for those willing to do the hard yards is potentially very high. Many of these opportunities will come as over-levered companies fall by the way side, and government will be keen to help if part of the focus is on keeping people employed.
In the last few weeks and months, a raft of well known high street retailers in the UK have been taken into administration, Woolworths, Zavvi, Adams Kids and Whittards to name a few. Many more will undoubtedly follow early in the New Year after they tally up the numbers for what must have been extremely difficult trading times over the all important Christmas period. 30-50% discounts were not hard to find, even early on in the season, and the impact on the margins of these retailers will become clear soon enough. The ability of government to look at more bail-out type packages to support those who are next to fall off the cliff has got to be increasingly limited. Other non-financial solutions are being desperately looked at, in order for it to be as easy as possible for companies that are big employers to remain in business and keep paying wages.
Many of the companies that will fail, will do so because their balance sheet leverage increased over the past 10 years and as a consequence their sensitivity to margin erosion is acute. This tale is applicable to many more high street names - Boots, MFI, Countrywide, Hilton, Gala Coral, EMI for example. As these leveraged companies come to refinance their original loans (taken in the good times at low interest rates), banks will either choose not to refinance at all, or will do so at incredibly penal credit costs. 2009 will see plenty of covenant breaches on the loans that backed these highly levered deals, which will lead to banks embarking on restructuring programs that will see existing private equity investors diluted out of sight. At this point in time most of the debt that exists from the LBOs mentioned above trades in the market at yields that reflect that the private equity holders investments are worthless, and that these companies are technically insolvent. The insolvency expert Begbies Traynor has predicted that at least 15 national retail chains will go bust in the UK by mid January.
That is where we are heading, but the above commentary can be read in any newspaper so is not particularly revelationary. What is more compelling, and optimistic is that out of all this, there will be some really great opportunities for real business people to pick up the pieces. And these pieces will likely come at very low cost.
A private equity company (that one of the readers of this blog works for), was responsible for purchasing Whittards (the speciality tea and coffee maker) out of pre-packaged administration in the last couple of weeks. Whittards employs 950 people in 130 different stores across the UK. It generated close to £50mm worth of revenues last year, having been purchased by the now beleaguered Icelandic retail group, Baugur, for over £20mm 3 years ago. The sale price out of the "pre-packaged" administration process this time was believed to be less than £1mm. Presumably given Baugurs troubles, they were forced sellers as they would not have had the money to have put into the business at this point in time to get it back on track. I don't know the ins-and-outs of whether Whittards can be turned into a viable business, but if it can then the upside to the investors on their small purchase price could be huge. They are in effect buying a cheap call-option; not quite free, but close.
There will be plenty of opportunities of this nature that start to rise up from the ashes in 2009. I would suspect that there will be other non-private equity participants looking to enter the fray; consultancy firms who earn fees for fixing ailing business should probably look into this area. They have the right people in place to oversee the real business change that will lead ailing companies back onto the right track - so why not see the upside through ownership? I expect to see more fund raising taking place of this nature. Pre-packaged bankruptcies, where obligations to past creditors are close to nil, could well be the territory where the seeds for a broader economic recovery are grown. Governments will certainly be on the side of anyone who is willing to try to keep people employed in the process, especially if they don't have to spend any more taxpayers money. What is for sure is that there certainly won't be much sympathy for creditor complaints that have arisen out of the excesses of the past.
Monday, 29 December 2008
Monday, 22 December 2008
Status Anxiety
"Were an alien to pick up our news channels, it would conclude that human civilisation depended on the production of cheap plastic tat." This would be the outsiders view of our existence according to Tim Harford, in his book "The Logic of Life". For my money, he probably goes a bit far in discrediting our ability to produce useful things, but the importance of the consumer to economic growth during the last 25 years, particularly in the UK and the US, has been very clear.
In a simplified story-line, China has been the global producer of last resort, and the US has been the consumer of last resort. This plentiful arrangement had worked quite nicely for both parties up until recently. China funded a decent chunk of the credit that US consumers fed-on, and in return the US purchased the "tat" and not-so-tat stuff that was made in China, creating jobs, prosperity and a very large current account surplus in China. This surplus was then recycled into more US government and consumer debt, and more "tat" was bought to fill the houses that were rising in value so nicely in places like California and Florida. Then a wheel fell off the wagon.
Now, attempts to fix the broken wagon have almost been fully exhausted; the Federal Reserve has reduced interest rates to 0% and we have been through a variety of various asset purchase plans and bail-out plans. The only remaining tool left in the bag is to start printing money - which didn't work quite so well for the Weimar Republic in Germany in the early 1930s. Hyperinflation, and the Nazi party followed in short order.
Within the US and the UK, the solutions being proposed to "get things back on track" seem to be aimed at recreating a more sustainable version of the spend, borrow, work philosophy that successfully drove up economic growth over the past quarter of a century, and that also led to the current implosion. After the initial stage of the overall crisis, which started as a banking crisis, we have gone through several stages of thinking within what is termed the "real economy", that have led us in a downward spiral:
1) Pessimism. Fueled by news commentary on the plight of the financial system, which led to:
2) Lower planned spending;
3) More pessimism from banks, because of this lower planned spending. As a consequence, banks started to lend less;
4) Lower spending because of less consumer credit;
5) Lower earnings for companies because we are buying less of their stuff;
6) Less credit available to companies because their earnings are falling;
7) Companies can't get credit, so lower inventories/ stock or companies can't refinance debts so they either sell assets or default;
8) Banks need to lend less because the are taking writedowns against past loans to these failing companies;
9) Layoffs/ recession etc. etc.
It looks like in the short-run, there is a serious dependence on consumption to keep this legal "Madoff" scheme going ("Ponzi" is so last year). In the run up to Christmas, which the British theologian Don Cupitt referred to as "the Disneyfication of Christianity", we are reminded on news channels of how absolutely critical it is for our shopkeepers lives that we get out and spend this year.
In the longer term, perhaps there are more choices, and we could go about things in a different way. A completely counterintuitive approach might be that we collectively accept a lower average income and take more leisure time, doing things that don't involve consumer spending. It's interesting to note that the typical British man earns roughly twice what his father did at the same age, on an inflation adjusted basis. When today's children are in their forties and fifties, perhaps they will opt to use their increased prosperity to work less and take more leisure time. Instead of being twice as rich as their parents, they may opt to start their weekend on Wednesday afternoon. In theory this would be possible, as we are rich enough already. A survey done 10 years ago by a couple of US economists (Solnick and Hemenway) found that many Harvard students would rather have an income of $50,000 in a world where most people were poorer than an income of $100,000 in a world where most people were richer. Perhaps that survey says something about those Harvard graduates, but the point is played out across society. There is no rational economic logic to this behaviour.
To continue the theme of Harford's "The Logic of Life", he identifies this sort of behaviour with what he calls "status anxiety". The desire that "status anxiety" produces is almost insatiable because it is largely relative - the better someone else is doing, then the better you need to be doing. Perhaps in China, the opposite happens to what happens in the US; status comes not from having a yacht, but from having produced the most stuff and having saved the most. It is what George Soros would call a reflexive process; i.e. it is a self-reinforcing process, and becomes the bias of a society or culture. Neither route is necessarily right.
On a personal level, I would like to retain the choice to work longer, for more ability to consume or to work less for more free time, and to take the trade off decision at a personal level.
One worry is that the current response to the excesses of past consumerism, might make this trade off more difficult for us all. Current government bail-outs that are aimed at reinvigorating our consumer orientated economies will in effect be placing the motherload of a credit card bill onto future generations, which may limit those choices. Taxes will need to go up at some point in the future.
The erosion of tax revenues will only be made up by longer working lives, or more successful, innovative companies. If there is a collective move away from 'consumerism', towards working less and taking more leisure time we will see plenty of defaulting governments in 15-20 years time as the burden of today's debts are unmet by the desire of the next generation to sustain the approach our generation so eagerly lapped up.
As many people around the world are facing up to their relatively tough economic situations, there is evidence that a significant number are looking to reconsider their work/life balance - either through their own choosing, or through an enforced situation...i.e. they have been laid off. For many in this camp, the lucky ones who were closely involved in the gold-rush of the last 25 years, or those who've worked long enough to have achieved the standard of living their parents had at a considerably earlier age, there are real choices.
The flexibility to opt for a simpler more frugal existence is there for the taking, albeit that many people would say this is too difficult a change to contemplate; private school fees, 2 cars, golf club membership can't be given up. The alternatives are substantial; perhaps working in the 'day job' from monday to wednesday afternoon (by which time you will be at your parents income level) and then spending thursday and friday working on charity projects, sporting endeavours, or whatever else flicks our collective switches.
The burden of financial responsibility for the problems that the work, spend, borrow philosophy advocated over the past 25 years, is being shifted onto the next generation, who will not have been the beneficiaries of the 'good times', but will be picking up the tab. Is it fair, given that they may want to move down the route towards a more holistic lifestyle, that they should be burdened with an even greater responsibility for tax revenue generation than ever before?
It's a difficult time to be making policy decisions, but the law of unintended consequences may mean that widespread economic bailouts just reinforce the behaviour patterns that got us into this mess. As difficult as it is to swallow for many people and many businesses, it is important that sufficient pain is felt by the system in the short-to-medium term so that we are really forced to consider what approach we choose to collectively take for the long term.
In a simplified story-line, China has been the global producer of last resort, and the US has been the consumer of last resort. This plentiful arrangement had worked quite nicely for both parties up until recently. China funded a decent chunk of the credit that US consumers fed-on, and in return the US purchased the "tat" and not-so-tat stuff that was made in China, creating jobs, prosperity and a very large current account surplus in China. This surplus was then recycled into more US government and consumer debt, and more "tat" was bought to fill the houses that were rising in value so nicely in places like California and Florida. Then a wheel fell off the wagon.
Now, attempts to fix the broken wagon have almost been fully exhausted; the Federal Reserve has reduced interest rates to 0% and we have been through a variety of various asset purchase plans and bail-out plans. The only remaining tool left in the bag is to start printing money - which didn't work quite so well for the Weimar Republic in Germany in the early 1930s. Hyperinflation, and the Nazi party followed in short order.
Within the US and the UK, the solutions being proposed to "get things back on track" seem to be aimed at recreating a more sustainable version of the spend, borrow, work philosophy that successfully drove up economic growth over the past quarter of a century, and that also led to the current implosion. After the initial stage of the overall crisis, which started as a banking crisis, we have gone through several stages of thinking within what is termed the "real economy", that have led us in a downward spiral:
1) Pessimism. Fueled by news commentary on the plight of the financial system, which led to:
2) Lower planned spending;
3) More pessimism from banks, because of this lower planned spending. As a consequence, banks started to lend less;
4) Lower spending because of less consumer credit;
5) Lower earnings for companies because we are buying less of their stuff;
6) Less credit available to companies because their earnings are falling;
7) Companies can't get credit, so lower inventories/ stock or companies can't refinance debts so they either sell assets or default;
8) Banks need to lend less because the are taking writedowns against past loans to these failing companies;
9) Layoffs/ recession etc. etc.
It looks like in the short-run, there is a serious dependence on consumption to keep this legal "Madoff" scheme going ("Ponzi" is so last year). In the run up to Christmas, which the British theologian Don Cupitt referred to as "the Disneyfication of Christianity", we are reminded on news channels of how absolutely critical it is for our shopkeepers lives that we get out and spend this year.
In the longer term, perhaps there are more choices, and we could go about things in a different way. A completely counterintuitive approach might be that we collectively accept a lower average income and take more leisure time, doing things that don't involve consumer spending. It's interesting to note that the typical British man earns roughly twice what his father did at the same age, on an inflation adjusted basis. When today's children are in their forties and fifties, perhaps they will opt to use their increased prosperity to work less and take more leisure time. Instead of being twice as rich as their parents, they may opt to start their weekend on Wednesday afternoon. In theory this would be possible, as we are rich enough already. A survey done 10 years ago by a couple of US economists (Solnick and Hemenway) found that many Harvard students would rather have an income of $50,000 in a world where most people were poorer than an income of $100,000 in a world where most people were richer. Perhaps that survey says something about those Harvard graduates, but the point is played out across society. There is no rational economic logic to this behaviour.
To continue the theme of Harford's "The Logic of Life", he identifies this sort of behaviour with what he calls "status anxiety". The desire that "status anxiety" produces is almost insatiable because it is largely relative - the better someone else is doing, then the better you need to be doing. Perhaps in China, the opposite happens to what happens in the US; status comes not from having a yacht, but from having produced the most stuff and having saved the most. It is what George Soros would call a reflexive process; i.e. it is a self-reinforcing process, and becomes the bias of a society or culture. Neither route is necessarily right.
On a personal level, I would like to retain the choice to work longer, for more ability to consume or to work less for more free time, and to take the trade off decision at a personal level.
One worry is that the current response to the excesses of past consumerism, might make this trade off more difficult for us all. Current government bail-outs that are aimed at reinvigorating our consumer orientated economies will in effect be placing the motherload of a credit card bill onto future generations, which may limit those choices. Taxes will need to go up at some point in the future.
The erosion of tax revenues will only be made up by longer working lives, or more successful, innovative companies. If there is a collective move away from 'consumerism', towards working less and taking more leisure time we will see plenty of defaulting governments in 15-20 years time as the burden of today's debts are unmet by the desire of the next generation to sustain the approach our generation so eagerly lapped up.
As many people around the world are facing up to their relatively tough economic situations, there is evidence that a significant number are looking to reconsider their work/life balance - either through their own choosing, or through an enforced situation...i.e. they have been laid off. For many in this camp, the lucky ones who were closely involved in the gold-rush of the last 25 years, or those who've worked long enough to have achieved the standard of living their parents had at a considerably earlier age, there are real choices.
The flexibility to opt for a simpler more frugal existence is there for the taking, albeit that many people would say this is too difficult a change to contemplate; private school fees, 2 cars, golf club membership can't be given up. The alternatives are substantial; perhaps working in the 'day job' from monday to wednesday afternoon (by which time you will be at your parents income level) and then spending thursday and friday working on charity projects, sporting endeavours, or whatever else flicks our collective switches.
The burden of financial responsibility for the problems that the work, spend, borrow philosophy advocated over the past 25 years, is being shifted onto the next generation, who will not have been the beneficiaries of the 'good times', but will be picking up the tab. Is it fair, given that they may want to move down the route towards a more holistic lifestyle, that they should be burdened with an even greater responsibility for tax revenue generation than ever before?
It's a difficult time to be making policy decisions, but the law of unintended consequences may mean that widespread economic bailouts just reinforce the behaviour patterns that got us into this mess. As difficult as it is to swallow for many people and many businesses, it is important that sufficient pain is felt by the system in the short-to-medium term so that we are really forced to consider what approach we choose to collectively take for the long term.
Sunday, 14 December 2008
The Long View...
One of the most striking aspects of some of the grandest cathedrals in Europe is that these buildings tended to take an incredibly long time to complete. Notre Dame in Paris was started in 1163 and finished 1345, St. Peter's in Rome was started in 1506 and completed in 1626 (a bit of a rush job, that one), and Barcelona's Sagrada Familia - started in 1882 and still under construction. On the subject of the long construction period of the Sagrada Familia, Antoni Gaudi (the original architect) was reported to have commented that "...my client is not in a hurry". The agreeable client, God in this case, makes this "long view" a bit more viable.
What strikes me about these undertakings is that those who devoted their working lives to these magnificent, all encompassing, projects would likely in many cases never actually see the fruition of their work. Presumably the divine connection that they were attributing to their work, may have been sufficient compensation. Many of an atheistic persuasion would say that they were deluded. Personally, though, I'm glad that they did, whatever of their reasons. Those individuals involved in these projects will have had greater legacies attributable to them than most of the projects people concern themselves with in their working lives. The trade-off is that with mortgage payments to be met, banks tend not to accept 'godliness' as an acceptable form of credit, so most of us are pushed down the route of a form of pragmatic short-termism.
Recently, I had the opportunity to take a insiders tour of the Sagrada Familia, with the current leading architect and construction engineer on the project. The passion that was on display for their work was pretty awe inspiring - to be honest i was fairly jealous about feeling as engrossed in an undertaking as these guys did. I also set to thinking as to where else in the world, and what sort of other projects exist that encompass this "long view" mentality. What becomes clear is that the notion of what the term "long-term" means in the developed world is shorter than it used to be. There are cultural consistencies - the Japanese when asked for a nominal figure in years as to what the "long-term" means always give a longer time period than people from the US, but in both cases that figure is less than it was 25 years ago. There are plenty of good reasons for this - the acceleration of technology, the short-horizon perspective of market-drive economics, the next-election perspective of democracies, or the basic requirement for personal multi-tasking. All of these are on the increase.
Nevertheless, on the search for projects that encompass the long view, my brother (who was also on the Sagrada Familia tour) highlighted a group based in the US, called the Long Now Foundation. Their website advertises that they hope to "provide a counterpoint to today's 'faster/cheaper' mindset and promote 'slower/better' thinking. We hope to creatively foster responsibility in the framework of the next 10,000 years." Pretty heady stuff. The term "Long Now" was apparently coined by one of the founders of the foundation, Brian Eno (the former U2 producer), who upon moving from the UK to New York "found that here and now meant this room and this five minutes as opposed to the larger here and now he was used to back in England". The point of their foundation is to explore whatever may be helpful for thinking, understanding, and acting over very long periods of time.
The initial project that the Long Now Foundation decided to embark upon was the construction of a 10,000 year clock. The idea for this was borne out of an observation by a computer scientist called Danny Hillis, who helped form the Foundation.
"When I was a child, people used to talk about what would happen by the year 2000. For the next thirty years they kept talking about what would happen by the year 2000, and now no one mentions a future date at all. The future has been shrinking by one year per year for my entire life. I think it is time for us to start a long-term project that gets people thinking past the mental barrier of an ever-shortening future. I would like to propose a large (think Stonehenge) mechanical clock, powered by seasonal temperature changes. It ticks once a year, bongs once a century, and the cuckoo comes out every millenium."
A brilliant idea. The complexity of trying to design something of this nature is where the concept becomes really interesting. Once you start to think of the logistics and planning that would be required, especially in the knowledge that you need to get things right at the outset, because making big changes even in the early years of the project (the first thousand years or so) is going to be beyond your control. 10,000 years is roughly about as long as the history of human technology. There are very, very few pieces of technology that are that old, currently still in existence - basically a few fragments of pots. Geologically, though, 10,000 years is a drop in the ocean. When this group started thinking about building something that lasts that long, the real problem they established was not with decay and corrosion, or even with finding a sustainable power source. People are the real problem. If something becomes unimportant to people, it tends to get destroyed, or substituted. There are countless cathedrals that have not survived for these reasons.
The conclusion that was drawn by the foundation was that the only way to survive over the long run is to be made of materials large and worthless, like Stonehenge and the Pyramids, or to become lost. They point to the Dead Sea Scrolls, that managed to survive for a couple of thousand years because they were lost. Now they've been located and preserved in a museum, the sense is that they won't last as long again. The Pyramids and Stonehenge have survived close to 5000 years, but over time they have been periodically pillaged and looted and its not clear as to their original purpose.
The principles that directed the design of the clock were vast and complex. As a starting point, they considered the very basic idea of how to power it in a sustainable way. Options included atomic power (poor maintainability, transparency), chemical power (poor scalability) etc. (full list at http://www.longnow.org/projects/clock/principles). Other issues that were up for consideration were - how to create a source of timing, options for how to display time, what concept of time to display and where to house the clock to ensure survival. On this last question, given the failure of human constructions to have survived the test of time, they reverted to Nature. A mountain in the Great Basin National Park, Nevada, will house the clock on the basis of its remoteness (over 200miles from any city), and is a relatively inaccessible and inhospitable location.
Whether this project will survive the 10,000 year test of time, obviously remains for the future. It would be against the balance of probabilities if it did. What I find interesting in the design concepts that are raised by undertaking a project that is so forward looking is that there are so many variables to consider. Very basically, what the future looks like thousands of years forward, and what civilisation will look like at that time.
One of the criticisms of the endeavours of our current institutions; governments, companies, charities, agencies etc. is that they are constructed in ways that don't benefit from taking this design principle into their construction, and consequently find themselves in life-threatening difficulties when we have periods of relatively high stress. Much of this happens because these institutions are reactive as opposed to proactive about the direction they want to take themselves. What I mean by this is that a public company often runs itself on the basis that it needs to report on itself to stakeholders every 3 months. A proactive institution will have considered the long view design principles, not necessarily for 10,000 years, but over a longer period such that they are less surprised about the "once in a generation" shifts that occur. There is no guarantee that they will succeed in understanding the future context ahead of time, but considering it in the way the Long Now Foundation looked at the design issues the "Clock for the Long Now" encountered would certainly create a fighting chance during stressful periods, like now.
What strikes me about these undertakings is that those who devoted their working lives to these magnificent, all encompassing, projects would likely in many cases never actually see the fruition of their work. Presumably the divine connection that they were attributing to their work, may have been sufficient compensation. Many of an atheistic persuasion would say that they were deluded. Personally, though, I'm glad that they did, whatever of their reasons. Those individuals involved in these projects will have had greater legacies attributable to them than most of the projects people concern themselves with in their working lives. The trade-off is that with mortgage payments to be met, banks tend not to accept 'godliness' as an acceptable form of credit, so most of us are pushed down the route of a form of pragmatic short-termism.
Recently, I had the opportunity to take a insiders tour of the Sagrada Familia, with the current leading architect and construction engineer on the project. The passion that was on display for their work was pretty awe inspiring - to be honest i was fairly jealous about feeling as engrossed in an undertaking as these guys did. I also set to thinking as to where else in the world, and what sort of other projects exist that encompass this "long view" mentality. What becomes clear is that the notion of what the term "long-term" means in the developed world is shorter than it used to be. There are cultural consistencies - the Japanese when asked for a nominal figure in years as to what the "long-term" means always give a longer time period than people from the US, but in both cases that figure is less than it was 25 years ago. There are plenty of good reasons for this - the acceleration of technology, the short-horizon perspective of market-drive economics, the next-election perspective of democracies, or the basic requirement for personal multi-tasking. All of these are on the increase.
Nevertheless, on the search for projects that encompass the long view, my brother (who was also on the Sagrada Familia tour) highlighted a group based in the US, called the Long Now Foundation. Their website advertises that they hope to "provide a counterpoint to today's 'faster/cheaper' mindset and promote 'slower/better' thinking. We hope to creatively foster responsibility in the framework of the next 10,000 years." Pretty heady stuff. The term "Long Now" was apparently coined by one of the founders of the foundation, Brian Eno (the former U2 producer), who upon moving from the UK to New York "found that here and now meant this room and this five minutes as opposed to the larger here and now he was used to back in England". The point of their foundation is to explore whatever may be helpful for thinking, understanding, and acting over very long periods of time.
The initial project that the Long Now Foundation decided to embark upon was the construction of a 10,000 year clock. The idea for this was borne out of an observation by a computer scientist called Danny Hillis, who helped form the Foundation.
"When I was a child, people used to talk about what would happen by the year 2000. For the next thirty years they kept talking about what would happen by the year 2000, and now no one mentions a future date at all. The future has been shrinking by one year per year for my entire life. I think it is time for us to start a long-term project that gets people thinking past the mental barrier of an ever-shortening future. I would like to propose a large (think Stonehenge) mechanical clock, powered by seasonal temperature changes. It ticks once a year, bongs once a century, and the cuckoo comes out every millenium."
A brilliant idea. The complexity of trying to design something of this nature is where the concept becomes really interesting. Once you start to think of the logistics and planning that would be required, especially in the knowledge that you need to get things right at the outset, because making big changes even in the early years of the project (the first thousand years or so) is going to be beyond your control. 10,000 years is roughly about as long as the history of human technology. There are very, very few pieces of technology that are that old, currently still in existence - basically a few fragments of pots. Geologically, though, 10,000 years is a drop in the ocean. When this group started thinking about building something that lasts that long, the real problem they established was not with decay and corrosion, or even with finding a sustainable power source. People are the real problem. If something becomes unimportant to people, it tends to get destroyed, or substituted. There are countless cathedrals that have not survived for these reasons.
The conclusion that was drawn by the foundation was that the only way to survive over the long run is to be made of materials large and worthless, like Stonehenge and the Pyramids, or to become lost. They point to the Dead Sea Scrolls, that managed to survive for a couple of thousand years because they were lost. Now they've been located and preserved in a museum, the sense is that they won't last as long again. The Pyramids and Stonehenge have survived close to 5000 years, but over time they have been periodically pillaged and looted and its not clear as to their original purpose.
The principles that directed the design of the clock were vast and complex. As a starting point, they considered the very basic idea of how to power it in a sustainable way. Options included atomic power (poor maintainability, transparency), chemical power (poor scalability) etc. (full list at http://www.longnow.org/projects/clock/principles). Other issues that were up for consideration were - how to create a source of timing, options for how to display time, what concept of time to display and where to house the clock to ensure survival. On this last question, given the failure of human constructions to have survived the test of time, they reverted to Nature. A mountain in the Great Basin National Park, Nevada, will house the clock on the basis of its remoteness (over 200miles from any city), and is a relatively inaccessible and inhospitable location.
Whether this project will survive the 10,000 year test of time, obviously remains for the future. It would be against the balance of probabilities if it did. What I find interesting in the design concepts that are raised by undertaking a project that is so forward looking is that there are so many variables to consider. Very basically, what the future looks like thousands of years forward, and what civilisation will look like at that time.
One of the criticisms of the endeavours of our current institutions; governments, companies, charities, agencies etc. is that they are constructed in ways that don't benefit from taking this design principle into their construction, and consequently find themselves in life-threatening difficulties when we have periods of relatively high stress. Much of this happens because these institutions are reactive as opposed to proactive about the direction they want to take themselves. What I mean by this is that a public company often runs itself on the basis that it needs to report on itself to stakeholders every 3 months. A proactive institution will have considered the long view design principles, not necessarily for 10,000 years, but over a longer period such that they are less surprised about the "once in a generation" shifts that occur. There is no guarantee that they will succeed in understanding the future context ahead of time, but considering it in the way the Long Now Foundation looked at the design issues the "Clock for the Long Now" encountered would certainly create a fighting chance during stressful periods, like now.
Sunday, 7 December 2008
Life is about choices...
A few years ago I was lucky enough to take a trip to follow the Inca Trail to Machu Picchu in Peru. Machu Picchu is often referred to as the "Lost City of the Incas", or at least it was lost until a US historian Hiram Bingham rediscovered it after several centuries of lostness in 1911. Since then it has become a major tourist destination, attracting close to 400,000 visitors per year, many of whom travel south from the USA. It was a great trip, to what is a magical place. For some reason, though, I regularly recall a particularly inconspicuous memory from the trip. I was walking outside of Aguas Calientes, which was the small town nearby to Machu Picchu, one afternoon at the base of a very steep rock face. On a part of this face some wise old bean had knocked in some metal rungs, to form a kind of ladder that stretched a hundred odd feet up to a ledge, where presumably you could get a decent view of the area. At first glance the ladder looked reasonably official and fairly well put together, so I decided to head upwards. I got about 5-6 rungs up the ladder and thought this just isn't safe, because there wasn't much to cling on to and it was for all intents and purposes a vertical incline. So I lowered myself back down, and began to ponder why someone could be allowed to put such an unsafe ladder there. I will call my Peruvian legal council I joked to myself.
Later that afternoon back at the backpackers lodge I was staying at I saw a couple returning from what clearly had been an unsucessful tourist outing. The couple were American and the lady was on crutches having just returned from hospital. She had broken her leg in a fall, and they were picking up their gear before heading home from their now shortened "holiday of a lifetime". I asked the husband what had happened. They had been out having a stroll around Aguas Calientes the previous evening and had seen a metal runged ladder hammered into a vertical rock face, that appeared to lead a hundred odd feet up to a good lookout point. They headed up, thinking that it was a little unsafe, but thinking that it couldn't be too unsafe because otherwise someone would have put a warning sign up, or something health and safety conscious to that effect. Unfortunately his wife had fallen from about the 20th rung up, and had broken her leg in the fall.
What was interesting to me was that this guy was angry at what had happened, not with his wife, but with the local tourist authorities for the ladders existence. He said that if he could have sued somebody he would, and would certainly have done so if it had happened back in the USA. I listened to his unfortunate situation sympathetically - on the exterior, but in the quiet avenues of my mind I was thinking "what a pair of muppets". I regularly think about this when the concept of personal responsibility is up for discussion. Sometimes there are fairly humorous examples of a society's willingness to "outsource" personal responsibility and pass it into the hands of a legal body, agency, a committee, anybody really. For example:
I was reading a newspaper report earlier this week, that outlined how a Brooklyn jury awarded just over $4.5mm to Anderson Alexander, a former New York City police detective injured when the office chair he was sitting on tipped over and he shot himself in the knee with a 9mm Smith & Wesson he was holding.
"This case is not about him shooting himself," Alexander's lawyer Matthew Maiorana told the Daily News. "This case is about a broken chair and an unsafe workplace..."
I cracked on searching for further gems of this nature. You don't have to search very hard...
"A Canadian woman whose 9-year-old son tunneled (under a fence) into an electric sub-station and was badly burned is suing the Manitoba power utility for negligence"
"Brian Hopkins, 25, of Astoria, Queens, New York City, 'who survived an electric shock and fire two years ago when he climbed atop an empty, stationary Amtrak train after a night bar hopping in Boston is suing the railroad - because Amtrak didn't do enough to protect trespassers like him."
These cases are at the comical end of the spectrum, here silly individuals claim that it's someone elses fault that they are silly. Silliness all round you could say. I recall a university lecturer of mine talking about how economics was about choices. He recalled an experience when his 8-year-old daughter and him were going on a walk. He had told her to take her jacket because it was chilly outside. "No, I don't need it," she refuted. He explained to her that she would get cold if she didn't have her jacket, yet she still insisted she didn't need it. "Fine", he said and they went out for the walk. Five minutes later she began to start muttering about how cold it was and was rubbing her arms. What was his response to this? Cut the walk short? Give her his coat? No, he made her walk the rest of the way home enduring the cold. "Life is about choices", he explained to his daughter.
60 years ago people reading this article would say of this example, “Well done, he taught his daughter a valuable lesson.” But today, many reading this would cry, “Child Abuse!". Personal protection is obviously good, but only up to a point. In the liberal societies that we live, freedom of choice is generally considered to be a good thing. I agree. The price of that though, should be that you bear the consequences of the choices that you make, again up to a point. The various groups that have the goal to help people make better choices - governments, regulators, charities etc. - should not by accident be encouraging people to be less self aware and take more risks because of the insurance and legal claims they can call upon if something goes wrong.
The current financial mess is in large part caused by risk-taking behaviour that was excessive because it was fed by a feeling that if something went wrong then the fall out would be somewhere else and somebody elses problem. This runs right through the financial system: from the guy with a poor credit rating, who bought a house he could only afford in very specific circumstances, sold to him by a mortgage broker who knew that he wouldn't be responsible for that loan for more than about 20 seconds, to the banks that bought these loans with a view to repackaging them and selling them on to a hedge fund manager who was investing money that wasn't his, to the successful property millionaire who had invested his money with the hedge fund on the back of making vast fortunes building cheap homes that were being sold to those who couldn't really afford them if the truth be told. Each one of those participants were encouraged by the notion that the personal "fall-out" of their actions could be blamed and claimed against somebody else. Wise up, because now it's every man for himself.
As Herbert Spencer aptly said, “The ultimate result of shielding men from the effects of folly is to fill the world with fools.”
Later that afternoon back at the backpackers lodge I was staying at I saw a couple returning from what clearly had been an unsucessful tourist outing. The couple were American and the lady was on crutches having just returned from hospital. She had broken her leg in a fall, and they were picking up their gear before heading home from their now shortened "holiday of a lifetime". I asked the husband what had happened. They had been out having a stroll around Aguas Calientes the previous evening and had seen a metal runged ladder hammered into a vertical rock face, that appeared to lead a hundred odd feet up to a good lookout point. They headed up, thinking that it was a little unsafe, but thinking that it couldn't be too unsafe because otherwise someone would have put a warning sign up, or something health and safety conscious to that effect. Unfortunately his wife had fallen from about the 20th rung up, and had broken her leg in the fall.
What was interesting to me was that this guy was angry at what had happened, not with his wife, but with the local tourist authorities for the ladders existence. He said that if he could have sued somebody he would, and would certainly have done so if it had happened back in the USA. I listened to his unfortunate situation sympathetically - on the exterior, but in the quiet avenues of my mind I was thinking "what a pair of muppets". I regularly think about this when the concept of personal responsibility is up for discussion. Sometimes there are fairly humorous examples of a society's willingness to "outsource" personal responsibility and pass it into the hands of a legal body, agency, a committee, anybody really. For example:
I was reading a newspaper report earlier this week, that outlined how a Brooklyn jury awarded just over $4.5mm to Anderson Alexander, a former New York City police detective injured when the office chair he was sitting on tipped over and he shot himself in the knee with a 9mm Smith & Wesson he was holding.
"This case is not about him shooting himself," Alexander's lawyer Matthew Maiorana told the Daily News. "This case is about a broken chair and an unsafe workplace..."
I cracked on searching for further gems of this nature. You don't have to search very hard...
"A Canadian woman whose 9-year-old son tunneled (under a fence) into an electric sub-station and was badly burned is suing the Manitoba power utility for negligence"
"Brian Hopkins, 25, of Astoria, Queens, New York City, 'who survived an electric shock and fire two years ago when he climbed atop an empty, stationary Amtrak train after a night bar hopping in Boston is suing the railroad - because Amtrak didn't do enough to protect trespassers like him."
These cases are at the comical end of the spectrum, here silly individuals claim that it's someone elses fault that they are silly. Silliness all round you could say. I recall a university lecturer of mine talking about how economics was about choices. He recalled an experience when his 8-year-old daughter and him were going on a walk. He had told her to take her jacket because it was chilly outside. "No, I don't need it," she refuted. He explained to her that she would get cold if she didn't have her jacket, yet she still insisted she didn't need it. "Fine", he said and they went out for the walk. Five minutes later she began to start muttering about how cold it was and was rubbing her arms. What was his response to this? Cut the walk short? Give her his coat? No, he made her walk the rest of the way home enduring the cold. "Life is about choices", he explained to his daughter.
60 years ago people reading this article would say of this example, “Well done, he taught his daughter a valuable lesson.” But today, many reading this would cry, “Child Abuse!". Personal protection is obviously good, but only up to a point. In the liberal societies that we live, freedom of choice is generally considered to be a good thing. I agree. The price of that though, should be that you bear the consequences of the choices that you make, again up to a point. The various groups that have the goal to help people make better choices - governments, regulators, charities etc. - should not by accident be encouraging people to be less self aware and take more risks because of the insurance and legal claims they can call upon if something goes wrong.
The current financial mess is in large part caused by risk-taking behaviour that was excessive because it was fed by a feeling that if something went wrong then the fall out would be somewhere else and somebody elses problem. This runs right through the financial system: from the guy with a poor credit rating, who bought a house he could only afford in very specific circumstances, sold to him by a mortgage broker who knew that he wouldn't be responsible for that loan for more than about 20 seconds, to the banks that bought these loans with a view to repackaging them and selling them on to a hedge fund manager who was investing money that wasn't his, to the successful property millionaire who had invested his money with the hedge fund on the back of making vast fortunes building cheap homes that were being sold to those who couldn't really afford them if the truth be told. Each one of those participants were encouraged by the notion that the personal "fall-out" of their actions could be blamed and claimed against somebody else. Wise up, because now it's every man for himself.
As Herbert Spencer aptly said, “The ultimate result of shielding men from the effects of folly is to fill the world with fools.”
Monday, 1 December 2008
When I grow up I want to be...
When I was growing up in Dublin in the early 1980s, my uncle Jim regularly asked me what I wanted to be when I grew up. Jim worked for the insurance and pensions company Prudential, or "the Pru" as he would proudly say in his thick (ish) Northern Irish accent. He was a great advocate of his job, but suggested that I'd make a good lawyer, disturbingly because he thought I could lie well. I used to tell him that I wanted to be a train driver.
Over time, I lost my focus and variously moved through aspirations to play for Manchester United, to wanting to be a professional golfer. In fact the only unifying thing that I can think of was that I wanted to do something that was its own end, meaning that I wanted to score the winning goal in FA cup final, not to be the coach. Later as i moved through the latter stages of school and then on to university the reality dawned somewhat that a) you are slow and can't hit a barn door from 15 yards with a football, or a golf ball for that matter and b) that train driving may not be the lucrative sort of job that will make you a "catch" with the girls you are trying to impress, or help fund the lifestyle that James Bond seems to make look so compelling.
The prolific US bank robber Willie Sutton was once asked by a journalist late in his life:
"Willie, why did you rob banks?" to which he responded quite reasonably "...'cos that's where the money is."
Although I'm keen not to draw a direct parallel between myself and Willie Sutton, the truth is that when I was moving through the latter stages of an economics degree at university the most appealing places to work were investment banks. Cos that was where the money was. The milkround was full of glamorous looking, seemingly big hitters who were only a couple of years older than me. They were living the work-hard, play-hard, moneyed lifestyles that seemed to be an attractive kickstart to the ultimate journey towards success, whatever that was. A couple of years later I found myself returning as one of these people on recruitment trips for Lehman Brothers amongst the Dublin graduates, feeling a bit like the "boy done good" and advocating the banking lifestyle to the current crop of the best graduates that Dublin had to offer. My sister still, rightly, takes the micky out of one of the presentations that we gave in Dublin, where one of the senior Lehman guys spoke of new graduates having an immediate impact when they start their careers for Lehman - the phrase he used was "flying your desk". Worthy of micky taking, to be fair.
The world for university graduates of 2009 will be very different. Across the board graduate recruitment by investment banks will either be non-existent (Lehman for one) or scaled back to almost nil. For the best and the brightest from undergraduate and the MBA universe, things must seem pretty confusing. The Dean of the Harvard Business School was quoted last year saying that he would only buy shares in the US stock markets again when the percentage of his MBA students going into investment banking jobs was less than 10%. Last year it was 41% of the class that went to investment banking jobs. The forward looking statistics for this year showed that 45% of the MBA class were targeting investment banking jobs; albeit that these statistics were put together before the full extent to the current financial mire was known. The statistics for 2009 may well tell a different story.
The point of view the Harvard Dean was trying to express was that banking was always meant to be the facilitator in real business, being the coach, not the goalscorer, i.e. not the end game in itself. A crucial part of the economic jigsaw, but in my view and his not the most important. Banks move capital around the system to the places where that capital is going to get the best reward for a given level of risk. A lot of the time they aren't very good at this. What they don't do is make the widgets, cars, baby-shuffles (whatever they are) that improve the quality of life of people in the world. "Non-financial" companies do that. Banks cannot create jobs in and of themselves, they only exist because of the ambition and entrepreneurship that exists amongst these non-financial companies. Banks facilitate these companies growth by organising their financing requirements, and the banks should do well when their clients do well, but not the other way round. If the movers and shakers that were coming out of Harvard were aspiring not to be creating or joining great non-financial companies, but more to be facilitators of others who ran great companies then there was something at issue. Why had we found ourselves in a situation where instead of being the person to hole the putt to win the Open, the aspiration was to be the proverbial caddy?
The answer was 'cos that was where the money was', and the ability to create that sense of achievement within that "caddying" part of the economy. The ability of investment banks to pay starting salaries of $150,000 to MBA graduates, with potential for bonuses, and for the real prospect of earning many hundreds of thousand or even millions of dollars within a 5 year period, was hard to baulk at. That world no longer exists. I would predict that we will see a reversal of the trend, back to the way it was when my Dad finished his MBA at the London Business School in early 1970s.The jobs to be getting then were with industrial companies, who made real things themselves.
A positive point amidst the changing scenery is that many of the worlds great companies were formed at times of high economic stress. Microsoft is an excellent case in point. The capacity for the brightest minds coming out of top level education to come up with new ways of creating their own version of success is likely, I think, to be fuelled more at this time than when it was 'easy' to slide into a well paid banking job and thrive financially that way.
In an interview with the FT this week, the Chief Executive of Cobham, the UK aerospace and defence company, was asked: "Do you think this crisis shows that the UK has become too dependent on financial services?" Alan Cook responded: "We employ about 300,000 people in the industry in the UK, either through the supply chain or through original equipment manufacturers. From our point of view, we're really dependent upon recruiting some really key talent from universities and from further education. I see this as a window of opportunity, because in the past 10 years students have been encouraged to join banks and brokers with the desire to earn vast sums of money, huge bonuses and a glittering career. I think maybe we've suffered from that. Now we're looking at turning round to our graduates and young people and saying look, this manufacturing and engineering is a fantastic opportunity for you. Grasp it, take it, this is where the careers are."
As something to be impressed by, or to be proud of, maybe it would be more impressive dinner party conversation in Notting Hill to say - "I helped design the Eclipse 750 jet, which we flew from London to Courchevel for our family ski trip last half-term" rather than "I helped facilitate the design of the jet that we flew last week, by lending the money to the smart people who knew what they were doing."
Over time, I lost my focus and variously moved through aspirations to play for Manchester United, to wanting to be a professional golfer. In fact the only unifying thing that I can think of was that I wanted to do something that was its own end, meaning that I wanted to score the winning goal in FA cup final, not to be the coach. Later as i moved through the latter stages of school and then on to university the reality dawned somewhat that a) you are slow and can't hit a barn door from 15 yards with a football, or a golf ball for that matter and b) that train driving may not be the lucrative sort of job that will make you a "catch" with the girls you are trying to impress, or help fund the lifestyle that James Bond seems to make look so compelling.
The prolific US bank robber Willie Sutton was once asked by a journalist late in his life:
"Willie, why did you rob banks?" to which he responded quite reasonably "...'cos that's where the money is."
Although I'm keen not to draw a direct parallel between myself and Willie Sutton, the truth is that when I was moving through the latter stages of an economics degree at university the most appealing places to work were investment banks. Cos that was where the money was. The milkround was full of glamorous looking, seemingly big hitters who were only a couple of years older than me. They were living the work-hard, play-hard, moneyed lifestyles that seemed to be an attractive kickstart to the ultimate journey towards success, whatever that was. A couple of years later I found myself returning as one of these people on recruitment trips for Lehman Brothers amongst the Dublin graduates, feeling a bit like the "boy done good" and advocating the banking lifestyle to the current crop of the best graduates that Dublin had to offer. My sister still, rightly, takes the micky out of one of the presentations that we gave in Dublin, where one of the senior Lehman guys spoke of new graduates having an immediate impact when they start their careers for Lehman - the phrase he used was "flying your desk". Worthy of micky taking, to be fair.
The world for university graduates of 2009 will be very different. Across the board graduate recruitment by investment banks will either be non-existent (Lehman for one) or scaled back to almost nil. For the best and the brightest from undergraduate and the MBA universe, things must seem pretty confusing. The Dean of the Harvard Business School was quoted last year saying that he would only buy shares in the US stock markets again when the percentage of his MBA students going into investment banking jobs was less than 10%. Last year it was 41% of the class that went to investment banking jobs. The forward looking statistics for this year showed that 45% of the MBA class were targeting investment banking jobs; albeit that these statistics were put together before the full extent to the current financial mire was known. The statistics for 2009 may well tell a different story.
The point of view the Harvard Dean was trying to express was that banking was always meant to be the facilitator in real business, being the coach, not the goalscorer, i.e. not the end game in itself. A crucial part of the economic jigsaw, but in my view and his not the most important. Banks move capital around the system to the places where that capital is going to get the best reward for a given level of risk. A lot of the time they aren't very good at this. What they don't do is make the widgets, cars, baby-shuffles (whatever they are) that improve the quality of life of people in the world. "Non-financial" companies do that. Banks cannot create jobs in and of themselves, they only exist because of the ambition and entrepreneurship that exists amongst these non-financial companies. Banks facilitate these companies growth by organising their financing requirements, and the banks should do well when their clients do well, but not the other way round. If the movers and shakers that were coming out of Harvard were aspiring not to be creating or joining great non-financial companies, but more to be facilitators of others who ran great companies then there was something at issue. Why had we found ourselves in a situation where instead of being the person to hole the putt to win the Open, the aspiration was to be the proverbial caddy?
The answer was 'cos that was where the money was', and the ability to create that sense of achievement within that "caddying" part of the economy. The ability of investment banks to pay starting salaries of $150,000 to MBA graduates, with potential for bonuses, and for the real prospect of earning many hundreds of thousand or even millions of dollars within a 5 year period, was hard to baulk at. That world no longer exists. I would predict that we will see a reversal of the trend, back to the way it was when my Dad finished his MBA at the London Business School in early 1970s.The jobs to be getting then were with industrial companies, who made real things themselves.
A positive point amidst the changing scenery is that many of the worlds great companies were formed at times of high economic stress. Microsoft is an excellent case in point. The capacity for the brightest minds coming out of top level education to come up with new ways of creating their own version of success is likely, I think, to be fuelled more at this time than when it was 'easy' to slide into a well paid banking job and thrive financially that way.
In an interview with the FT this week, the Chief Executive of Cobham, the UK aerospace and defence company, was asked: "Do you think this crisis shows that the UK has become too dependent on financial services?" Alan Cook responded: "We employ about 300,000 people in the industry in the UK, either through the supply chain or through original equipment manufacturers. From our point of view, we're really dependent upon recruiting some really key talent from universities and from further education. I see this as a window of opportunity, because in the past 10 years students have been encouraged to join banks and brokers with the desire to earn vast sums of money, huge bonuses and a glittering career. I think maybe we've suffered from that. Now we're looking at turning round to our graduates and young people and saying look, this manufacturing and engineering is a fantastic opportunity for you. Grasp it, take it, this is where the careers are."
As something to be impressed by, or to be proud of, maybe it would be more impressive dinner party conversation in Notting Hill to say - "I helped design the Eclipse 750 jet, which we flew from London to Courchevel for our family ski trip last half-term" rather than "I helped facilitate the design of the jet that we flew last week, by lending the money to the smart people who knew what they were doing."
Monday, 24 November 2008
A parable for corporate America...
"What's right about America is that although we have a mess of problems, we have great capacity - intellect and resources - to do some thing about them."
Henry Ford
Henry Ford launched Ford Motor company in a converted factory in 1903 with $28,000 from 12 investors. He was 40 years old when he founded the company, which would go on to become one of the largest and most profitable companies in the world, as well as being one of the few to survive the Great Depression. Ford had a global vision, with consumerism as the key to peace, and in a true reflection of America's "great capacity" he pulled in resources, fought hard, and ultimately succeeded in turning his vision into reality. He regularly reflected in his career that the capacity to do what he did, was made possible by the "great capacity" that existed in America at the time, and that perhaps didn't in large parts of the rest of the world.
It was 5 long years between the formation of Ford Motor Company and the time that it started to become scalable and economical. The vision that Ford brought to his investors during those difficult, unprofitable years was the idea that car travel was not solely to remain the privilege of the very wealthy elite, but that the "common man" could come to enjoy. He claimed:
"I will build a car for the great multitude. It will be large enough for the family, but small enough for the individual to run and care for. It will be constructed of the best materials, by the best men to be hired, after the simplest designs that modern engineering can devise. But it will be low enough in price that no man making a good salary will be unable to own one - and enjoy with his family the blessing of hours of pleasure in God's great open spaces".
Even prior to the formation of Ford Motor Company in 1903, Ford had held this vision and had been working against the tide of opinion on his "whacky" idea that car travel could be for all. He had some success as an engineer in developing racing cars and managed to convince an old acquaintance, Alexander Malcomson (a Detroit area coal dealer) to form a partnership with him. "Ford and Malcomson, Ltd" would manufacture inexpensive automobiles. The duo leased a factory and contracted with a machine shop (owned by the Dodge family) to supply $160,000 worth of parts. Sales of Ford and Malcomsons cars were slow and a crisis arose when the Dodge brothers demanded payment for their supplies. In response Ford managed to convince another group of investors to reform and capitalise a new company and for the Dodge family to accept payment via ownership of a portion of this new company - Ford Motor Company.
The patience and vision that Fords investors shared with him during that decade long period without much success was a testament to a prevailing sense of "can do" that must have existed in each of their minds - "the great capacity" that Ford spoke of in the quote above. Surely there were plenty of moments when they questioned their own sanity.
In 1908 Henry Ford introduced the Model T. Earlier models were produced at a rate of only a few a day at a rented factory, with groups of 2-3 men working on each car from components made to order by other companies. The first Model Ts were built at the Piquette Road Manufacturing Plant, the first company-owned factory. In its first full year of production, 1909, about 18,000 Model Ts were built. As demand for the car grew, the company moved production to the much larger Highland Park Plant were they produced close to 70,000 and 170,000 respectively in the first 2 years on that site. By 1913, the company had developed all of the basic techniques of the assembly line and mass production. Ford introduced the worlds first moving assembly line that year, which reduced chassis assembly time from 12.5 hours to 2 hours and 40minutes (in just one month) and ultimately to 1 hour and 33 minutes. Annual output rose to 202,667 units that ear. Ford raised wages to $5/ day (almost double local rates), through a "profit-sharing" approach with employees and sales rose over 300,000 in 1914 and over 1/2million units by 1915. In 1920 production exceeded 1mm units. And the rest as they say "is history".
As of 2008 it is thought that the Detroit auto-industry employs directly and indirectly over 3mm Americans. Over the past century it has no doubt, created countless wealth for these people and changed the lives of many who enjoy with their families "...the blessing of hours of pleasure in God's great open spaces." As of today, the US auto industry stands on the precipice, however, as the last several decades have seen the industry become inflexible, unresponsive and badly managed. In fact it has probably moved about as far away from Henry Fords vision of the entrepreneurial economy as any set of companies in America.
Had that set of early investors in Fords vision been swayed a century ago, and pulled the plug on his ambitions, then its almost certain that the world auto industry would have come into being in some other form. Nevertheless, the thing that has made the US the economic powerhouse that it has been, was the likelihood that as individuals, as Henry Ford said "...they have great capacity - intellect and resources - to do something about them". Perhaps that "great capacity" has weakened over the years as the US has been struck by the "winners curse".
More probably, as the world has become a more competitive place, the "great capacity" is springing up from Bombay, Shanghai or Moscow.
This week has seen the National Intelligence Council (NIC), which is a center of strategic thinking within the US government, release a report called "Global Trends 2025: A Transformed World". They produce a similar forward looking strategic report every four years, with a focus on the changing position of the US in the world. This years report draws up 4 main ideas about where things are going.
The whole international system—as constructed following WWII—will be revolutionized. Not only will new players—Brazil, Russia, India and China— have a seat at the international high table, they will bring new stakes and rules of the game.
The unprecedented transfer of wealth roughly from West to East now under way will continue for the foreseeable future.
Unprecedented economic growth, coupled with 1.5 billion more people, will put pressure on resources—particularly energy, food, and water—raising the specter of scarcities emerging as demand outstrips supply.
The potential for conflict will increase owing partly to political turbulence in parts of the greater Middle East.
All pretty grand stuff. The projects primary goal is to provide US policy-makers with a view of how developments could evolve, identifying opportunities and potentially negative developments that might warrant policy action. In the context of the changing world, more competitive world it's seems pretty important to think of where the next Ford Motor Company is going to come from, and how to ensure that the next 3mm job industry is based in America and not in Taipei.
We can't race to an answer to that question, but there are impressive innovations happening in the US, some of which could hit the jackpot in this regard. What will the Model T Ford of the 21st Century look like?
A visionary company based in Albuquerque, New Mexico, echoes Fords vision of a revolutionary mode of transport that would be "...low in price that no man making a good salary will be unable to own one - and enjoy with his family the blessing of hours of pleasure in God's great open spaces". Eclipse Aviation (http://www.eclipseaviation.com/#/eclipse500/style/gallery/) manufactures VLJs (very light jets). It was founded by one of the earliest employees of Microsoft, who i think it's fair to say were quite visionary. He had a vision much like Bill Gates did for personal computing at Microsoft - that jet ownership in the 21st century could be like car ownership was in the 20th century.
The company produces revolutionary 6-seater VLJs (very light jets), that travel at the same speeds as commercial jets (top speed >400mph), are much more fuel efficient, are extremely safe and are considerably cheaper to produce (about 1/3 cost) than the next best thing. Eclipse is not at the point where it can produce a jet that anyone earning a good salary can afford, but it has the vision that at some point in the future this will be the case. Notably, the price of a Model T only dropped to the "affordable level" of $440 in 1915, some 15 years after it was first conceived.
Eclipse Aviation currently finds itself in a similar position to that which Ford Motor Company found itself early in its life. Ford and Malcomson Ltd., you recall had to pay its suppliers (Dodge) in shares in a recapitalised company, because their car sales were slow in the early years. Eclipse is actually in a better position than Ford at that time in that they have an order book for over 2500 of the Eclipse 500 model, but through the usual teething problems in its early stage production process, now largely resolved, it was using cash faster than its production line could produce saleable planes.
As of last week, it was on the precipice of insolvency. This comes as a consequence of suppliers not getting paid on time - they stop supply of the parts that are key for Eclipse to make its planes, and you end up in a vicious cycle until everything stops. Here is a company with a fantastic vision, a fantastic product and an amazing order book of demand, that although it has made mistakes along the way could well be in possession of a truly transformational technology. Perhaps a mirror image of Ford Motor company in the period from 1900-1908, prior to the Model T production line really starting to work.
The question for Eclipse after several rounds of private financing, and an incredibly tough global market situation is: Where are the American investors with that "great capacity" that Ford spoke of?
Sadly for the US, is that they are being replaced in this case by a "greater capacity" from other parts of the world. Eclipse are likely to be recapitalised by 2 European companies, with the backing of 2 European governments. These two organizations are close to committing to recapitalise Eclipse which will enable suppliers to be paid, and the production line to start rolling. Much of the production will be moved to those countries, where job creation is the goal of the backing governments. The private investors involved in the deal share the vision of the idea that this is a transformational technology that they can profit extensively from. An order book of 2500 will hopefully be increased, and a large scale new market will open up. Not least the business that my brother helped found, Taxijet, based in Barcelona, that relies on the supply of Eclipse 500s for its business model to work will benefit hugely.
So on reflection: The Model T - designed in America, manufactured in Detroit and exported the world over. Tax revenue, job creation all to the credit of the USA. The Eclipse 500; designed in America, manufacture moved to Europe and, with time, used the world over. Tax revenue and job creation - not to the benefit of the burgeoning hole in the US finances. Is this a sign of things to come, as foretold by the NIC report?
It's been said before, but Barack Obama has a lot on his plate.
Henry Ford
Henry Ford launched Ford Motor company in a converted factory in 1903 with $28,000 from 12 investors. He was 40 years old when he founded the company, which would go on to become one of the largest and most profitable companies in the world, as well as being one of the few to survive the Great Depression. Ford had a global vision, with consumerism as the key to peace, and in a true reflection of America's "great capacity" he pulled in resources, fought hard, and ultimately succeeded in turning his vision into reality. He regularly reflected in his career that the capacity to do what he did, was made possible by the "great capacity" that existed in America at the time, and that perhaps didn't in large parts of the rest of the world.
It was 5 long years between the formation of Ford Motor Company and the time that it started to become scalable and economical. The vision that Ford brought to his investors during those difficult, unprofitable years was the idea that car travel was not solely to remain the privilege of the very wealthy elite, but that the "common man" could come to enjoy. He claimed:
"I will build a car for the great multitude. It will be large enough for the family, but small enough for the individual to run and care for. It will be constructed of the best materials, by the best men to be hired, after the simplest designs that modern engineering can devise. But it will be low enough in price that no man making a good salary will be unable to own one - and enjoy with his family the blessing of hours of pleasure in God's great open spaces".
Even prior to the formation of Ford Motor Company in 1903, Ford had held this vision and had been working against the tide of opinion on his "whacky" idea that car travel could be for all. He had some success as an engineer in developing racing cars and managed to convince an old acquaintance, Alexander Malcomson (a Detroit area coal dealer) to form a partnership with him. "Ford and Malcomson, Ltd" would manufacture inexpensive automobiles. The duo leased a factory and contracted with a machine shop (owned by the Dodge family) to supply $160,000 worth of parts. Sales of Ford and Malcomsons cars were slow and a crisis arose when the Dodge brothers demanded payment for their supplies. In response Ford managed to convince another group of investors to reform and capitalise a new company and for the Dodge family to accept payment via ownership of a portion of this new company - Ford Motor Company.
The patience and vision that Fords investors shared with him during that decade long period without much success was a testament to a prevailing sense of "can do" that must have existed in each of their minds - "the great capacity" that Ford spoke of in the quote above. Surely there were plenty of moments when they questioned their own sanity.
In 1908 Henry Ford introduced the Model T. Earlier models were produced at a rate of only a few a day at a rented factory, with groups of 2-3 men working on each car from components made to order by other companies. The first Model Ts were built at the Piquette Road Manufacturing Plant, the first company-owned factory. In its first full year of production, 1909, about 18,000 Model Ts were built. As demand for the car grew, the company moved production to the much larger Highland Park Plant were they produced close to 70,000 and 170,000 respectively in the first 2 years on that site. By 1913, the company had developed all of the basic techniques of the assembly line and mass production. Ford introduced the worlds first moving assembly line that year, which reduced chassis assembly time from 12.5 hours to 2 hours and 40minutes (in just one month) and ultimately to 1 hour and 33 minutes. Annual output rose to 202,667 units that ear. Ford raised wages to $5/ day (almost double local rates), through a "profit-sharing" approach with employees and sales rose over 300,000 in 1914 and over 1/2million units by 1915. In 1920 production exceeded 1mm units. And the rest as they say "is history".
As of 2008 it is thought that the Detroit auto-industry employs directly and indirectly over 3mm Americans. Over the past century it has no doubt, created countless wealth for these people and changed the lives of many who enjoy with their families "...the blessing of hours of pleasure in God's great open spaces." As of today, the US auto industry stands on the precipice, however, as the last several decades have seen the industry become inflexible, unresponsive and badly managed. In fact it has probably moved about as far away from Henry Fords vision of the entrepreneurial economy as any set of companies in America.
Had that set of early investors in Fords vision been swayed a century ago, and pulled the plug on his ambitions, then its almost certain that the world auto industry would have come into being in some other form. Nevertheless, the thing that has made the US the economic powerhouse that it has been, was the likelihood that as individuals, as Henry Ford said "...they have great capacity - intellect and resources - to do something about them". Perhaps that "great capacity" has weakened over the years as the US has been struck by the "winners curse".
More probably, as the world has become a more competitive place, the "great capacity" is springing up from Bombay, Shanghai or Moscow.
This week has seen the National Intelligence Council (NIC), which is a center of strategic thinking within the US government, release a report called "Global Trends 2025: A Transformed World". They produce a similar forward looking strategic report every four years, with a focus on the changing position of the US in the world. This years report draws up 4 main ideas about where things are going.
The whole international system—as constructed following WWII—will be revolutionized. Not only will new players—Brazil, Russia, India and China— have a seat at the international high table, they will bring new stakes and rules of the game.
The unprecedented transfer of wealth roughly from West to East now under way will continue for the foreseeable future.
Unprecedented economic growth, coupled with 1.5 billion more people, will put pressure on resources—particularly energy, food, and water—raising the specter of scarcities emerging as demand outstrips supply.
The potential for conflict will increase owing partly to political turbulence in parts of the greater Middle East.
All pretty grand stuff. The projects primary goal is to provide US policy-makers with a view of how developments could evolve, identifying opportunities and potentially negative developments that might warrant policy action. In the context of the changing world, more competitive world it's seems pretty important to think of where the next Ford Motor Company is going to come from, and how to ensure that the next 3mm job industry is based in America and not in Taipei.
We can't race to an answer to that question, but there are impressive innovations happening in the US, some of which could hit the jackpot in this regard. What will the Model T Ford of the 21st Century look like?
A visionary company based in Albuquerque, New Mexico, echoes Fords vision of a revolutionary mode of transport that would be "...low in price that no man making a good salary will be unable to own one - and enjoy with his family the blessing of hours of pleasure in God's great open spaces". Eclipse Aviation (http://www.eclipseaviation.com/#/eclipse500/style/gallery/) manufactures VLJs (very light jets). It was founded by one of the earliest employees of Microsoft, who i think it's fair to say were quite visionary. He had a vision much like Bill Gates did for personal computing at Microsoft - that jet ownership in the 21st century could be like car ownership was in the 20th century.
The company produces revolutionary 6-seater VLJs (very light jets), that travel at the same speeds as commercial jets (top speed >400mph), are much more fuel efficient, are extremely safe and are considerably cheaper to produce (about 1/3 cost) than the next best thing. Eclipse is not at the point where it can produce a jet that anyone earning a good salary can afford, but it has the vision that at some point in the future this will be the case. Notably, the price of a Model T only dropped to the "affordable level" of $440 in 1915, some 15 years after it was first conceived.
Eclipse Aviation currently finds itself in a similar position to that which Ford Motor Company found itself early in its life. Ford and Malcomson Ltd., you recall had to pay its suppliers (Dodge) in shares in a recapitalised company, because their car sales were slow in the early years. Eclipse is actually in a better position than Ford at that time in that they have an order book for over 2500 of the Eclipse 500 model, but through the usual teething problems in its early stage production process, now largely resolved, it was using cash faster than its production line could produce saleable planes.
As of last week, it was on the precipice of insolvency. This comes as a consequence of suppliers not getting paid on time - they stop supply of the parts that are key for Eclipse to make its planes, and you end up in a vicious cycle until everything stops. Here is a company with a fantastic vision, a fantastic product and an amazing order book of demand, that although it has made mistakes along the way could well be in possession of a truly transformational technology. Perhaps a mirror image of Ford Motor company in the period from 1900-1908, prior to the Model T production line really starting to work.
The question for Eclipse after several rounds of private financing, and an incredibly tough global market situation is: Where are the American investors with that "great capacity" that Ford spoke of?
Sadly for the US, is that they are being replaced in this case by a "greater capacity" from other parts of the world. Eclipse are likely to be recapitalised by 2 European companies, with the backing of 2 European governments. These two organizations are close to committing to recapitalise Eclipse which will enable suppliers to be paid, and the production line to start rolling. Much of the production will be moved to those countries, where job creation is the goal of the backing governments. The private investors involved in the deal share the vision of the idea that this is a transformational technology that they can profit extensively from. An order book of 2500 will hopefully be increased, and a large scale new market will open up. Not least the business that my brother helped found, Taxijet, based in Barcelona, that relies on the supply of Eclipse 500s for its business model to work will benefit hugely.
So on reflection: The Model T - designed in America, manufactured in Detroit and exported the world over. Tax revenue, job creation all to the credit of the USA. The Eclipse 500; designed in America, manufacture moved to Europe and, with time, used the world over. Tax revenue and job creation - not to the benefit of the burgeoning hole in the US finances. Is this a sign of things to come, as foretold by the NIC report?
It's been said before, but Barack Obama has a lot on his plate.
Sunday, 16 November 2008
The Big Opportunity...
This week has seen Barclays resolutely attempting to avoid coming into contact with a UK government bail-out package. Barclays have been determined not to follow the path of Lloyds TSB, HBOS, RBS and Bradford & Bingley, to the extent that they are willing to a) really annoy existing shareholders and b) offer what looks like a golden deal to a sovereign wealth fund from Qatar instead.
Why would they want to do this to avoid taking UK government investment?
In order to shore-up its capital position Barclays is looking at the following headline terms in the £7.3bn deal with the Qatar Investment Authority (QIA):
1) £3bn of paper issued to QIA and Abu Dhabi Investment Authority - paying a coupon of 14% over a fixed term running to 2019, accompanied by an issue of warrants, exercisable at below Thursday's closing share price at any time over five years. Given the volatility of Barclays stock, applying normal valuation measures, these warrants are worth at least £750mm to the Middle Eastern investors.
2) A further issue of £4.3bn of short-term convertibles, paying 9.75% until they convert (before next June). The conversion price into Barclays shares is at a 25% discount to the closing price on Thursday.
3) Assuming full conversion, the Middle Eastern investors will have 31.2% of the bank.
Now consider the terms on offer from HM Treasury:
1) 10-11% coupon on preference shares, no warrants (i.e. no gift currently valued at £750mm; that's a few schools/ hospitals)
2) Existing shareholders (many of whom are British taxpayers) would get the chance to buy new stock at historically depressed prices when according to management, the underlying business is holding up remarkably well.
3) Both shareholders and the rest of us would get a full fledged prospectus, given the London market as a whole some idea that Barclays balance sheet is as strong as the board insists.
Can the benefit of avoiding having the government on your shareholder register really be so great that you are prepared to effectively pay 50 per cent more for your capital? What the exact reasons are for this isn't clear, perhaps Barclays wants to ensure that there is no interference in protecting its compensation structure which along with its competitor banks has been so widely criticised, or they want to keep their books out of the intellectual scrutiny that might be applied by the Daily Mail if the British taxpayer was a big owner.
I'm not so much concerned as to why Barclays would choose to go down this route, as interesting as that may be. What is at issue is whether as a UK taxpayer the government is going to get the best deals for the taxpayer money they are investing. The sum total of global government sponsored bail-out packages amounts to $3.5 TRILLION so far. That's a lot of money. How it's spent can do a lot of good, and potentially a lot of harm.
In most cases around the globe it's questionable as to whether it's in the hands of those who know what they are doing. Those funds are being put on the credit card of the next several generations, and if current governments can't secure good deals in these negotiations then taxpayers globally will be paying the price for it at some stage in the future. This commentary is prevalent across the press currently - full of scare-mongering about how this $3.5trillion is going to 'disappear'.
Personally I sit on the other side of the fence. As I see it, there is an unbelievable opportunity here to generate great returns for taxpayers if governments invest their money wisely. If I had the opportunity to invest in the Barclays deal that QIA is getting i would take it...14% fixed return, warrants, cheap convertibles; i can borrow 5.5% from Barclays right now...time to bring back the leverage! I would like my taxpayer money spent on this, rather than spent on some inefficient public sector job creation scheme to create 'new' unsustainable jobs to fill the void of job losses in the private sector.
What is worrying though is that there is an understandable fear from these private sector institutions that government sponsorship will turn them into inefficient public sector organizations. I notice today that the government appears to be getting that message in the UK. The £37bn worth of direct equity investments by the UK government into UK banks will be "held at arms length with no direct boardroom representation". The 2 men who have been handed responsibility for managing these investments, have said "We must operate on a commercial basis at arm's length...our job is manage the taxpayer's investments, not to manage banks." I look forward to the Daily Mail commentary on this: "Scumbag bankers who stole our money, won't be made to pay, in government climbdown" etc. etc.
What is more worrying for the rest of the world is that the UK actually appears to understand things better than any of its peers, even though they still aren't getting the best terms available for taxpayer investments. In the USA, the myriad bailout packages that have been touted all seem to be confused in what they are trying to achieve. It's surprising, as if Hank Paulson had run Goldman Sachs with such confused thinking he would have been out of his job pretty quickly. The same sort of deals mentioned above are available to the US government from US banks. If they want to shore up the financial system, they should be taking these sort of deals and not spending taxpayers money on the sort of weak assets that the TARP plan was aimed at.
Banks who made mistakes, and have poor assets on their books should suffer through their share prices. The government should take preference shares in these institutions so that further writedowns are attributable to existing shareholders first, and as these institutions start to recover gains will be attributed to taxpayers investments in the form of these preference shares.
The TARP program that has now been thrown out, to me was not dissimilar to any plans to bail-out the US auto industry. The "Big 3" (General Motors, Ford and Chrysler) have been problem children of the capital markets for a long time; they only survived the past 10 years because credit market conditions were as crazily good as we now are fully aware. Instead of fixing the roof while the sun was shining they embarked on crony capitalism, lobbying government for artificial support for visionless business plans...and getting it. As Thomas Friedman of the NY Times writes "The blame for this travesty not only belongs to the auto executives, but must be shared equally with the entire Michigan delegation in the House and Senate, virtually all of whom, year after year voted however the Detroit automakers and unions instructed them to vote. That shielded GM, Ford and Chrysler from environmental concerns, mileage concerns and the full impact of global competition that could have forced Detroit to adapt long ago."
As Friedman also points out there are sustainable business plans within the auto-industry: from www.autochannel.com - "ALLISTON, Ontario, Canada - Honda of Canada Mfg. officially opened its newest investment in Canada - a state of the art $154mm engine plant. The new facility will produce 200,000 fuel-efficient four-cylinder engines annually for Civic production in response to growing North American demand for vehicles that provide excellent fuel economy".
That could have been a tale about General Motors, but is not. Don't waste taxpayers money on these guys. Do something powerful, innovative and profitable with that money now that there is this big opportunity.
Why would they want to do this to avoid taking UK government investment?
In order to shore-up its capital position Barclays is looking at the following headline terms in the £7.3bn deal with the Qatar Investment Authority (QIA):
1) £3bn of paper issued to QIA and Abu Dhabi Investment Authority - paying a coupon of 14% over a fixed term running to 2019, accompanied by an issue of warrants, exercisable at below Thursday's closing share price at any time over five years. Given the volatility of Barclays stock, applying normal valuation measures, these warrants are worth at least £750mm to the Middle Eastern investors.
2) A further issue of £4.3bn of short-term convertibles, paying 9.75% until they convert (before next June). The conversion price into Barclays shares is at a 25% discount to the closing price on Thursday.
3) Assuming full conversion, the Middle Eastern investors will have 31.2% of the bank.
Now consider the terms on offer from HM Treasury:
1) 10-11% coupon on preference shares, no warrants (i.e. no gift currently valued at £750mm; that's a few schools/ hospitals)
2) Existing shareholders (many of whom are British taxpayers) would get the chance to buy new stock at historically depressed prices when according to management, the underlying business is holding up remarkably well.
3) Both shareholders and the rest of us would get a full fledged prospectus, given the London market as a whole some idea that Barclays balance sheet is as strong as the board insists.
Can the benefit of avoiding having the government on your shareholder register really be so great that you are prepared to effectively pay 50 per cent more for your capital? What the exact reasons are for this isn't clear, perhaps Barclays wants to ensure that there is no interference in protecting its compensation structure which along with its competitor banks has been so widely criticised, or they want to keep their books out of the intellectual scrutiny that might be applied by the Daily Mail if the British taxpayer was a big owner.
I'm not so much concerned as to why Barclays would choose to go down this route, as interesting as that may be. What is at issue is whether as a UK taxpayer the government is going to get the best deals for the taxpayer money they are investing. The sum total of global government sponsored bail-out packages amounts to $3.5 TRILLION so far. That's a lot of money. How it's spent can do a lot of good, and potentially a lot of harm.
In most cases around the globe it's questionable as to whether it's in the hands of those who know what they are doing. Those funds are being put on the credit card of the next several generations, and if current governments can't secure good deals in these negotiations then taxpayers globally will be paying the price for it at some stage in the future. This commentary is prevalent across the press currently - full of scare-mongering about how this $3.5trillion is going to 'disappear'.
Personally I sit on the other side of the fence. As I see it, there is an unbelievable opportunity here to generate great returns for taxpayers if governments invest their money wisely. If I had the opportunity to invest in the Barclays deal that QIA is getting i would take it...14% fixed return, warrants, cheap convertibles; i can borrow 5.5% from Barclays right now...time to bring back the leverage! I would like my taxpayer money spent on this, rather than spent on some inefficient public sector job creation scheme to create 'new' unsustainable jobs to fill the void of job losses in the private sector.
What is worrying though is that there is an understandable fear from these private sector institutions that government sponsorship will turn them into inefficient public sector organizations. I notice today that the government appears to be getting that message in the UK. The £37bn worth of direct equity investments by the UK government into UK banks will be "held at arms length with no direct boardroom representation". The 2 men who have been handed responsibility for managing these investments, have said "We must operate on a commercial basis at arm's length...our job is manage the taxpayer's investments, not to manage banks." I look forward to the Daily Mail commentary on this: "Scumbag bankers who stole our money, won't be made to pay, in government climbdown" etc. etc.
What is more worrying for the rest of the world is that the UK actually appears to understand things better than any of its peers, even though they still aren't getting the best terms available for taxpayer investments. In the USA, the myriad bailout packages that have been touted all seem to be confused in what they are trying to achieve. It's surprising, as if Hank Paulson had run Goldman Sachs with such confused thinking he would have been out of his job pretty quickly. The same sort of deals mentioned above are available to the US government from US banks. If they want to shore up the financial system, they should be taking these sort of deals and not spending taxpayers money on the sort of weak assets that the TARP plan was aimed at.
Banks who made mistakes, and have poor assets on their books should suffer through their share prices. The government should take preference shares in these institutions so that further writedowns are attributable to existing shareholders first, and as these institutions start to recover gains will be attributed to taxpayers investments in the form of these preference shares.
The TARP program that has now been thrown out, to me was not dissimilar to any plans to bail-out the US auto industry. The "Big 3" (General Motors, Ford and Chrysler) have been problem children of the capital markets for a long time; they only survived the past 10 years because credit market conditions were as crazily good as we now are fully aware. Instead of fixing the roof while the sun was shining they embarked on crony capitalism, lobbying government for artificial support for visionless business plans...and getting it. As Thomas Friedman of the NY Times writes "The blame for this travesty not only belongs to the auto executives, but must be shared equally with the entire Michigan delegation in the House and Senate, virtually all of whom, year after year voted however the Detroit automakers and unions instructed them to vote. That shielded GM, Ford and Chrysler from environmental concerns, mileage concerns and the full impact of global competition that could have forced Detroit to adapt long ago."
As Friedman also points out there are sustainable business plans within the auto-industry: from www.autochannel.com - "ALLISTON, Ontario, Canada - Honda of Canada Mfg. officially opened its newest investment in Canada - a state of the art $154mm engine plant. The new facility will produce 200,000 fuel-efficient four-cylinder engines annually for Civic production in response to growing North American demand for vehicles that provide excellent fuel economy".
That could have been a tale about General Motors, but is not. Don't waste taxpayers money on these guys. Do something powerful, innovative and profitable with that money now that there is this big opportunity.
Monday, 10 November 2008
Cristiano Ronaldos of the Economic World
Last week in Ireland the results of a public sector pay and performance review were announced. The consultancy group Mercer had been mandated by the government in 2004 to create a performance measurement system that would lead to pay rises for best performers. Mercer had created 5 point "Performance Management and Development System" scale, with 5 awarded for outstanding performance and 1 for poor performance. In designing the system the estimate was that 20% of staff who were rated would be a 1 or a 2 on the scale, and consequently would not receive a pay rise. (This would be a pay rise on top of 5% increase under social partnership agreements, and on top of 70% pay increases over the past 7years). Perfect, you might think - here is a great opportunity for real reward for performance - a chance for the Cristiano Ronaldos of the Civil Service to get their just rewards and the chance for the Ali Dias (who? Google search him) to be sent back to the Rymans league.
As it turned out, it appears that due to managers within the civil service ignoring the schemes guidelines, virtually every (98.4%) staff member was given a pay rise of 6000 Euros last year. The 18 employees who received the 'one' grade got no pay rise, while the 285 who were ranked '2' received an increase but were denied a promotion. So essentially an extra 111mm worth of tax payers money was 'self allocated' to all but 1.6% of the 19000 workforce...but because that money was allocated in a socialist fashion; i.e. because everybody was included this was OK.
There is no doubt that there are true "5s" working within the civil sector in Ireland. There is also without any shadow of a doubt plenty of "1s". The problem for the "5s" is a big a problem for the rest of us as the existence of the "1s"...if they feel that their organisation cannot distinguish between doing a good job and doing a bad job, then what's the point of trying. And if truth be told the performance of public sector organisations in the UK and Ireland has been questionable at best from a "value for taxpayer investment" over any time period you could choose, so we might feel reading the above that managerially they are a shambles.
The sort of faulty reward culture mentioned above, is at least as big a problem as the private sector "bonus culture", that is being criticised so heavily in the media currently. At the very least within the private sector there are attempts (perhaps veiled) to attribute pay for performance...often-times in the private sector though when performance is at a 1 or 2 standard the business that the employer works for does not survive.
My Dad told me that this week he was listening to a radio program in Ireland, where Joe Higgins, a socialist senator, explained to the listening Irish public that the last 12 months prove that "capitalism doesn't work". The alternative that Joe is advocating is unclear; but the sound-bite culture that he exists in makes this compelling listening, even though what he really advocates is represented by the tale above.
Anyway, back to Dad (and Mum)...who witnessed both the economic boom in Ireland in the past 15 years, but who also lived in Ireland before the tide started rising: "My perception is that in the last 5, 10, 15 years in Ireland, for all its shortcomings - capitalism has raised incomes and wealth in orders of magnitude beyond any alternative system. It has raised many - though not enough - out of poverty...not enough boats were lifted on the tide, but there was a tide and it lifted many people and many public services. But politicians are trapped in the short-term...no one seems to do the 'hang on mate'...House prices are down 30% - but hang on; they went up 300% in the past 15years...I have a wage freeze this year, when inflation is 4% - but hang on, your salary if you're a public servant has gone up over 70% in the last 7years...I won't get to the Maldives for the new year - but hang on, I can remember when the problem was that I couldn't afford the bus fare to Donaghadee*"
*exotic beach 'resort' near Belfast - also known as a 'contradiction in terms'
The world is a competitive place. Denying that this is the case would mean that watching Arsenal play Manchester United with an 'equal opportunities' policy in place might not make compelling viewing...but i might get to play at Old Trafford. In the context of Neill playing centre forward for Arsenal, and others of my ilk filling the rest of the positions, I suspect gate receipts would fall to nil quite rapidly. This makes for a good analogy as to what would happen to tax receipts in Ireland or the UK, or anywhere else for that matter if we don't differentiate properly between the Ali Dias and the Cristiano Ronaldos within both our public and private sector organisations.
So whether we choose to call this socialism or capitalism doesn't really matter to me, but the gist is that the best outcomes come from 1) realising that the world is a competitive place 2) empowering and encouraging people with talent to make a difference to themselves and those around them and hopefully as a happy consequence 3) a desire amongst those empowered to bring along the Ali Dias in society, without necessarily giving them an outing at Old Trafford.
To that end, the Premiership Allstars of Economic society for me are the likes of Mohamed Yunus from the Grameen Bank in Bangladesh and Martin Burt who developed Fundacion Paraguaya. There are plenty more out there, but these 2 are known better to me than others.
Firstly Mohamed Yunus, who won the Nobel Peace Prize in 2006, for essentially creating a viable banking system to the poor that has been annually profitable and has paved the way for 7 million borrowers (mostly women) in Bangladesh to pull themselves out of poverty through their own hard work and enterprise. On a cumulative basis the bank has given out loans totaling about USD $6bn with a repayment rate of 99.3%. Current deposits and own resources of Grameen Bank today amount to 143% of outstanding loans. Accordingly, 58% of all of the Grameen borrowers have crossed the poverty line as a direct result of the opportunity that this "capitalist" endeavour has presented to them.
The Grameen Bank was born as a tiny homegrown project run with the help of several of Yunus' students at Chittagong university where he was an economics professor. Three of these students remain as senior management within the bank over 25 years after they started the project.
Big fan of this. It is sustainable, self sufficient and economically viable without public sector hand-outs.
Secondly, Martin Burt who set up Fundacion Paraguaya; which is essentially a rural business school set up in one of the poorest countries in South America. It aims to transform its students into rural entrepreneurs and increase the relevancy of the education they receive through their participation in a profit-making school business. This microcredit program has supported 35,000 small entrepreneurs and created 18,000 jobs.
The key focus of both Grameen Bank and Fundacion Paraguaya has been on sustainability; neither undertaking requires the 'charity' of socialists and those 'capitalist' enterprises that have been funded by either Grameen Bank of Fundacion Paraguaya have gone on to become important sources of jobs and revenue, and a means by which families have been able to pull themselves above the poverty line in many cases.
This isn't an attempt to deny the ease with which the free market approach can go wrong, but just to clarify that if the likes of Ireland choose not to compete then the alternatives truly are unsustainable. With the big news of Barack Obamas victory this week representing a truly epoch making event for many, one of the small point aspects that struck me most was where some of the votes came from. Obama throughout the campaign pledged to take 10million of the lowest paid out of taxation, paid for by taxing those earning more than $250,000. Whether that is the right thing to do or not remains to be seen, but what is impressive is that 52% of those in the high income bracket chose to vote for Obama thus saying (although not categorically) that their interests are may be better served by choosing to help others more than themselves.
As it turned out, it appears that due to managers within the civil service ignoring the schemes guidelines, virtually every (98.4%) staff member was given a pay rise of 6000 Euros last year. The 18 employees who received the 'one' grade got no pay rise, while the 285 who were ranked '2' received an increase but were denied a promotion. So essentially an extra 111mm worth of tax payers money was 'self allocated' to all but 1.6% of the 19000 workforce...but because that money was allocated in a socialist fashion; i.e. because everybody was included this was OK.
There is no doubt that there are true "5s" working within the civil sector in Ireland. There is also without any shadow of a doubt plenty of "1s". The problem for the "5s" is a big a problem for the rest of us as the existence of the "1s"...if they feel that their organisation cannot distinguish between doing a good job and doing a bad job, then what's the point of trying. And if truth be told the performance of public sector organisations in the UK and Ireland has been questionable at best from a "value for taxpayer investment" over any time period you could choose, so we might feel reading the above that managerially they are a shambles.
The sort of faulty reward culture mentioned above, is at least as big a problem as the private sector "bonus culture", that is being criticised so heavily in the media currently. At the very least within the private sector there are attempts (perhaps veiled) to attribute pay for performance...often-times in the private sector though when performance is at a 1 or 2 standard the business that the employer works for does not survive.
My Dad told me that this week he was listening to a radio program in Ireland, where Joe Higgins, a socialist senator, explained to the listening Irish public that the last 12 months prove that "capitalism doesn't work". The alternative that Joe is advocating is unclear; but the sound-bite culture that he exists in makes this compelling listening, even though what he really advocates is represented by the tale above.
Anyway, back to Dad (and Mum)...who witnessed both the economic boom in Ireland in the past 15 years, but who also lived in Ireland before the tide started rising: "My perception is that in the last 5, 10, 15 years in Ireland, for all its shortcomings - capitalism has raised incomes and wealth in orders of magnitude beyond any alternative system. It has raised many - though not enough - out of poverty...not enough boats were lifted on the tide, but there was a tide and it lifted many people and many public services. But politicians are trapped in the short-term...no one seems to do the 'hang on mate'...House prices are down 30% - but hang on; they went up 300% in the past 15years...I have a wage freeze this year, when inflation is 4% - but hang on, your salary if you're a public servant has gone up over 70% in the last 7years...I won't get to the Maldives for the new year - but hang on, I can remember when the problem was that I couldn't afford the bus fare to Donaghadee*"
*exotic beach 'resort' near Belfast - also known as a 'contradiction in terms'
The world is a competitive place. Denying that this is the case would mean that watching Arsenal play Manchester United with an 'equal opportunities' policy in place might not make compelling viewing...but i might get to play at Old Trafford. In the context of Neill playing centre forward for Arsenal, and others of my ilk filling the rest of the positions, I suspect gate receipts would fall to nil quite rapidly. This makes for a good analogy as to what would happen to tax receipts in Ireland or the UK, or anywhere else for that matter if we don't differentiate properly between the Ali Dias and the Cristiano Ronaldos within both our public and private sector organisations.
So whether we choose to call this socialism or capitalism doesn't really matter to me, but the gist is that the best outcomes come from 1) realising that the world is a competitive place 2) empowering and encouraging people with talent to make a difference to themselves and those around them and hopefully as a happy consequence 3) a desire amongst those empowered to bring along the Ali Dias in society, without necessarily giving them an outing at Old Trafford.
To that end, the Premiership Allstars of Economic society for me are the likes of Mohamed Yunus from the Grameen Bank in Bangladesh and Martin Burt who developed Fundacion Paraguaya. There are plenty more out there, but these 2 are known better to me than others.
Firstly Mohamed Yunus, who won the Nobel Peace Prize in 2006, for essentially creating a viable banking system to the poor that has been annually profitable and has paved the way for 7 million borrowers (mostly women) in Bangladesh to pull themselves out of poverty through their own hard work and enterprise. On a cumulative basis the bank has given out loans totaling about USD $6bn with a repayment rate of 99.3%. Current deposits and own resources of Grameen Bank today amount to 143% of outstanding loans. Accordingly, 58% of all of the Grameen borrowers have crossed the poverty line as a direct result of the opportunity that this "capitalist" endeavour has presented to them.
The Grameen Bank was born as a tiny homegrown project run with the help of several of Yunus' students at Chittagong university where he was an economics professor. Three of these students remain as senior management within the bank over 25 years after they started the project.
Big fan of this. It is sustainable, self sufficient and economically viable without public sector hand-outs.
Secondly, Martin Burt who set up Fundacion Paraguaya; which is essentially a rural business school set up in one of the poorest countries in South America. It aims to transform its students into rural entrepreneurs and increase the relevancy of the education they receive through their participation in a profit-making school business. This microcredit program has supported 35,000 small entrepreneurs and created 18,000 jobs.
The key focus of both Grameen Bank and Fundacion Paraguaya has been on sustainability; neither undertaking requires the 'charity' of socialists and those 'capitalist' enterprises that have been funded by either Grameen Bank of Fundacion Paraguaya have gone on to become important sources of jobs and revenue, and a means by which families have been able to pull themselves above the poverty line in many cases.
This isn't an attempt to deny the ease with which the free market approach can go wrong, but just to clarify that if the likes of Ireland choose not to compete then the alternatives truly are unsustainable. With the big news of Barack Obamas victory this week representing a truly epoch making event for many, one of the small point aspects that struck me most was where some of the votes came from. Obama throughout the campaign pledged to take 10million of the lowest paid out of taxation, paid for by taxing those earning more than $250,000. Whether that is the right thing to do or not remains to be seen, but what is impressive is that 52% of those in the high income bracket chose to vote for Obama thus saying (although not categorically) that their interests are may be better served by choosing to help others more than themselves.
Monday, 3 November 2008
Statistics are like bikinis...
Statistics are like bikinis. What they reveal is suggestive, but what they conceal is vital. (Aaron Levenstein)
Average pub discussions over the past 20 years have probably involved the odd commentary on how the price of a pint has changed over that time. "A lot" would typically be the consensus opinion; and that opinion would be correct. The Good Pub Guide celebrated its 25th anniversary in 2007 and as part of the celebrations managed to convince a series of pubs to sell pints on the 28th of September 2007 at the same price as they were selling in 1982. The Drunken Duck in Hawkshead, Cumbria for example were selling pints of "Cracker Ale" (named after the pub dog from 1982) from their own micro-Brewery for only 62p. 2007 prices were £2.65 for the same. That represents inflation of 427% over that time. Needless to say a lot of the increase is due to tax increases justified by a greater awareness that Guinness is not as good for you as the old adverts would have suggested. Nevertheless, inflation was unquestionably substantial.
Elsewhere in the world of the man on the Clapham omnibus, or in current parlance an individual from the "real economy" there is plenty of anecdotal evidence of substantial price inflation across our monthly regular purchases, over whatever time horizon you might choose. In 1982 the price of a gallon of petrol was £1.59 (35p/ litre) and the average house price was £23,644. 25 years on in 2007 as the Good Pub Guide celebrated their 25 year anniversary those figures were just over £5/ gallon (111p/ litre) and average house prices were just shy of £200,000. Those are price increases of 214% and 747% respectively. The latter in particular would form the bulk of monthly outgoings, through mortgage payments, for the average home owning Brit. For those across the pond the average house price in the USA in 1982 was just over $82,000. In March 2007 it was $324,000. A 295% increase.
The centerpiece of economic policy in the UK, the USA and many other countries over the past 20 years has been clearly stated as targeting of inflation, through rigid observance of monetarist economic policies. The UK ceded control over interest rates in 1997 by making the Bank of England independent and in theory removed from political decision making. Their strict and only charge was responsibility for keeping inflation below it's target rate (below 2%), through monetary policy and interest rate management. The gist here is that if prices are kept stable then it makes it easier for individuals and businesses to make sounder, more long term decisions about savings and investment.
So given that statistics about inflation directly affected (in fact were the only thing that affected) the rate of interest set by the Bank of England it might be fair to say that the accuracy of that statistic was fairly important. The same is true in the US, and in the European Union, albeit that both the Federal Reserve and the ECB have a slightly wider mandate than just inflation targeting.
Consequently if inflation calculations failed to truly recognise properly the extent of inflation in the "real economy" we might end up in a situation where interest rates were not at the right level, and money supply would be out of whack with what was required to the right balance between savings and investment.
According to the Bank of England and the IMF inflation in the UK between 1982-2007 was 112%, based on the Consumer Price Index. In the US according to the IMF that figure was 114%. "Hang on a second" - you might reasonably say, "the cost of my house and the price that i pay for petrol have risen by loads more than that during that period...and they are pretty important aspects of my monthly outgoings".
So how do the central bankers get their inflation figures?
It depends on the "market basket" which is chosen. In the United States, the price of food, fuel and purchasing a home are excluded from the "core" inflation rate. That is why the price of food, fuel and buying a home can rise so rapidly without being reflected in the official "rate of inflation". Which seems fairly ridiculous, as the value of your home plays a pretty key role in your approach to discretionary purchases and the amount of credit that a bank might lend you to make those discretionary purchases.
In China the price of food is included, so they started showing a sharp rise in inflation as soon as food prices started rising. In India the price of fuel is subsidized by the government, as is wheat too. So that makes things appear different than they actually are. Somebody is paying the real price somewhere. In the case of imported oil, that has been a hefty bill, which is why upward adjustments are being made now.
Perhaps most disturbingly, if you look into the details of how the Bureau of Labor Statistics (BLS - or potentially just BS) calculates its CPI figures for the USA there has been clear political manipulation over the past 20 years pushing this office to portray the US economy as strong and inflation free. As a case in point, during the early 1990s during the Clinton era there were significant budgetary issues with the rising costs of Social Security, Medicare and government pension provisions - the cost of which was indexed off CPI. Perhaps it's cynical to connect these to the changes in inflation calculations that followed, but it's clear that they had the effect of reducing that CPI figure considerably, and consequently the outgoings from the Treasury.
Three main changes were made to CPI calculations: 1) hedonic quality adjustments, 2) calculations of housing costs via owners equivalent rent and 3) geometric weighting/ product substitution. Running through these - Hedonic quality adjustments accelerated in the late 1990s paving the way for huge price declines in the cost of computers and other durable goods - a dubious assumption belied by the experience; as your new model MAC or PC was going up by a hundred dollars or so it was actually going down according to CPI calculations because it was twice as powerful. As regards 2) it was claimed that a measure of housing base on what an owner might get for renting his house would more accurately reflect the real world - dubious again. The average cost of homes has appreciated 3 times the annual pace of substituted owners equivalent rent, which would have raised the total CPI by around 1% had the change not been made. Regarding the third change, product substitution and geometric weighting both presumed that more expensive goods and services would be used less and substituted with their less costly alternatives: more hamburgers/ less filet mignon when beef prices were higher etc. Proven untrue also.
As a consequence of these changes some estimates suggest that the inflation figures used by the US government and the Federal Reserve may have been 3-4% too low. Some might say, well what difference does it make. IT MAKES A MASSIVE DIFFERENCE.
The correct measure of inflation matters in many areas, not least in the calculation of social security payments and wage bargaining adjustments. The number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. It seems pretty evident now that interest rates in the US/ UK were way too low based on the real evidence about inflation. Credit expansion of close to $23 trillion between 2000-2008 in the US was driven by a complete imbalance between the relative costs of savings and investment. Most of that credit was "created" or "asset backed" by rising property prices, which as i've explored above were completely misrepresented in terms of the inflation figures being published. Manipulation is less obvious in the UK, but the "basket" calculation still unrepresents hugely the housing boom which we've seen in the last 15 years, and on which much of the credit expansion has been based.
If people are looking for places to point a finger of blame, the statistics would be a good place to start. 98% of statistics are made up apparently.
Average pub discussions over the past 20 years have probably involved the odd commentary on how the price of a pint has changed over that time. "A lot" would typically be the consensus opinion; and that opinion would be correct. The Good Pub Guide celebrated its 25th anniversary in 2007 and as part of the celebrations managed to convince a series of pubs to sell pints on the 28th of September 2007 at the same price as they were selling in 1982. The Drunken Duck in Hawkshead, Cumbria for example were selling pints of "Cracker Ale" (named after the pub dog from 1982) from their own micro-Brewery for only 62p. 2007 prices were £2.65 for the same. That represents inflation of 427% over that time. Needless to say a lot of the increase is due to tax increases justified by a greater awareness that Guinness is not as good for you as the old adverts would have suggested. Nevertheless, inflation was unquestionably substantial.
Elsewhere in the world of the man on the Clapham omnibus, or in current parlance an individual from the "real economy" there is plenty of anecdotal evidence of substantial price inflation across our monthly regular purchases, over whatever time horizon you might choose. In 1982 the price of a gallon of petrol was £1.59 (35p/ litre) and the average house price was £23,644. 25 years on in 2007 as the Good Pub Guide celebrated their 25 year anniversary those figures were just over £5/ gallon (111p/ litre) and average house prices were just shy of £200,000. Those are price increases of 214% and 747% respectively. The latter in particular would form the bulk of monthly outgoings, through mortgage payments, for the average home owning Brit. For those across the pond the average house price in the USA in 1982 was just over $82,000. In March 2007 it was $324,000. A 295% increase.
The centerpiece of economic policy in the UK, the USA and many other countries over the past 20 years has been clearly stated as targeting of inflation, through rigid observance of monetarist economic policies. The UK ceded control over interest rates in 1997 by making the Bank of England independent and in theory removed from political decision making. Their strict and only charge was responsibility for keeping inflation below it's target rate (below 2%), through monetary policy and interest rate management. The gist here is that if prices are kept stable then it makes it easier for individuals and businesses to make sounder, more long term decisions about savings and investment.
So given that statistics about inflation directly affected (in fact were the only thing that affected) the rate of interest set by the Bank of England it might be fair to say that the accuracy of that statistic was fairly important. The same is true in the US, and in the European Union, albeit that both the Federal Reserve and the ECB have a slightly wider mandate than just inflation targeting.
Consequently if inflation calculations failed to truly recognise properly the extent of inflation in the "real economy" we might end up in a situation where interest rates were not at the right level, and money supply would be out of whack with what was required to the right balance between savings and investment.
According to the Bank of England and the IMF inflation in the UK between 1982-2007 was 112%, based on the Consumer Price Index. In the US according to the IMF that figure was 114%. "Hang on a second" - you might reasonably say, "the cost of my house and the price that i pay for petrol have risen by loads more than that during that period...and they are pretty important aspects of my monthly outgoings".
So how do the central bankers get their inflation figures?
It depends on the "market basket" which is chosen. In the United States, the price of food, fuel and purchasing a home are excluded from the "core" inflation rate. That is why the price of food, fuel and buying a home can rise so rapidly without being reflected in the official "rate of inflation". Which seems fairly ridiculous, as the value of your home plays a pretty key role in your approach to discretionary purchases and the amount of credit that a bank might lend you to make those discretionary purchases.
In China the price of food is included, so they started showing a sharp rise in inflation as soon as food prices started rising. In India the price of fuel is subsidized by the government, as is wheat too. So that makes things appear different than they actually are. Somebody is paying the real price somewhere. In the case of imported oil, that has been a hefty bill, which is why upward adjustments are being made now.
Perhaps most disturbingly, if you look into the details of how the Bureau of Labor Statistics (BLS - or potentially just BS) calculates its CPI figures for the USA there has been clear political manipulation over the past 20 years pushing this office to portray the US economy as strong and inflation free. As a case in point, during the early 1990s during the Clinton era there were significant budgetary issues with the rising costs of Social Security, Medicare and government pension provisions - the cost of which was indexed off CPI. Perhaps it's cynical to connect these to the changes in inflation calculations that followed, but it's clear that they had the effect of reducing that CPI figure considerably, and consequently the outgoings from the Treasury.
Three main changes were made to CPI calculations: 1) hedonic quality adjustments, 2) calculations of housing costs via owners equivalent rent and 3) geometric weighting/ product substitution. Running through these - Hedonic quality adjustments accelerated in the late 1990s paving the way for huge price declines in the cost of computers and other durable goods - a dubious assumption belied by the experience; as your new model MAC or PC was going up by a hundred dollars or so it was actually going down according to CPI calculations because it was twice as powerful. As regards 2) it was claimed that a measure of housing base on what an owner might get for renting his house would more accurately reflect the real world - dubious again. The average cost of homes has appreciated 3 times the annual pace of substituted owners equivalent rent, which would have raised the total CPI by around 1% had the change not been made. Regarding the third change, product substitution and geometric weighting both presumed that more expensive goods and services would be used less and substituted with their less costly alternatives: more hamburgers/ less filet mignon when beef prices were higher etc. Proven untrue also.
As a consequence of these changes some estimates suggest that the inflation figures used by the US government and the Federal Reserve may have been 3-4% too low. Some might say, well what difference does it make. IT MAKES A MASSIVE DIFFERENCE.
The correct measure of inflation matters in many areas, not least in the calculation of social security payments and wage bargaining adjustments. The number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. It seems pretty evident now that interest rates in the US/ UK were way too low based on the real evidence about inflation. Credit expansion of close to $23 trillion between 2000-2008 in the US was driven by a complete imbalance between the relative costs of savings and investment. Most of that credit was "created" or "asset backed" by rising property prices, which as i've explored above were completely misrepresented in terms of the inflation figures being published. Manipulation is less obvious in the UK, but the "basket" calculation still unrepresents hugely the housing boom which we've seen in the last 15 years, and on which much of the credit expansion has been based.
If people are looking for places to point a finger of blame, the statistics would be a good place to start. 98% of statistics are made up apparently.
Monday, 27 October 2008
The great lesson of history...
As stockmarkets continue their volatile passage downwards one seemingly safe haven investment would appear to be the printing rights to Das Kapital - global sales have been soaring of late, with the likes of Nicolas Sarkozy seen palming his way through the minutiae. The whole viability of Capitalism is being called into question within popular media, and to some extent in government policy response. What is certainly true and is self evident in the events of the past few weeks, is that poorly regulated capitalism is bankrupt and the the banking elite who ran the show were inept.
What is also true is that there is a human tendency to latch onto systems and processes and label them unwittingly as better than they actually are, or in the sudden case of their failure to totally discredit them. In other words it's part of the human condition to overreact. There are plenty of cases throughout history to demonstrate that what we think as societies makes us strongest is also likely to lead to our precipitous demise. Nothing is perfect, and thinking things are typically limits our ability to see the wood from the trees - or as Leonard Cohen put it more eloquently:
Ring the bells that still can ring
Forget your perfect offering
There is a crack in everything,
That's how the light gets in.
The laissez faire, free-market approach isn't perfect...what is surprising is that people are thinking that this is surprising. The alternatives are worse.
What is (with hindsight) easiest to pinpoint is the fact that people, governments, bankers, regulators etc. overestimated the ability of the Monetarist approach to economic management to lead us to the promised land. As the Keynesian dogma was ushered out, the Chicago school ushered in an era of central banks aggressively fighting inflation, led by Paul Volcker at the Fed through the early 80s. Once his credibility was achieved in this area, with considerable pain in the early years (interest rates of 18% in 1982, and similar in the late 80s in the UK) global interest rates stabilised at extremely low levels never previously seen. Credit creation flourished and business investment shot up rapidly, global growth started to move above long term trends and the ruling powers of the world convinced their populaces of how smart they were, as they advocated their "light touch" approach to regulating capital markets, trade and business investment.
Military historians should be a compulsory member of any powerful decision making body, as they can likely point to the cycles of history to forewarn of likely problems when things are plain sailing...there is so much evidence in their field. In an article called the "Victory Disease" by Major Tim Karchner of the US army he outlines a whole host of major battles lost throughout history where the consequence of past battles having been won, was the likelihood of losing the next one increasing. It paints a nice parallel to the hubris of wealth creation over the past 25 years leading to where we are heading today.
The British military experience during the Zulu wars of the late 19th century illustrates the symptoms of the "Victory Disease" as Karchner calls it. The native Zulu population of Southern Africa was just another indigenous people for the British Army to defeat in the British Empire's colonization of Africa. Before fighting the Zulus, the British Army had fought the Boers over areas in southeastern Africa, but most of the British army's experience had been in battles with various indigenous tribes - the Xosas, Pedis and Gcalkas.
The British defeat at the Battle of Isandlwana on 22 January 1879 illustrates the danger of military force using established patterns. When planning the campaign that led to the Isandlwana defeat, the British commanding officer Lord Chelmsford (a good Essex boy) planned to fight the Zulus in the same manner in which he had "fought a messy little war on the Cape frontier to a successful conclusion". Unfortunately those battles were fought in a guerilla warfare mode, and instead the Zulus just produced an enormous army. The dialogue taken from the 1964 film "Zulu" has a comic sadness to it:
Adendorff: The classical attack of the Zulus is in the shape of a fighting bull buffalo, like this (he uses a bayonet to draw a diagram in the dirt): the head, the horns, and the loins. First the head moves forward and the enemy naturally moves in to meet it - but it's only a feint. The warriors in the head then disperse to form the encircling horns, and the enemy is drawn in on the loins, and the horns close in on the back and sides. (He stabs the bayonet into the ground.) Finish.
Lt. Bromhead: It looks, uh, jolly simple, doesn't it?
Adendorff: Oh, it's jolly deadly, old boy.
Lt. Bromhead: Good show, Adendorff, we'll make an Englishman of you yet!
In both the cinema and reality the Zulu army attacked one of the unsuspecting British regiments while it was encamped and killed virtually every man.
This week saw perhaps the greatist advocate of the monetarist doctrine, Alan Greenspan, admit that in truth (and with the benefit of hindsight) that the system wasn't perfect, even though for long periods it appeared to be.
The congressional committee's Democratic chairman, Henry Waxman, pressed him: "You found that your view of the world, your ideology, was not right, it was not working?" Greenspan agreed: "That's precisely the reason I was shocked because I'd been going for 40 years or so with considerable evidence that it was working exceptionally well."
The great strength of Monetarist economics - it's success over a long period of time - runs the risk of now becoming its greatest weakness. The world collectively was so confident in it that now that it has been proven fallible, that fallibility will cause gigantic fall-out. The human overreaction condition will likely kick in on the same scale. We may now embark a grand reworking, or perhaps even a complete destruction of capitalism as we have seen it work for the past 30 odd years, and blame the current failure on the concepts themselves. The truth is that the system is still the best available, but its practitioners need some work. This same scenario repeats itself over and over in our history.
But then the great lesson of history is that we never learn the great lesson of history.
What is also true is that there is a human tendency to latch onto systems and processes and label them unwittingly as better than they actually are, or in the sudden case of their failure to totally discredit them. In other words it's part of the human condition to overreact. There are plenty of cases throughout history to demonstrate that what we think as societies makes us strongest is also likely to lead to our precipitous demise. Nothing is perfect, and thinking things are typically limits our ability to see the wood from the trees - or as Leonard Cohen put it more eloquently:
Ring the bells that still can ring
Forget your perfect offering
There is a crack in everything,
That's how the light gets in.
The laissez faire, free-market approach isn't perfect...what is surprising is that people are thinking that this is surprising. The alternatives are worse.
What is (with hindsight) easiest to pinpoint is the fact that people, governments, bankers, regulators etc. overestimated the ability of the Monetarist approach to economic management to lead us to the promised land. As the Keynesian dogma was ushered out, the Chicago school ushered in an era of central banks aggressively fighting inflation, led by Paul Volcker at the Fed through the early 80s. Once his credibility was achieved in this area, with considerable pain in the early years (interest rates of 18% in 1982, and similar in the late 80s in the UK) global interest rates stabilised at extremely low levels never previously seen. Credit creation flourished and business investment shot up rapidly, global growth started to move above long term trends and the ruling powers of the world convinced their populaces of how smart they were, as they advocated their "light touch" approach to regulating capital markets, trade and business investment.
Military historians should be a compulsory member of any powerful decision making body, as they can likely point to the cycles of history to forewarn of likely problems when things are plain sailing...there is so much evidence in their field. In an article called the "Victory Disease" by Major Tim Karchner of the US army he outlines a whole host of major battles lost throughout history where the consequence of past battles having been won, was the likelihood of losing the next one increasing. It paints a nice parallel to the hubris of wealth creation over the past 25 years leading to where we are heading today.
The British military experience during the Zulu wars of the late 19th century illustrates the symptoms of the "Victory Disease" as Karchner calls it. The native Zulu population of Southern Africa was just another indigenous people for the British Army to defeat in the British Empire's colonization of Africa. Before fighting the Zulus, the British Army had fought the Boers over areas in southeastern Africa, but most of the British army's experience had been in battles with various indigenous tribes - the Xosas, Pedis and Gcalkas.
The British defeat at the Battle of Isandlwana on 22 January 1879 illustrates the danger of military force using established patterns. When planning the campaign that led to the Isandlwana defeat, the British commanding officer Lord Chelmsford (a good Essex boy) planned to fight the Zulus in the same manner in which he had "fought a messy little war on the Cape frontier to a successful conclusion". Unfortunately those battles were fought in a guerilla warfare mode, and instead the Zulus just produced an enormous army. The dialogue taken from the 1964 film "Zulu" has a comic sadness to it:
Adendorff: The classical attack of the Zulus is in the shape of a fighting bull buffalo, like this (he uses a bayonet to draw a diagram in the dirt): the head, the horns, and the loins. First the head moves forward and the enemy naturally moves in to meet it - but it's only a feint. The warriors in the head then disperse to form the encircling horns, and the enemy is drawn in on the loins, and the horns close in on the back and sides. (He stabs the bayonet into the ground.) Finish.
Lt. Bromhead: It looks, uh, jolly simple, doesn't it?
Adendorff: Oh, it's jolly deadly, old boy.
Lt. Bromhead: Good show, Adendorff, we'll make an Englishman of you yet!
In both the cinema and reality the Zulu army attacked one of the unsuspecting British regiments while it was encamped and killed virtually every man.
This week saw perhaps the greatist advocate of the monetarist doctrine, Alan Greenspan, admit that in truth (and with the benefit of hindsight) that the system wasn't perfect, even though for long periods it appeared to be.
The congressional committee's Democratic chairman, Henry Waxman, pressed him: "You found that your view of the world, your ideology, was not right, it was not working?" Greenspan agreed: "That's precisely the reason I was shocked because I'd been going for 40 years or so with considerable evidence that it was working exceptionally well."
The great strength of Monetarist economics - it's success over a long period of time - runs the risk of now becoming its greatest weakness. The world collectively was so confident in it that now that it has been proven fallible, that fallibility will cause gigantic fall-out. The human overreaction condition will likely kick in on the same scale. We may now embark a grand reworking, or perhaps even a complete destruction of capitalism as we have seen it work for the past 30 odd years, and blame the current failure on the concepts themselves. The truth is that the system is still the best available, but its practitioners need some work. This same scenario repeats itself over and over in our history.
But then the great lesson of history is that we never learn the great lesson of history.
Monday, 20 October 2008
Regulating integrity
Adam Smith once said that "Virtue is to be more feared than vice, because its excesses are not subject to the regulation of conscience". Perhaps a slightly funny way to look at the world, but i think it's a pretty insightful way to think about how we go about regulating the important institutions in society.
As the world is in the process of looking to apportion blame for the current financial crisis it seems that the majority of blame is being position squarely at the door of the worlds banks. The truth is that it's not really as simple as that, but thinking like that will keep things simple as people try to understand the process that led to their home being reposessed. The worrying knock-on effect of simply blaming "the banks" for this mess is that what is likely to follow is a whole raft of very poor regulation, that fails to increase the trust that once existed between each of us as individuals and these important institutions. People who work for banks, quite simply cannot be trusted, so to protect individuals from their wily ways swaths of rules will be introduced. We will move further away from the 'old' notion that Adam Smith points to, which is "regulation by conscience". I don't think it's too much of a stretch to suggest that one of the major causes of the current banking crisis was not insufficient regulation, but just poor quality regulation. The best form of regulation i can think of is this regulation by conscience...if i do something, do i fundamentally believe that in the grand scheme of things that this is a good thing to do. Good regulation, would create an environment where that would be the first port of call when making decisions, not to go and check the rule book. This is understandable a tall-order, as it involves a big mental shift across the system.
One of the rule books by which banks have been told to manage their capital and consequently their risk is the Basel Accords. The most recent version of this rule book, which was being put in place in banks across the world was catchily called "Basel II". Effectively this is a set of recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of these recommendations is to create an international standard that banking regulators can use when creating their rules about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. In practice Basel II attempts to accomplish this by setting up complex risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to safeguard its solvency and overall economic stability. Interestingly (if you get your kicks out this sort of thing), the big shift between Basel I and Basel II, was to give the worlds big credit rating agencies a much greater role in the whole process (not exactly looking like a rock-star move that one)...in fact under certain forms of this rulebook capital requirements for banks to hold against particular loans was directly taken from the credit rating from Moody's or Standard and Poors. Very simply if either of this 2 said your asset was AAA rated, the capital you required against that asset was reduced to virtually nil.
In a very simple example, the basic capital requirement for a bank is 8% of it's asset portfolio. So if the bank has made £100 million worth of loans, then they would need to hold £8 million worth as minimum 'protection' against those loans turning sour.
Under the Basel Accords, If however you carved up your mortgage book (via securitisation for example) and retained only mortgage assets with AAA ratings then you would only need to keep a fraction of that £8 million worth of capital against your mortgage assets. This could be a brilliant way of boosting shareholder returns; say the £100mm worth of mortgages pay an income of £2million per annum then your return on capital (very simply) is £2mm/£8mm x 100% = 25%. If however you could reduce you capital by restructuring your mortgage book, such that your income dropped from £2 million to £1 million, but commensurately you dropped your capital requirement to £2mm, then you would have doubled your 'return on equity' - £1mm/£2mm x 100% = 50%. Magic. Your shareholders think you are a genius, and now on the same amount of capital as you started with (£8mm), under the same terms you could go out and lend 4 times as much. Your shareholders are going to love you magic CEO person.
One of the biggest money spinners for banks over the past few years has been more complex forms of that stated above. One of my main jobs at the investment banks i worked at involved discussing with clients how to structure investments in such a way as to make them compelling from a 'return on capital perspective'. The method of doing this involved looking into the Basel II rule book and restructuring investments for our bank clients so that they could legally reduce their capital requirement so as to increase their return on equity. The problem in reality is that you weren't actually doing anything to change materially the quality of the investments...it was a grand form of window-dressing, or in the more base terminology of a former colleague; 'polishing turds'.
A second, and similar trend that developed over the past few years was a change in international accounting standards for banks (this was the one that Lehman Brothers grabbed with both hands so successfully until it blew them up). Another catchily titled accounting rule, called IAS 39, made it favourable for banks to shift some of their loans off "banking books" and onto "trading books". The trade off was simple...if you put assets onto your trading book, then the capital requirement against those assets dropped (good) but in return for this little pick me up you had to 'mark to market' those assets on a daily basis and record the changes in value through your overall profit and loss account. This would likely have the effect of increasing the volatility of your earnings...but when the assets that you are holding increase in value you look great. The large scale transitioning of assets onto trading books, effectively meant banks needed less capital for the same size loan portfolio. Consequently Lehman Brothers (and others) were able to have assets to capital of astronomic proportions. When all of the assets on these books collectively started to fall in value the speed with which Lehman was taken from hero to insolvent was very rapid. This was another rule change that in principle was a good idea, but the agents who were living by it played by the rules, but didn't have incentives to grasp the goal of the rule change.
One question that i hope regulators who are looking at the world now will focus on is this - The Basel Accords in principle are an absolutely fine way of thinking about securing the safety of the worlds banking system, but in practice if the agents who are supposed to live up to these standards didn't care for the principle of what they were about in their 'regulation of conscience' then you won't get the outcome you are after. I think the results speak for themselves.
As the world is in the process of looking to apportion blame for the current financial crisis it seems that the majority of blame is being position squarely at the door of the worlds banks. The truth is that it's not really as simple as that, but thinking like that will keep things simple as people try to understand the process that led to their home being reposessed. The worrying knock-on effect of simply blaming "the banks" for this mess is that what is likely to follow is a whole raft of very poor regulation, that fails to increase the trust that once existed between each of us as individuals and these important institutions. People who work for banks, quite simply cannot be trusted, so to protect individuals from their wily ways swaths of rules will be introduced. We will move further away from the 'old' notion that Adam Smith points to, which is "regulation by conscience". I don't think it's too much of a stretch to suggest that one of the major causes of the current banking crisis was not insufficient regulation, but just poor quality regulation. The best form of regulation i can think of is this regulation by conscience...if i do something, do i fundamentally believe that in the grand scheme of things that this is a good thing to do. Good regulation, would create an environment where that would be the first port of call when making decisions, not to go and check the rule book. This is understandable a tall-order, as it involves a big mental shift across the system.
One of the rule books by which banks have been told to manage their capital and consequently their risk is the Basel Accords. The most recent version of this rule book, which was being put in place in banks across the world was catchily called "Basel II". Effectively this is a set of recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of these recommendations is to create an international standard that banking regulators can use when creating their rules about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. In practice Basel II attempts to accomplish this by setting up complex risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to safeguard its solvency and overall economic stability. Interestingly (if you get your kicks out this sort of thing), the big shift between Basel I and Basel II, was to give the worlds big credit rating agencies a much greater role in the whole process (not exactly looking like a rock-star move that one)...in fact under certain forms of this rulebook capital requirements for banks to hold against particular loans was directly taken from the credit rating from Moody's or Standard and Poors. Very simply if either of this 2 said your asset was AAA rated, the capital you required against that asset was reduced to virtually nil.
In a very simple example, the basic capital requirement for a bank is 8% of it's asset portfolio. So if the bank has made £100 million worth of loans, then they would need to hold £8 million worth as minimum 'protection' against those loans turning sour.
Under the Basel Accords, If however you carved up your mortgage book (via securitisation for example) and retained only mortgage assets with AAA ratings then you would only need to keep a fraction of that £8 million worth of capital against your mortgage assets. This could be a brilliant way of boosting shareholder returns; say the £100mm worth of mortgages pay an income of £2million per annum then your return on capital (very simply) is £2mm/£8mm x 100% = 25%. If however you could reduce you capital by restructuring your mortgage book, such that your income dropped from £2 million to £1 million, but commensurately you dropped your capital requirement to £2mm, then you would have doubled your 'return on equity' - £1mm/£2mm x 100% = 50%. Magic. Your shareholders think you are a genius, and now on the same amount of capital as you started with (£8mm), under the same terms you could go out and lend 4 times as much. Your shareholders are going to love you magic CEO person.
One of the biggest money spinners for banks over the past few years has been more complex forms of that stated above. One of my main jobs at the investment banks i worked at involved discussing with clients how to structure investments in such a way as to make them compelling from a 'return on capital perspective'. The method of doing this involved looking into the Basel II rule book and restructuring investments for our bank clients so that they could legally reduce their capital requirement so as to increase their return on equity. The problem in reality is that you weren't actually doing anything to change materially the quality of the investments...it was a grand form of window-dressing, or in the more base terminology of a former colleague; 'polishing turds'.
A second, and similar trend that developed over the past few years was a change in international accounting standards for banks (this was the one that Lehman Brothers grabbed with both hands so successfully until it blew them up). Another catchily titled accounting rule, called IAS 39, made it favourable for banks to shift some of their loans off "banking books" and onto "trading books". The trade off was simple...if you put assets onto your trading book, then the capital requirement against those assets dropped (good) but in return for this little pick me up you had to 'mark to market' those assets on a daily basis and record the changes in value through your overall profit and loss account. This would likely have the effect of increasing the volatility of your earnings...but when the assets that you are holding increase in value you look great. The large scale transitioning of assets onto trading books, effectively meant banks needed less capital for the same size loan portfolio. Consequently Lehman Brothers (and others) were able to have assets to capital of astronomic proportions. When all of the assets on these books collectively started to fall in value the speed with which Lehman was taken from hero to insolvent was very rapid. This was another rule change that in principle was a good idea, but the agents who were living by it played by the rules, but didn't have incentives to grasp the goal of the rule change.
One question that i hope regulators who are looking at the world now will focus on is this - The Basel Accords in principle are an absolutely fine way of thinking about securing the safety of the worlds banking system, but in practice if the agents who are supposed to live up to these standards didn't care for the principle of what they were about in their 'regulation of conscience' then you won't get the outcome you are after. I think the results speak for themselves.
Monday, 13 October 2008
Jam today or jam tomorrow...
An important tenet of many organised religions is the concept of delayed gratification. This can be seen as a measure of self-control, self-discipline and self-organisation - all of which are in theory helpful to the leading of a happy and at the same time socially responsible existence. Many psychologists, perhaps most notably Freud, tested the concept of delayed gratification on children - and it's has been widely recognised to be an important guide to the probable future success as those children pass into adulthood.
Life throws up many opportunities where we have to make decisions of this nature - do we want to have some jam today, or more jam tomorrow...and how much jam tomorrow would compensate for not having any jam today. Some Christian approaches may even suggest that we would not need to have any more jam tomorrow to compensate for no jam today, because the very process of self-discipline would actually increase the satisfaction of the same amount of jam tomorrow. I think everybody has experienced this concept - a piece of chocolate that has been promised as a reward for finishing the housework, the pint of beer after a long days walking.
Delayed gratification has lost its appeal in many western societies over the past 20-30 years. Perhaps a decline in religious leadership of our societies, or the rapid development of 'on demand' services, from media to finance, to travel and so on. There are plenty of reasons why, but it is certainly the case that gratification has become more immediate. As a child i can certainly recall delayed gratification as being central to my parents approach to parenthood. As children our weekly pocket money was paid every saturday morning, and we were given 10p for every year of age we were. The pocket money was never, ever paid before the Saturday morning, no matter how much pleading took place. I recall on one occasion, when i was eight years old coming back from our local park after Saturday morning football, and going with my Dad to our local newsagent (The Grange Star, Rathfarnham); Dad was picking up the papers and handed me my 80p pocket money for the week. I headed into the shop with him and surreptiously bought eighty 1p sweets (a truly glutenous performance). On returning to the car my Dad saw the substantial bag i was carrying and asked knowingly what i had bought. I hesitantly answered truthfully and proceeded to get an ear bashing for my totally reckless, greedy spending.
These sorts of reactions did not stem from any particular religious inclination, but i think my parents understood, perhaps intuitively (more probably from their parents) that it is an important life skill. Stories of my maternal grandfather working for the Bank or Ireland through the 50s and 60s, and his client relationships with farmers, shopkeepers and small business owners in the west of ireland were full of indirect tales of delayed gratification. The 'on demand' world that we exist in would have been inexplicable to them.
The financial mire that we are heading into could be directly attributable to the fall of the importance of delayed gratification. The credit expansion that has taken place since the early 80s, driven by low interest rates has been a grand borrowing against future income taken to excess. In banking terms we would call this the 'discount rate' - the rate of interest that we would use to discount a future sum of money into a figure today. As world wide interest rates fell, the true discount rate fell too...the real value of holding money in savings accounts dropped preciptously. The opportunity cost of spending was reduced to virtually nothing in the US where real interest rates during the Greenspan years were negative.
In my time working in the world of investment banking, the system encouraged short-termism and the 'jam today' mentality. From compensation packages to accounting approaches money tomorrow was a distant relation to money today. The same sadly held true as it now seems through broad swaths of western economies...from individuals, banks and in some of the worst cases governments. In the US, the fact that it has historically had a savings rate that hovered near zero, and at times was negative suggests that delayed purchases were not on the agenda. Sadly this doesn't create happier lives in the long run. In our societies the concept of success is measured in immediate ways - a new car, a new house, the biggest TV, the most exotic holiday.
What is going to be tricky is reversing this process. The American novellist Thomas Perry once said that "Reading a novel in which all characters illustrate patience, hard work, chastity, and delayed gratification could be a pretty dull experience". As recessions grip in various parts of the world people are going to have to find a way to make these things interesting again.
Life throws up many opportunities where we have to make decisions of this nature - do we want to have some jam today, or more jam tomorrow...and how much jam tomorrow would compensate for not having any jam today. Some Christian approaches may even suggest that we would not need to have any more jam tomorrow to compensate for no jam today, because the very process of self-discipline would actually increase the satisfaction of the same amount of jam tomorrow. I think everybody has experienced this concept - a piece of chocolate that has been promised as a reward for finishing the housework, the pint of beer after a long days walking.
Delayed gratification has lost its appeal in many western societies over the past 20-30 years. Perhaps a decline in religious leadership of our societies, or the rapid development of 'on demand' services, from media to finance, to travel and so on. There are plenty of reasons why, but it is certainly the case that gratification has become more immediate. As a child i can certainly recall delayed gratification as being central to my parents approach to parenthood. As children our weekly pocket money was paid every saturday morning, and we were given 10p for every year of age we were. The pocket money was never, ever paid before the Saturday morning, no matter how much pleading took place. I recall on one occasion, when i was eight years old coming back from our local park after Saturday morning football, and going with my Dad to our local newsagent (The Grange Star, Rathfarnham); Dad was picking up the papers and handed me my 80p pocket money for the week. I headed into the shop with him and surreptiously bought eighty 1p sweets (a truly glutenous performance). On returning to the car my Dad saw the substantial bag i was carrying and asked knowingly what i had bought. I hesitantly answered truthfully and proceeded to get an ear bashing for my totally reckless, greedy spending.
These sorts of reactions did not stem from any particular religious inclination, but i think my parents understood, perhaps intuitively (more probably from their parents) that it is an important life skill. Stories of my maternal grandfather working for the Bank or Ireland through the 50s and 60s, and his client relationships with farmers, shopkeepers and small business owners in the west of ireland were full of indirect tales of delayed gratification. The 'on demand' world that we exist in would have been inexplicable to them.
The financial mire that we are heading into could be directly attributable to the fall of the importance of delayed gratification. The credit expansion that has taken place since the early 80s, driven by low interest rates has been a grand borrowing against future income taken to excess. In banking terms we would call this the 'discount rate' - the rate of interest that we would use to discount a future sum of money into a figure today. As world wide interest rates fell, the true discount rate fell too...the real value of holding money in savings accounts dropped preciptously. The opportunity cost of spending was reduced to virtually nothing in the US where real interest rates during the Greenspan years were negative.
In my time working in the world of investment banking, the system encouraged short-termism and the 'jam today' mentality. From compensation packages to accounting approaches money tomorrow was a distant relation to money today. The same sadly held true as it now seems through broad swaths of western economies...from individuals, banks and in some of the worst cases governments. In the US, the fact that it has historically had a savings rate that hovered near zero, and at times was negative suggests that delayed purchases were not on the agenda. Sadly this doesn't create happier lives in the long run. In our societies the concept of success is measured in immediate ways - a new car, a new house, the biggest TV, the most exotic holiday.
What is going to be tricky is reversing this process. The American novellist Thomas Perry once said that "Reading a novel in which all characters illustrate patience, hard work, chastity, and delayed gratification could be a pretty dull experience". As recessions grip in various parts of the world people are going to have to find a way to make these things interesting again.
Monday, 6 October 2008
Value Added
The concept of what 'value added' means has always been confusing to me. It is assumed, i think, that the answer is straightforward...but I have never really found it so. Apparently it's the case that the sun emits enough energy that ,if appropriately captured, 2 days worth of sun would sufficiently cover the entire human energy consumption for a year. In one sense, value added, would be the creation of a technology that captures this energy and i would have to work less presumably because my energy bills would have fallen...perhaps the 4hours less that i would have worked a week could be filled playing golf; as could everybody else in humanity...which might make the local club a bit busy. Alternatively i could continue to work the same amount, but would be able to buy more 'stuff'...a new set of golf clubs for example. These apparently are the old style economics of 'trade-off', opportunity cost and value creation.
For generations of economists, 'wealth creation' implies capital formation in these terms - generating and developing income-creating tangible assets. I think i can grasp this concept...i build a technology that can capture the energy of the sun in a highly efficient way, and can use this technology to generate income in some form.
In the Autumn of last year the US Census Bureau published figures for median real incomes for US families between 2000-2007. CNN at the time commented on the statistics that “...This is the first business cycle ever in which the middle class had less income at the end than the beginning” – from around $58,500 to $56,000. At around this time, the FTSE had touched a high pushing 6750, and the Dow was well above 14000. Markets were booming, both in equity and credit markets.
So while GDP growth, and a variety of market indicators reflected an economy that was growing steadily, the real incomes of the majority of Americans had actually fallen.
Away from the income generation of the average American, the growth of home mortgages exploded from an annual rate of $368.3 billion in 2000 to an annual rate of $884.9 billion in 2004, compared with a simultaneous increase in residential building from $446.9 billion to $662.3 billion. Altogether, the United States experienced a credit expansion of close to $10 trillion during these four years. By 2007, the size of the US mortgage market had reached an estimated $12trillion, of which an estimated $1.3trillion had been pushed into the hands of the euphemistically entitled 'subprime'.
At the same time as credit was expanding, so too was GDP. During 2000-2004 GDP added $1.9trillion to the country's, so the ratio of credit expansion to GDP growth was just over 5 times. During the 4 year period after the end of the 2nd world war, this ratio was roughly equal.
While consumption, residential building and government spending soared, unprecedented imbalances developed in the economy - record-low saving; a record-high trade deficit; a vertical surge of household indebtedness; anemic employment and income growth from wages and salaries; outsized government deficits; and protracted, unusual weakness in business fixed investment.
The crux of all this is that all that really happened in the US economy over the past 8years, was asset price inflation fuelled by record low interest rates. The average American was borrowing against a 'guaranteed' increase in asset prices (between 2000-2007 the average annual price increase was around 15%, stock markets showed similar annual gains). In truth, they were actually borrowing more than the expected future increases in asset prices. This is i think is technically known as Ponzi scheme. Ponzi schemes can be quite effective, if a touch morally bankrupt, as long a the music is still playing.
Charles Prince (the last Citibank CEO) was quoted in the middle of last year as saying that...
"When the music stops, in terms of liquidity, things will be complicated. But as long as the music playing, you've got to get up and dance. We're still dancing." Charles Ponzi would have been proud.
So where are things at?
Some numbers: US Credit expansion 2000-2008 was around $23trillion. GDP growth was nominally estimated at $3.6bn over the same period. Since the highs of the housing markets in 2006 and stock markets in autumn 2007 the estimated falls in asset values that the credit expansion are financing is estimated at over $5trillion. So the US consumer is by any accounting standard insolvent. We're well past the Keynes situation: If you owe a bank a hundred pounds, you have a problem...if you owe them a $100million, it has one.
Banks, Financial institutions and increasingly Governments are largely bearing the responsibility for the outstanding debt that financed these assets. Capital ratios are falling, so banks are seeking new capital and deleveraging (trying to sell assets) to get back to appropriate capital adequacy ratios. Banks will be net sellers of assets until their capital ratios reach a 'reasonable' level, but are going to be in a vicious circle with falling asset prices...the more assets they sell, the further the prices of assets they hold will fall, forcing them to sell yet more assets to balance their capital positions.
The goal of the US bail-out currently is to try to stem the descending flow of asset prices that a forced deleveraging has created. $700bn is a lot of money, but may well be a bit like trying to fix a leak in the Hoover Dam with a tube of hand-held polyfiller.
As Milton Friedman put it: "We all agree that pessimism is a mark of superior intellect"
For generations of economists, 'wealth creation' implies capital formation in these terms - generating and developing income-creating tangible assets. I think i can grasp this concept...i build a technology that can capture the energy of the sun in a highly efficient way, and can use this technology to generate income in some form.
In the Autumn of last year the US Census Bureau published figures for median real incomes for US families between 2000-2007. CNN at the time commented on the statistics that “...This is the first business cycle ever in which the middle class had less income at the end than the beginning” – from around $58,500 to $56,000. At around this time, the FTSE had touched a high pushing 6750, and the Dow was well above 14000. Markets were booming, both in equity and credit markets.
So while GDP growth, and a variety of market indicators reflected an economy that was growing steadily, the real incomes of the majority of Americans had actually fallen.
Away from the income generation of the average American, the growth of home mortgages exploded from an annual rate of $368.3 billion in 2000 to an annual rate of $884.9 billion in 2004, compared with a simultaneous increase in residential building from $446.9 billion to $662.3 billion. Altogether, the United States experienced a credit expansion of close to $10 trillion during these four years. By 2007, the size of the US mortgage market had reached an estimated $12trillion, of which an estimated $1.3trillion had been pushed into the hands of the euphemistically entitled 'subprime'.
At the same time as credit was expanding, so too was GDP. During 2000-2004 GDP added $1.9trillion to the country's, so the ratio of credit expansion to GDP growth was just over 5 times. During the 4 year period after the end of the 2nd world war, this ratio was roughly equal.
While consumption, residential building and government spending soared, unprecedented imbalances developed in the economy - record-low saving; a record-high trade deficit; a vertical surge of household indebtedness; anemic employment and income growth from wages and salaries; outsized government deficits; and protracted, unusual weakness in business fixed investment.
The crux of all this is that all that really happened in the US economy over the past 8years, was asset price inflation fuelled by record low interest rates. The average American was borrowing against a 'guaranteed' increase in asset prices (between 2000-2007 the average annual price increase was around 15%, stock markets showed similar annual gains). In truth, they were actually borrowing more than the expected future increases in asset prices. This is i think is technically known as Ponzi scheme. Ponzi schemes can be quite effective, if a touch morally bankrupt, as long a the music is still playing.
Charles Prince (the last Citibank CEO) was quoted in the middle of last year as saying that...
"When the music stops, in terms of liquidity, things will be complicated. But as long as the music playing, you've got to get up and dance. We're still dancing." Charles Ponzi would have been proud.
So where are things at?
Some numbers: US Credit expansion 2000-2008 was around $23trillion. GDP growth was nominally estimated at $3.6bn over the same period. Since the highs of the housing markets in 2006 and stock markets in autumn 2007 the estimated falls in asset values that the credit expansion are financing is estimated at over $5trillion. So the US consumer is by any accounting standard insolvent. We're well past the Keynes situation: If you owe a bank a hundred pounds, you have a problem...if you owe them a $100million, it has one.
Banks, Financial institutions and increasingly Governments are largely bearing the responsibility for the outstanding debt that financed these assets. Capital ratios are falling, so banks are seeking new capital and deleveraging (trying to sell assets) to get back to appropriate capital adequacy ratios. Banks will be net sellers of assets until their capital ratios reach a 'reasonable' level, but are going to be in a vicious circle with falling asset prices...the more assets they sell, the further the prices of assets they hold will fall, forcing them to sell yet more assets to balance their capital positions.
The goal of the US bail-out currently is to try to stem the descending flow of asset prices that a forced deleveraging has created. $700bn is a lot of money, but may well be a bit like trying to fix a leak in the Hoover Dam with a tube of hand-held polyfiller.
As Milton Friedman put it: "We all agree that pessimism is a mark of superior intellect"
Subscribe to:
Posts (Atom)
Subscribe To
Posts
All Comments
