We are finally getting rid of a culture where our best and brightest were going into activities that were directed at creating fake-non-long-term economic growth….
Is financial engineering fake economic growth? Not to the extent that it finances real economic growth (i.e. expand the possibilities of real growth to occur)… however, most of the financial engineering we experienced during the last number of years wasn’t really directed to productive economic growth, but, rather incented to provide quick intermediation fees (and augment the % of profits that the financial industry had in our economy) regardless of the economic outcome… this is/was deplorable and I hope it stays in the mind of various generations to come (although I also believe that financial memory is rather short)… None of this would have happened if we had not allowed “Economic Intermediation” (be it in the financial industry, in the real estate industry, any industry to be paid on a fee-based, no-skin in the game, I’ll be gone and I-would-have –spent-all-the-money-by-the-time-you-go-bust-and-realize”)…
If an intermediary is wise enough to recommend the purchase of a particular asset, they should be paid the majority of their work based on the results of that recommendation (why is this so crazy!!)…
Here is a recommendation: Create a payment structure where they make a killing when they recommend something that works out, but, they don't earn anything when they recommend something that flops (perhaps something to cover basic costs).
Now, don't lock them for too long of a time for this payment structure to work (i.e. if the recommendation goes bust after a “rational” period of time, they should have already cashed out under the assumption that there were other forces beyond the recommendation itself that brought the asset down).
Last point - we should always look at performace / profits / growth over a 10 years period - financial industry profits never were what they were back then - if we subtract all the losses today, we see that just like everything - there is always reversion to the mean.
Thursday, April 30, 2009
Nature Costs are Costs Too
There is a lot of discussion today about our impact on the planet. As we manufacture goods, and consume natural resources, we are using a “free good” – our resources, our bodies of water, our soil, our forests, our sky and who happen to have no “owner” and thus no consumption cost or tax. Should we ask ourselves what the cost of using all these resources is? How so? What if we damage these in such a manner that it will cost our children more to “consume/use/clean” them than it cost us? What if we damage them to a point that our children can’t use them anymore? What if we use them to a point that have side-effects: like hurting other natural habitats that are used by living creatures, that at the same time are at the bottom of the food pyramid of some other ecosystem that could very well be us?
It’s very encouraging that the US is moving forward with its plans to recognize the costs involved in our economic development via the cap and trade system proposed. It’s only fair to our children, to the next generation that we recognize and pay for those costs, and not simply “steal” from them or impose those costs on them. I say we will all be better and our economy not only will not suffer but become stronger (through forced innovation).
It’s very encouraging that the US is moving forward with its plans to recognize the costs involved in our economic development via the cap and trade system proposed. It’s only fair to our children, to the next generation that we recognize and pay for those costs, and not simply “steal” from them or impose those costs on them. I say we will all be better and our economy not only will not suffer but become stronger (through forced innovation).
Tuesday, April 21, 2009
Spain - the new Argentina
Its always the same - pegged, fixed, converted currencies - people/countries want the benefits and not the downside, people/countries believe the hype, don't think about the consequences.
Argentina dollarized its economy in the early 90's in an effort to defeat inflation and start a new wave of liberal economic policies with the intenation of modernizing its economy. Inflation was defeated, capital flowed in, the economy grew, etc.... and people believed the hype, the country enjoyed the benefits.... but, with all those capital inflows, new credit to individuals, AND rising prices/purchasing power (standard of living) comes a responsibility; the country requires to create something with that and invest the money (not spend it), become more productive (to produce more with the same tomorrow), and save for bad times... Argentina spent a lot of money (albeit there was significant investment), did not become more productive (albeit technology modernized various industries), and did not save much money... this is a simplification of the problem - but I simply want to make a point and a comparison to Spain...
Spain went through its own dollarization (its Euroization) -> a country that was running large country risk spreads, with lack of credit (on a relative basis) suddenly found itself in a miracle - just by changing its currency, money started flowing into the country, there wasn't a currency spread anymore, credit to individuals started flowing -> it was a new beginning for Spain -> prices for assets increased, salaries increased, there was a newfound purchasing power -> what a miracle! why didnt they do it before?... the country did create many things with that though -> today Spain is a very competitive country in a number of industries (even outside Spain), including banking, infrastructure, and green energy... however, I am not sure they did everything they had to do -> did they save enough?, did they become more productive?... I am nobody to judge, maybe they did... but, I think they are in real trouble now - a la Argentina... the economy and their wealth grew in a currency that can't adjust now via a devaluation or monetary policy (just like Argentina's price level/economy could not adjust via their currency or monetary policy) - so, it neeeds to adjust via the price level itself and unemployment... its a choice Argentina had -> devalue and shatter asset values/credit or maintain the currency and suffer deflation, and send the country into a deep recession with very high unemployment..
What could Spain had done? Don't believe the hype -> you become richer by truly producing more goods and services that (1) are a necessity at home or (2) that are needed/wanted elsewhere in the world... you don't become richer by borrowing against higher value assets and then spending in non-productive things...
The basic point of this writing is this: The adoption of a more stable, more respected non-national currency brings very valuable beneifts to a country - it allows foreign capital to trust the unit of account/store of wealth/medium of exchange in that country more (so more capital can flow in), it allows for longer-term credit to flow (because the threat of devaluation, inflation is decreased (never eliminated, because there is always the risk that the country would need to abandon the currency altogether)), and because of that new capital -> asset prices will increase, which then allows for more credit (and you get the idea)... there is no new wealth created solely by this -> the nationals of that country need to use that opportunity to invest the funds in productive assets, they need to become more productive relative to the world, they need to understand they need to save because bad times will always arrive... Its all too common for countries throughout history to not get this (or to not have their leaders (during good times) emphasize this enough.
Based on my experiences in Argentina, I'm not liking the current situation in Spain and the choices ahead of it (albeit with more influence with the European Central Bank than Argentina had with the Fed).
Argentina dollarized its economy in the early 90's in an effort to defeat inflation and start a new wave of liberal economic policies with the intenation of modernizing its economy. Inflation was defeated, capital flowed in, the economy grew, etc.... and people believed the hype, the country enjoyed the benefits.... but, with all those capital inflows, new credit to individuals, AND rising prices/purchasing power (standard of living) comes a responsibility; the country requires to create something with that and invest the money (not spend it), become more productive (to produce more with the same tomorrow), and save for bad times... Argentina spent a lot of money (albeit there was significant investment), did not become more productive (albeit technology modernized various industries), and did not save much money... this is a simplification of the problem - but I simply want to make a point and a comparison to Spain...
Spain went through its own dollarization (its Euroization) -> a country that was running large country risk spreads, with lack of credit (on a relative basis) suddenly found itself in a miracle - just by changing its currency, money started flowing into the country, there wasn't a currency spread anymore, credit to individuals started flowing -> it was a new beginning for Spain -> prices for assets increased, salaries increased, there was a newfound purchasing power -> what a miracle! why didnt they do it before?... the country did create many things with that though -> today Spain is a very competitive country in a number of industries (even outside Spain), including banking, infrastructure, and green energy... however, I am not sure they did everything they had to do -> did they save enough?, did they become more productive?... I am nobody to judge, maybe they did... but, I think they are in real trouble now - a la Argentina... the economy and their wealth grew in a currency that can't adjust now via a devaluation or monetary policy (just like Argentina's price level/economy could not adjust via their currency or monetary policy) - so, it neeeds to adjust via the price level itself and unemployment... its a choice Argentina had -> devalue and shatter asset values/credit or maintain the currency and suffer deflation, and send the country into a deep recession with very high unemployment..
What could Spain had done? Don't believe the hype -> you become richer by truly producing more goods and services that (1) are a necessity at home or (2) that are needed/wanted elsewhere in the world... you don't become richer by borrowing against higher value assets and then spending in non-productive things...
The basic point of this writing is this: The adoption of a more stable, more respected non-national currency brings very valuable beneifts to a country - it allows foreign capital to trust the unit of account/store of wealth/medium of exchange in that country more (so more capital can flow in), it allows for longer-term credit to flow (because the threat of devaluation, inflation is decreased (never eliminated, because there is always the risk that the country would need to abandon the currency altogether)), and because of that new capital -> asset prices will increase, which then allows for more credit (and you get the idea)... there is no new wealth created solely by this -> the nationals of that country need to use that opportunity to invest the funds in productive assets, they need to become more productive relative to the world, they need to understand they need to save because bad times will always arrive... Its all too common for countries throughout history to not get this (or to not have their leaders (during good times) emphasize this enough.
Based on my experiences in Argentina, I'm not liking the current situation in Spain and the choices ahead of it (albeit with more influence with the European Central Bank than Argentina had with the Fed).
Friday, April 10, 2009
Content vs. Technology
Without going into the details of the objectives of above the line advertising and below the line and taking things "on the margin" (everything else being equal).
The economics of any ad transaction will be disproportionately skewed to those players that are best able to 1) demonstrate cause/effect of the transaction, and 2) be closest to the product purchase decision. We are witnessing this with the astronomical rise in market value (revenues/cash flow) of a company like Google.
Google doesn't own content, its a technology company that has located itself right between online content and the advertiser, at a position that provides the best proxy for cause-effect and closest to the purchase decision (i.e. the "product" it offers is search - and presumably, when people search proactively for something (as opposed to consuming content passively on the TV at the other extreme), they should be interested in that product or service).
So, Google can let other companies be the ones that make the investments in "content", in that highly contested/hit or miss area and then through technology enable the advertising transaction in a very scalable manner, and thus, be able to extract a high % of the investment - a lot more companies will compete for eyeballs/content online than will investing in the technology to control that middle space that provides signficant functions to advertisers.
Strong content owners will always be able to fully monetize its content - premium content will always be a scarce product and they will always be able to do things that less powerful content companies or the technologies companies can't do: product integration or customized sales - having strong brands/powerful content will always be a high return game...but it has been really impressive to watch Google, well after the blow-up of the Internet bubble come in (with survivors of the first such as Yahoo and AOL, not to mention MSFT) and basically grow the industry and grab a disproportionate share of the dollars that are coming in (or better said perhaps driving a lot of money online) by simply being an intermediary (albeit a very special kind of intermediary)....so, I pose the question - how can content companies learn from Google and try to 1) become more data-driven results oriented, and 2) demonstrate how they impact purchase decisions... what is clear is that the click is not a perfect indicator of cause/effect and it doesn't necessarily carry the biggest load on a purchase decision (in most instances)... having said that, its the closest proxy created today for both...
The economics of any ad transaction will be disproportionately skewed to those players that are best able to 1) demonstrate cause/effect of the transaction, and 2) be closest to the product purchase decision. We are witnessing this with the astronomical rise in market value (revenues/cash flow) of a company like Google.
Google doesn't own content, its a technology company that has located itself right between online content and the advertiser, at a position that provides the best proxy for cause-effect and closest to the purchase decision (i.e. the "product" it offers is search - and presumably, when people search proactively for something (as opposed to consuming content passively on the TV at the other extreme), they should be interested in that product or service).
So, Google can let other companies be the ones that make the investments in "content", in that highly contested/hit or miss area and then through technology enable the advertising transaction in a very scalable manner, and thus, be able to extract a high % of the investment - a lot more companies will compete for eyeballs/content online than will investing in the technology to control that middle space that provides signficant functions to advertisers.
Strong content owners will always be able to fully monetize its content - premium content will always be a scarce product and they will always be able to do things that less powerful content companies or the technologies companies can't do: product integration or customized sales - having strong brands/powerful content will always be a high return game...but it has been really impressive to watch Google, well after the blow-up of the Internet bubble come in (with survivors of the first such as Yahoo and AOL, not to mention MSFT) and basically grow the industry and grab a disproportionate share of the dollars that are coming in (or better said perhaps driving a lot of money online) by simply being an intermediary (albeit a very special kind of intermediary)....so, I pose the question - how can content companies learn from Google and try to 1) become more data-driven results oriented, and 2) demonstrate how they impact purchase decisions... what is clear is that the click is not a perfect indicator of cause/effect and it doesn't necessarily carry the biggest load on a purchase decision (in most instances)... having said that, its the closest proxy created today for both...
Sunday, April 5, 2009
Internet kills industries? Not really... it disrupts industries
We hear more and more about how the Internet puts on a real challenge to some industries (to the point that some of them might disappear). Print media (newspapers, magazines) or Music industry (Record Labels, Retailers) come to mind...
I'm sure this is obvious to a lot of people (but potentially not) - but, industries do not die, they get disrupted (C Christensen's term), or more simply said - the structure of the industry changes and the players who extract economic returns also change.
Lets take media as an example: be it entertainment, information, sports, or even music - there are two basic concepts: Content creators and Consumers... and that reality will never change - for any industry to exist, there needs to be a product or service that satisfies a need... and the Internet has not changed that reality for any industry... it has simply made it easier/cheaper/more efficient for the manufacturer of a product or service to reach its consumption point...
The Internet economic model is the antithesis of the physical economic model... at a first level, it provides instant and seamless information to the consumer - the physical world required an investment close to consumption to provide that information (think any product or service you can research today on the Internet and think how you used to get information 15 years ago - think travel for example - a good amt of the service travel agents were providing was information)... at a second level, it provides the ability to transact without a physical presence, again, the physical world required physical contact (think Amazon for everything it sells vs. how you would acquire any product you today acquire on Amazon 15 years ago)... and at a third level it provides the ability to consume without a physical presence (think music for example)... when something reaches that third level (ability to consume without any physical presence - aka without the need for any middle person), then its pretty clear that unless you provide something that the content creator can't do by him/herself or something the consumer can't do by him/herself, then there isn't a need for middle person... in a very simplistic way - musicians can create music, post it on the Internet to be consumed or an author could theoretically publish a book online (if a software existed for them to do that) - who needs labels or a publisher or anybody else in the middle? (of course, labels and publishers do provide value - as a new artist or author would find it very difficult to be discovered without the investments and knowledge that labels and publishers put on the table).
Ultimately, the Internet disrupts, and takes away profits from "physical players" or i call them "friction players" (as they benefit from a friction-full environment) and either gives them back to manufacturers or end up in consumer surplus.
In a sense the newspaper industry was never an industry - it was a segment of the "news industry" - it was the "paper news industry"... and with the internet, it has allowed that the segment within the news industry called the "digital news industry" to become a bigger portion of the news industry... and the digital news industry is one that is more democratic, fragmented, just in time that brings the news (the product) closer to consumption by consumer... so while in the "written news industry" most of the economics were extracted by a middleperson (newspapers) that provided technology, guidance, buildings, etc. to the actual creators of the news (news writers)... the digital age has allowed the content creators to not need those middle men (supply and demand not decided by middleperson) and the economics to change as well - the billions of dollars that were supporting those middlemen (Newspapers) will now flow to the content creators or end up as extra savings for consumers to spend elsewhere (Starbucks coffee, iTunes, etc.)... The NEWS industry is as alive as ever, its consumed more than ever, and its more participatory than ever... just like the MUSIC industry is.
I'm sure this is obvious to a lot of people (but potentially not) - but, industries do not die, they get disrupted (C Christensen's term), or more simply said - the structure of the industry changes and the players who extract economic returns also change.
Lets take media as an example: be it entertainment, information, sports, or even music - there are two basic concepts: Content creators and Consumers... and that reality will never change - for any industry to exist, there needs to be a product or service that satisfies a need... and the Internet has not changed that reality for any industry... it has simply made it easier/cheaper/more efficient for the manufacturer of a product or service to reach its consumption point...
The Internet economic model is the antithesis of the physical economic model... at a first level, it provides instant and seamless information to the consumer - the physical world required an investment close to consumption to provide that information (think any product or service you can research today on the Internet and think how you used to get information 15 years ago - think travel for example - a good amt of the service travel agents were providing was information)... at a second level, it provides the ability to transact without a physical presence, again, the physical world required physical contact (think Amazon for everything it sells vs. how you would acquire any product you today acquire on Amazon 15 years ago)... and at a third level it provides the ability to consume without a physical presence (think music for example)... when something reaches that third level (ability to consume without any physical presence - aka without the need for any middle person), then its pretty clear that unless you provide something that the content creator can't do by him/herself or something the consumer can't do by him/herself, then there isn't a need for middle person... in a very simplistic way - musicians can create music, post it on the Internet to be consumed or an author could theoretically publish a book online (if a software existed for them to do that) - who needs labels or a publisher or anybody else in the middle? (of course, labels and publishers do provide value - as a new artist or author would find it very difficult to be discovered without the investments and knowledge that labels and publishers put on the table).
Ultimately, the Internet disrupts, and takes away profits from "physical players" or i call them "friction players" (as they benefit from a friction-full environment) and either gives them back to manufacturers or end up in consumer surplus.
In a sense the newspaper industry was never an industry - it was a segment of the "news industry" - it was the "paper news industry"... and with the internet, it has allowed that the segment within the news industry called the "digital news industry" to become a bigger portion of the news industry... and the digital news industry is one that is more democratic, fragmented, just in time that brings the news (the product) closer to consumption by consumer... so while in the "written news industry" most of the economics were extracted by a middleperson (newspapers) that provided technology, guidance, buildings, etc. to the actual creators of the news (news writers)... the digital age has allowed the content creators to not need those middle men (supply and demand not decided by middleperson) and the economics to change as well - the billions of dollars that were supporting those middlemen (Newspapers) will now flow to the content creators or end up as extra savings for consumers to spend elsewhere (Starbucks coffee, iTunes, etc.)... The NEWS industry is as alive as ever, its consumed more than ever, and its more participatory than ever... just like the MUSIC industry is.
Why are we protecting creditors? We are creating moral hazard.
I've been writing about this mortgage situation for close to 18 months now (and probably thinking about it for 24 months). Something that i've been asking myself since all these bailouts started is about the lack of questioning of the implied protection the government has given creditors.
There has been a lot written on those "bailouts" that basically protected shareholders (who rightfully were taking risks). However, there hasn't been enough written on the fact that all those capital injections are basically making creditors whole.
Maybe I am being naive (in that it probably doesn't really work that way), but, why don't we simply let the market run its course (with the banks?). In other words, if a bank is to fail, its shareholders lose, and its creditors lose... the government takes over and in a very fast transaction it puts it back into the market - there will obviously be a bid for the assets of that bank... here's the caveat - the bid will have two concepts: 1) how much debt would they be willing to take on and 2) how much capital will they put in.... the highest bidder takes the institution... and bingo, by default... the new debt level is known...
I am guessing it can't be that easy - creditors would have the right to sue (claiming that through a bankruptcy process they would've taken control of the bank (rather than unilaterally having to cede control)...
Regardless, the point here is that we talk about moral hazard on the equity side, but, one of the biggest moral hazards we might be creating happens to be on the credit side.
There has been a lot written on those "bailouts" that basically protected shareholders (who rightfully were taking risks). However, there hasn't been enough written on the fact that all those capital injections are basically making creditors whole.
Maybe I am being naive (in that it probably doesn't really work that way), but, why don't we simply let the market run its course (with the banks?). In other words, if a bank is to fail, its shareholders lose, and its creditors lose... the government takes over and in a very fast transaction it puts it back into the market - there will obviously be a bid for the assets of that bank... here's the caveat - the bid will have two concepts: 1) how much debt would they be willing to take on and 2) how much capital will they put in.... the highest bidder takes the institution... and bingo, by default... the new debt level is known...
I am guessing it can't be that easy - creditors would have the right to sue (claiming that through a bankruptcy process they would've taken control of the bank (rather than unilaterally having to cede control)...
Regardless, the point here is that we talk about moral hazard on the equity side, but, one of the biggest moral hazards we might be creating happens to be on the credit side.
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