BizBlast

Old Media Companies Try to Sabotage New Media Efforts

noreply@blogger.com (Erik Sherman) — Thu, 02 Apr 2009 13:24:00 +0000

Given the number of "studies" I've seen that claim to show the "superiority" of print over online, I've gotten a sense of desperation on the part of publishers. (And given their financial results and dropping ad revenue, no wonder.) The latest has some interesting data:

Among Web users, nearly two-thirds (63%) of banner ads were not seen. Respondents' eyes "passed over" 37% of the Internet ads and "stopped" on slightly less than a third, McPheters & Co. found.

In contrast to online ads, TV and magazine ads generated a strong propensity to be seen and recalled. Full-page, four-color magazine ads were determined to have 83% of the value of a 30-second television commercial, while a typical Internet banner ad has 16% of the value.

Here are the major findings from the press release issued by the market research firm that undertook the study:

Within a half hour, magazines effectively delivered more than twice the number of ad impressions as TV and more than 6 times those delivered online.
Though TV doesn't deliver as many ads per half hour as do magazines, net recall of TV ads was almost twice that of magazine ads; magazines in turn had ad recall almost three times that of Internet banner ads.
85% of Internet ads served appeared on-screen and could be identified by brand.
Among web users, 63% of banner ads were not seen. Respondents' eyes passed over 37% of the Internet ads and stopped on slightly less than a third.
For Internet ads, almost all net recall could be attributed to ads that were seen.
Internet video ads appeared much less frequently than banner ads, and their exposure skewed heavily towards young men. When they did appear they were twice as likely to be seen as banner ads.

In my experience I definitely avoid looking at banner ads. But there are some enormous suppositions and biases here:

The report does mention online vehicles other than banner ads, but only mentions video ads as appearing less frequently than banner ads and skewing heavily toward young men. But that is one of the most desired demographics for marketers. And, apparently, it didn't seem to measure text ads, which are surely the most prevelant form of online marketing today.
Recalling an ad is not necessarily the same as ad effectiveness. Consider the famous example of the hilarious Alka Seltzer ad series from the sixties. They had huge recall, but the company dropped them because no one remembered the product, just the humor. Also, if you find an ad irritating, is there any transference of that feeling toward the manufacturer?
Although it may be in the study, I don't see any mention of the intent of the ad. Was it meant to sell product? Recall doesn't show whether people buy, or even if they become more inclined to favor the mentioned brand.
Where is the audience spending its time? Even if magazine and television ads are more effective in a more extensive way than recall, is that the medium that consumers prefer to consume? If they read news and watch video online, then placing ads in print and on television starts reaching a smaller audience.
That last point has another implication: cost. Print and television ads cost more to run than online ads. So how much does it cost to acquire and maintain a customer? That must be part of the equation, particularly when budgets are constrained. Even if one type of ad is five times more effective, what if it costs a hundred or thousand times as much?

And now for the really big point, in my opinion. Conde Nast and CBS Vision (described by CBS as a new research initiative to explore changes and opportunities in the media marketplace) sponsored the study. I've generally found that sponsored studies almost always mean that the results are only released when they support the underlying goals of the corporate sponsors. For example, can you imagine a drug company backing a study showing that a cheap alternative to an expensive prescription medicine was superior?

But publishers and broadcasters all claim to be interested in online as a medium. (Disclosure: I cover high tech for BNET, which is owned by CBS Interactive.) But this clearly delivers the impression that the sponsors are interested in having older media -- which deliver more ad revenue and profit -- shown to be superior to online. In other words, it's the old dog at the media companies trying to kill off the upstart medium, with the Internet still a business toddler compared to print and broadcast. How are the media companies ever going to make the transition they say is coming if they do everything in their power to defeat it?

This is why tech companies like Google and Amazon, which are big in online advertising and media, are likely to be the real winners in the media wars. They aren't spending significant resources and time trying to debunk the very businesses they say they are anxious to establish. And the financial results the market has been seeing is nothing more than the public results of the internal uncivil wars taking place in these companies.

Dodd and AIG Scratch Each Other's Back

noreply@blogger.com (Erik Sherman) — Mon, 23 Mar 2009 19:50:00 +0000

The Hartford Currant has documented Connecticut Senator Christopher Dodd's flip-flop on the AIG bonuses, but it seems that there is more going on than he's addressed.

On Tuesday, Dodd said that he was not a member of the conference committee that crafted the final compromise bill and said that the exception had not been in the bill as he drafted it.

But late Wednesday, Dodd admitted in an interview with CNN that he had been involved in the change.

"I agreed reluctantly," Dodd said. "I was changing the amendment because others were insistent."

Don't think that Dodd is at an arm's length relationship with the financial services conglomerate. If you check the record of donations to him, you quickly see that AIG was his fourth largest contributor from 2003 to 2008, with a total of $223,478 donated.

The total money he raised during that time was $8,938,003. That means that AIG was directly responsible for 2.5 percent of all the money he raised during that period. The insurance industry was one of his top five industry donors with a total of $1,440,422, making AIG responsible for 15.5 percent of all insurance company donations to Dodd.

It's not surprising that Dodd has close ties to financial services as he's chair of the Senate's Banking, Housing, and Urban Affairs Committee. This is clearer when you add the total of campaign money received from 2003 to 2008 from securities and investments, insurance, and commercial banks: $6,588,012, or 73.7 percent of all campaign contributions to the senator.

It's not that the money comes directly from the companies, because that would violate election laws. However, 71% of the money comes from individuals; organizations like OpenSecrets.org collect the public information and then cross reference to find the totals. It seems pretty hard to believe that Dodd's own office wouldn't have made the same calculations.

noreply@blogger.com (Erik Sherman) — Mon, 02 Mar 2009 13:50:00 +0000

Wired has an article called Recipe for Disaster: The Formula That Killed Wall Street. It's about how a mathematician came up with an idea of how to easily quantify the coupling of risks in individual cases that investors want to know so they can make better decisions. For exmaple, you know that one investment has a given chance of going into default, and that one debt arrangement is bundled with others to make a bigger financial instrument in which you could put money. If one starts going badly, are others also more likely to head south, or are the individual risks really independent of each other? You need to know the answer if you're going to intelligently understand the risk.

The solution was a formula using a technique called a Gaussian copula function. All of Wall Street rejoiced because suddenly it was easy to calculate risk without waiting for historic data:

The effect on the securitization market was electric. Armed with Li's formula, Wall Street's quants saw a new world of possibilities. And the first thing they did was start creating a huge number of brand-new triple-A securities. Using Li's copula approach meant that ratings agencies like Moody's—or anybody wanting to model the risk of a tranche—no longer needed to puzzle over the underlying securities. All they needed was that correlation number, and out would come a rating telling them how safe or risky the tranche was.

And then, eventually, the market imploded. But when you look at the approach the mathematician took - examining the historic prices of credit default swaps - you start to see just how stupidly so many in finance acted:

The damage was foreseeable and, in fact, foreseen. In 1998, before Li had even invented his copula function, Paul Wilmott wrote that "the correlations between financial quantities are notoriously unstable." Wilmott, a quantitative-finance consultant and lecturer, argued that no theory should be built on such unpredictable parameters. And he wasn't alone. During the boom years, everybody could reel off reasons why the Gaussian copula function wasn't perfect. Li's approach made no allowance for unpredictability: It assumed that correlation was a constant rather than something mercurial. Investment banks would regularly phone Stanford's Duffie and ask him to come in and talk to them about exactly what Li's copula was. Every time, he would warn them that it was not suitable for use in risk management or valuation.

The article focuses on how you cannot count on the correlation of financial securities, because risks that seem out of sync one day can suddenly all manifest at the same time.

I'll put it a little differently than stated in the article becuase I think there's an even more fundamental point that financiers missed. Like any market, CDO purchases largely move on emotion - it's one of those indisputably human activities. When people think they are safe, they will do the most astoundingly stupid things because they simply don't perceive danger.

CDO prices are an accurate historic measurement of what people thought risk was, not of the actual inherent risk of the underlying investment on which the CDO was taken. So all of these investment decisions were made based on looking at people's perception of risk, whether right or wrong, and not the actual risk. No wonder everything blew up. It was like betting on the results of a card game when you weren't one of the players, didn't know their history of success, and couldn't see any of the cards. Here's the scary part: the people who didn't notice the difference are the ones still in charge.

Obama Administration Making the Banker's Error

noreply@blogger.com (Erik Sherman) — Sun, 01 Mar 2009 19:12:00 +0000

The Obama administration is already finding itself having to defend its economic projections of a strong economic recovery. We're still in the middle of a mess that stemmed in no small part from the refusal of bankers to consider the worst case scenario, from admitting that things could be far worse. So why is the current administration doing the same? For the same reason: It is unpleasant to ask people face reality.

But Obama was elected on the idea of a change in the past and some respect for the truth ... at least, that is the marketing angle his staff used. The only way to escape the danger of the overly optimistic is to use a range of scenarios: good, realistic, and bad. The bad one has to be really bad, take into account the worst that could happen. The realistic should be just that. Presenting only one scenario that tends toward the optimistic is to whistle past danger. To do what has been foolish in the past only continues the foolishness.

Did FDR Make the Great Depression Worse?

noreply@blogger.com (Erik Sherman) — Thu, 12 Feb 2009 23:50:00 +0000

Fortune has an article on the growingly common criticism that FDR's New Deal actually prolonged the Great Depression. The conclusion is that it probably wasn't as good as the fans claim or as bad as the critics complain. But I found an interesting juxtaposition of information. Here are statements from the article:

"Roosevelt's programs were first passed in 1933 but economists generally agree that the Great Depression did not end until 1939, when the country began preparing for World War II."

"On the more dire end of the scale, Harold L. Cole and Lee E. Ohanian, economics professors at the University of Pennsylvania and UCLA respectively, estimate the New Deal's labor and industrial policies caused the Depression to last seven years longer than otherwise."

Does that mean that the Depression should have been over two years before the New Deal was even passed?

What If Banks Are in Deeper Trouble Than Anyone Realizes?

noreply@blogger.com (Erik Sherman) — Fri, 30 Jan 2009 12:25:00 +0000

The Wall Street Journal has a sobering article that starts with a disturbing question: What if nearly half of U.S. banking assets turn out to be bad?

Defaults are rising on every form of debt, which should come as no surprise to anyone. Those who thought that the issue was subprime mortgages need to wake up and realize that no form of debt exists separate from any other. People strapping themselves with mortgages they cannot afford are clearly going to be financially strained elsewhere. But then, people taking out lines of credit against homes, using multiple credit cards, and leasing fancy autos that they wouldn't be able to afford to purchase are also going to be hard-put to manage any untoward financial situation. That will likely add up to a lot of money:

Indeed, Goldman Sachs Group estimates that troubled assets could exceed $5 trillion, if defined as assets that could show a loss rate close to, or above, 10%. To put that in context, $5 trillion is just over 40% of the $12.3 trillion in total assets of U.S. commercial banks.

Granted, actual losses will be much smaller than $5 trillion, and banks won't have to sell every bad asset. Most still can reserve for a good share of their losses. Moreover, the government already is on the hook for losses at Citigroup and Bank of America, with $3.8 trillion of assets between them.

Why take for granted that the losses will be a lot less? This is exactly the type of willful blindness that has led banks to where they are today.

The talk today is of creating a government-owned so-called bad bank, which would buy the bad assets and then liquidate them. The strategy is at least twenty years old and was in use during the 1980s, when many more banks were failing than are failing now.

The problem is that everyone is making things up as they go along. No institution to my knowledge has done risk management planning for such an extreme situation as that much potential default. Not even the U.S. government can take on this level of debt with impugnity. How many years -- how many decades -- will it take to pay off this volume of money?

I don't think anyone in government or the financial community is being straight, either with the public or with themselves. They are likely concerned about inducing panic, but maybe that is exactly what the public needs. Already we're seeing lowered spending and more attention to debt levels, at least by individuals. They are right to react strongly, because they see they are living with choices made over the years. But how long will it be until those who are in charge do the same?

Clever Retail Revamping

noreply@blogger.com (Erik Sherman) — Mon, 15 Dec 2008 13:15:00 +0000

The Financial Times has a story about Danish silverware company Georg Jensen, which recently revamped its retail look. How do executives justify such an expense at a down economic time? By being innovative. Jensen got in touch with 25 top Danish companies and offered a swap: use of consumer electronics, furnishings, housewares, and so on in return for a showcase of that company's goods. Jensen isn't selling the products of the other, just its own. It's similar to how many magazines get use of materials from various companies in return for credit. It's a smart bit of business innovation.

Making Sense of CEO Bonuses

noreply@blogger.com (Erik Sherman) — Tue, 09 Dec 2008 11:10:00 +0000

When do you pay a bonus? If you're smart, you sign that check when you've had a clearly-defined goal within the power of the potential recipient to deliver, the behavior you reward strengthens the business, and you watch to see that what you wanted actually occurred. And there's some odd news on this front. At Merrill Lynch, CEO John Thain thinks he deserves a $10 million bonus for 2008. This would be riotously funny if it weren't so tragic and indicative of the problems often found in upper management. Merrill has lost $11.67 billion this year. So far. Thain's view? He deserves a bonus because he helped keep it from getting a lot worse.

It's not that there is no case to be made for Thain. He only took over last December, so literally has been cleaning up the messes of others, and pulled off the acquisition by Bank of America. And yet, the board noted that more successful Wall Street firms - or at least one, Goldman Sachs - aren't giving out bonuses, and that acquiring BofA and the public at large might not sit too calmly with a big payout when so much was lost.

When Mr. Thain landed at Merrill in late 2007, he received a $15 million cash signing bonus and a pay package that was valued from about $50 million to $120 million over a number of years.

Merrill shares were trading above $50 when he was hired, and his pay package was structured heavily toward his ability to increase the price by another $40 or more. Merrill's shares have fallen steadily this year, closing Friday at $13.04 in 4 p.m. New York Stock Exchange composite trading.

As much disaster as he may have averted, he clearly signed on to do something that a more realistic person might have said wasn't possible. If you're going to get big bucks, then you need to deliver big. And if he couldn't see where things were going as recently as a year ago, then maybe he wasn't so insightful after all. Or is the board punishing Thain because it's embarrassed at not having checked the stupidity of his predecessors?

I have a tad more sympathy for Toyota management, which is seeing its bonuses reduced as car sales slide off the road. The company had been doing marvelously well and is clearly caught in forces larger than human decision. But when things go bad, employees are always asked to tighten their belts. Making the same request of management seems only fair.

GM Tries Hiding Plane

noreply@blogger.com (Erik Sherman) — Tue, 02 Dec 2008 10:30:00 +0000

The big three auto makers received scathing publicity when they used private jets to travel to Washington, D.C. so they could ask Congress for a public bailout of their companies, driven to the brink of fiscal death by inept management.

Representatives at the Nov. 19 House hearing, including Gary L. Ackerman, Democrat of New York, faulted Mr. Wagoner; Alan R. Mulally, the Ford Motor chief; and Robert L. Nardelli, the chief of Chrysler, for taking private jets to Washington to plead their case.

“Couldn’t you all have downgraded to first class?” Mr. Ackerman asked.

Critics of a federal aid package for G.M., Ford and Chrysler spotlighted the private jets as an example of why the companies did not deserve a bailout.

To keep such wasteful and arrogant activity from hitting the public spotlight happening again, General Motors for one decided to ... block the public's ability to track a plane it uses. Good lord, these people really will never learn, will they? Any bets on what they would do with bailout money? Do I hear waste it?

Bankerss Living in World of Dreams

noreply@blogger.com (Erik Sherman) — Mon, 01 Dec 2008 10:10:00 +0000

David Reilly in the Wall Street Journal wrote an interesting analysis of the banking system i which he argues that the institutions need as much of an overhaul as the auto industry.

The crisis, they have argued, is down to an impossible-to-predict perfect storm, predatory hedge funds, panicked investors, unrealistic accounting rules and economic changes that emerged so quickly there was no way to be prepared for them.

If only. The reality is the crisis is due to bad lending and investment decisions.

I agree, but would extend this a bit. Bad decisions caused the problem. The trigger was a series of events that stressed the business model enough that it crumbled.

The problem with the banks' explanation is that it effectively says, "If only things hadn't gone wrong, we'd have been fine." But nothing goes right forever. Bankers rode a long string of wins, and then kept pushing their luck. They didn't test extreme scenarios. That was heinously inept. As I've mentioned before, when you have events that are independent of each other, the probabilities of at least one happening add. Maybe some of these events aren't completely independent, but they're not completely dependent either. As the number of things that can go wrong increases, so are the chances that one of them will.

Executives who cannot grasp this simple fact and who keep telling themselves that everything will be fine are nothing more nor less than addicted gamblers. There is a reason that some financial institutions with a reputation for being overly conservative have lasted hundreds of years. They don't look for the short cut to profit.

We Don't Solve Problems Because We Don't Look At Them

noreply@blogger.com (Erik Sherman) — Thu, 20 Nov 2008 13:22:00 +0000

The Wall Street Journal in an article on an upcoming Senate probe into bond-rating firms had what I think is a telling quote:

Sen. Carl Levin (D., Mich.), who heads the investigations subcommittee, has called attention to financial derivatives known as credit-default swaps, which he calls "one of the prime culprits responsible for this financial disaster." Investigators are expected to look into how those derivatives were marketed and used by banks.

Consider that language carefully for a second: one of the "prime culprits" for the current financial debacle is the category of financial derivatives called credit default swaps.

When disaster hits and we as a people look for answers, we tend to point to the simplest and most obvious causes we can cite. These, however, are not causes. They are simply mechanisms that allow individual and collective weaknesses of greed and lying to act with increased effect. Derivatives of any type are nothing more than a legal fiction, a business arrangement between two parties that may or may not be based on quicksand. It is the behavior and willingness to ignore sense on the parts of the people involved that is the problem. You might as well say that cars cause automobile accidents, not their drivers.

I've lately been working on some articles about how executives pull their companies out of difficult economic times and otherwise manage risk. According to the experts I asked, the biggest problem companies have is when top managers refuse to see reality. They pretend that the worst cannot happen. They create one excuse after another for why the company must operate as it does. When bad things happen, they look for people to blame and don't think about the further unintended consequences of their actions. On BNET, I recently covered how high tech lay-offs were generally bad management. That was nothing more than a specific instance of a more general case. The problem is bloated staffing for the business that is here. But who is responsible for that level of hiring? The executives who then lay off the employees with no control over how the business runs. It is those top managers who are responsible - and who execute the innocent.

That's a practical example of finding someone else to blame, and of not noticing the problem as it developed. How long has GM had to see and fix its problems? Instead, management blames the high cost of employees, not the lack of understanding customers and providing what they would want. Until managers overcome the baser parts of their human nature, or at least struggle with them a bit, nothing will change, none of us will learn lessons, and the same behaviors that got us into trouble will shortly restart and then continue as though nothing happened. What a pity.

The Disease That Was Subprime Lending

noreply@blogger.com (Erik Sherman) — Sun, 16 Nov 2008 12:40:00 +0000

Those who think that the subprime mess was an unfortunate accident that could not be anticipated by management should read a BusinessWeek story called Sex, Lies, and Subprime Mortgages. Fraud and trading of sexual favors for mortagages that could be bundled into hot securities were supposedly common, and whistle blowers were shut down by managers who didn't want the good times to end. What went on was literally criminal, and I suspect that the major Wall Street institutions simply turned blind eyes to everything in their quest of deals that could yield profits and a quick exit before the players got caught. Unfortunately, the collective moral depravity set off a chain reaction that we will be facing for years. It does make me wonder what similar may have gone on in credit default swaps, credit card-based CDOs, and other such debacles.

Credit Card Derivatives: Facing Reality, One Step at a Time

noreply@blogger.com (Erik Sherman) — Sun, 09 Nov 2008 09:20:00 +0000

The amount of single-minded focus that the media has placed on the mortgage market and the collateralized debt obligations surrounding it is nothing more than a fad. I don't mean that the problem is a fad - far from it. This is part of something bigger that is here to stay for many years. But the media pays attention like an industry with ADD. Journalists have grabbed on this because it was big and bright, essentially as it latches onto a story about a celebrity or the murder of a pretty coed.

But the financial crisis is much more than mortgage-based CDOs and the London inter-bank rates. According to whom you ask, the derivatives market has hit between 1 and 1.25 quadrillion dollars. Yes, a thousand trillions. That is so massively beyond the size of the 50 trillion GDP of the entire world as to be stunning and scary.

We've seen two shoes drop in mortgages and credit default swaps (which is continuing to evolve as more defaults happen and more institutions become liable for the "insurance" they offered). Chances are strong for future rounds of stock market plummets as companies continue to need cash to cover their positions and sell securities to get it.

The next one is likely credit card derivatives. As I've mentioned before, there's an entire bond market created in the bundling of credit card and auto loan debt. I have yet to find a good estimate of the total market size. But consider this: a large part of the quarterly $5.29 billion write-off that AIG took in the last quarter of 2007 was for credit card derivatives exposure, possibly through credit default swaps. And around the end of September, Citi said that it "faced up to $10 billion in credit losses, partly because of rising credit card defaults."

Subprime mortgages got into enormous trouble with, what, a ten percent default rate? Last quarter, U.S. banks charged off 5.47 percent of all credit card loans, or about $50 billion. That was up from 3.85 percent in 2007.

To be sure, credit cards don’t represent a huge portion of assets for most banks. For example, they comprise about 14 percent of all consumer loans and leases at Bank of America, the country’s largest credit card issuer. The main problem, Nishikawa said, is that “everyone is so weak after what happened with mortgages that another blow to a consumer product would be hard to handle.”

Consumer groups have long complained that credit card issuers push cards onto people who don’t need them or can’t afford them. They say rising credit card defaults —- just like mortgage defaults —- are largely the fault of banks who lent to risky borrowers.

Innovest estimates about 30 percent of Bank of America’s credit card loans are to subprime borrowers —- second only to the failed Washington Mutual Inc., which had almost half of its credit card loans held by subprime borrowers.

What that story doesn't say is that in the event of a mortgage default, the bank still owns the property -- probably not longer at the value the bank had assumed when writing the mortgage, but still something. Credit cards? Totally unsecured. And when auto loans go bad, the car has lost enormous value once driven off the lot.

Even if the credit card and auto CDOs are smaller than CDOs based at least in part on subprime mortgages, the impact they'll have has the potential to be far larger.

The Inversion of Finance

noreply@blogger.com (Erik Sherman) — Sun, 26 Oct 2008 15:51:00 +0000

There's an interivew with FedEx's CEO Fred Smith in the Wall Street Journal online, and he makes one of the most intelligent and perceptive comments about the financial services industry that I've yet to see:

He attributes the financial crisis to "the intersection of four long-term developments." Reckless mortgage lending policies; high energy prices; mark-to-market accounting rules; and national policies that favor what he calls "the financial sector over the industrial sector."

"Rather than in our business where you have to have a dollar of equity for, 10 cents or 15 cents of debt," he explains, "it's exactly the opposite in the financial sector where you have one dollar of equity for 10, 25, 50 times risk." "Things became so flipped upside down," he explains, that "the assets at these banks became the liabilities and the liabilities became the assets. These people were making these fantastic returns -- at places like Fannie Mae and Freddie Mac -- but in reality they weren't adding a lot of value. I have said time and again that there is a fundamental tendency in good times in the financial sector to over-leverage. Our national policies actively encouraged all this debt."

The concept of assets becoming liabilities and liabilities becoming assets is so completely apt as to be startling in its simplicity.

I'm not sure I agree with his appeal to change the tax structure allowing capital purchases to be treated as out-of-pocket expenses. The question is whether you drive accounting rules by tax policy or tax policy by accounting rules. The reason for amortization is to more throughly match up expenses with revenues. At the same time, to be fair, once you've paid for that Boeing 777, you're not getting to return it and the money is gone. But what if it's financed and you're paying over time. It doesn't seem reasonable to allow the immediate expensing of the entire amount.

He mentions that he things the corporate tax rate should be lowered, and that at 38% it's even higher than Germany's 25%. My question would be not what the tax rate is on the books, but what the average realized tax rate is. I have a suspicion that most large corporations are managing to write off enough that the effective tax rate is far lower.

Credit Ratings Firms Spun Tales to Spin Gold

noreply@blogger.com (Erik Sherman) — Thu, 23 Oct 2008 08:50:00 +0000

In case you think truth never comes to light in Congress, then look at the Washington Post story about how the credit rating agencies knew for at least a year that they helped fuel the financial meltdown.

In one of the confidential documents obtained by the committee, Raymond W. McDaniel, chief executive of ratings firm Moody's, said analysts and executives are "continually 'pitched' by bankers, issuers, investors . . . whose views can color credit judgment."

"we 'drink the kool-aid,' " he wrote in a Oct. 21, 2007, memo to the board. "Unchecked, competition on this basis can place the entire financial system at risk."

I think this shows that their claims of "getting to the bottom" of programming errors in their risk management systems was so many lies and an attempt to slide a knife in the backs of technicians for what was primiarily an issue of their own greed.

Frankly, this has been true for many years and is exactly the same type of situation as faced the accounting firms that wanted to provide consulting and auditing services at the same time. You can't do it fairly because there's an inherent conflict of interest. Your vast income is the result of kissing the plump rear of those who run the client companies. People will always act in accordance with their personal financial incentives.

In short, I think this means that no one can believe a single word coming from any of the rating agencies. If they are willing to pump up ratings based on rewards, why wouldn't they knock down ratings because of the lack of them. I suspect that will come out at some point because it's part of the same human nature: If you won't look out for me, then screw you.

Now consider the extent of this. You can't trust the ratings on securities. On banks. On insurance carriers. On bonds. On anything. It might be that the ratings are often accurate, but how can you know? The morally reprehensible action of all these executives who knew of the problems and did nothing was that they destroyed any sense of trust in the system. Not blind belief, but the trust that institutions will do more or less what they are supposed to do. When that goes, so does the willingness to invest.

"We have to earn our credibility back," said Deven Sharma, president of Standard & Poor's.

Mr. Sharma, you simply cannot. No one with any sense will ever believe any of you, because you've all proven what you are willing to do to line your pockets. There's no reason to expect that you would be any less willing in the future so long as you thought that you wouldn't be caught. I'd call all of them a pack of swine, but it would be degrading to pigs.

Keeping Perspective During Panic

noreply@blogger.com (Erik Sherman) — Tue, 14 Oct 2008 15:30:00 +0000

The entire financial world seems to be in panic, lurching from one side of the economic ship to the other, rocking the whole thing. It's all madness, becasue it equates stock prices, or the vlaue that people place on companies, with the performance of the companies themselves. But look at IBM, a strong quarter and emphasis that management expects to hit its previous guidance for the rest of the year. Johnson & Johnson beat expectations. To get lost in the running crowd is to miss where you are, and that means missing the opportunities around you.

Credit Swaps are Old Friend

noreply@blogger.com (Erik Sherman) — Mon, 13 Oct 2008 12:35:00 +0000

Virtually everyone going on in the media about the credit crisis keeps talking about the subprime mortgages, but there's little talk about the credit swaps which were the real force in knocking everything over. At his blog, billionaire investor Mark Cuban pointed out that the crash of 1987 also was triggered by schemes to insure leveraged investments. In each case, the sudden requirement to pay up as things went south was why companies had to "dump everything AND sell stock index futures to raise cash, which in turn lead to a crisis of confidence and deleveraging." And he makes an additional interesting point:

Which is the genesis of our problem in the US. Its not wrong to run with bull markets and leverage to the hilt. That can be a very good thing. But we have to make the upside based on investments, rather than financial engineering. Which is exactly why we have to change our tax code. We want to encourage investment, not financial engineering.

He suggests having zero capital gains tax on selling stocks and bonds bought during an IPO and held for five or more years, and if sold early it would become taxes as regular income. Cuban also would not allow stock to be borrowed against, requiring a sale instead. I understand the impulse, but it's my understanding that there are already types of financial deals that effectively transfer ownership of stock for periods of time. Although I see the impulse, I suspect this would be as easily walked around as other blockades that regulators and legislators have tried to erect. How can you keep legislators from loosening things up over time because they get entirely too much money from the financial services industries?

Bailout: Just the Beginning

noreply@blogger.com (Erik Sherman) — Mon, 06 Oct 2008 12:03:00 +0000

Ah, should have known this was going to happen. According to the Financial Times, all sorts of people are pressuing the U.S. Treasury and the Federal Reserve to provide further help to the economy, possibly a mix of a rate cut, letting money markets borrow money to fund their holdings, and maybe even offering unsecured loans to regulated banks. In other words, the U.S. government is going to become like a parent who always bails out the troubled child until things get so bad that it's no longer possible. I'm sure some would liken the current situation to the intervention of a doctor, but unfortunately the illness was the result of the stupidity of the institutions in danger. How is curing the symptoms going to change the underlying behavior? It's not, and chances are that the cash is not going to travel much farther than the banks and their largest customers - the ones they want to keep happy. I'm already hearing stories from small business owners suddenly finding their credit lines pulled. Many will make it through, but when you remember that the majority of employment in the country comes from small businesses, it makes you wonder whether it's the economy that's getting a bailout, or the most elite piece.

Wall Street and the Wages of Estimation

noreply@blogger.com (Erik Sherman) — Tue, 23 Sep 2008 13:20:00 +0000

Last week, the New York Times blog Bits had a piece about Wall Street analysts "lying" to their computers. Written by a journalist who has covered both the Internet and trading and finance, it indicates how little many reporters know about the mathematical processes they write about -- otherwise there might have been much earlier warnings of the problems now facing the world's economy.

Yes, the current meltdown is supposed to be a "once in a hundred years" event, as the president of a consulting firm told the reporter. However, these black swan events, when considered together, happen far more frequently than every hundred years. That's because when you have potential events that are independent of each other, but still capable of creating financial cataclysm, the cchance of at least one of them happening is the sum of the separate chances of a given one happening.

So already experience and math suggest that the surprise at an unusual event should have the same tone as Captain Renault being "shocked, shocked" at the gambling at Rick's in Casablanca. The concept of adding probabilities for independent events has literally become math in grade school, or at least high school.

Now for the other revelation:

The people who ran the financial firms chose to program their risk-management systems with overly optimistic assumptions and to feed them oversimplified data. This kept them from sounding the alarm early enough.

Top bankers couldn’t simply ignore the computer models, because after the last round of big financial losses, regulators now require them to monitor their risk positions. Indeed, if the models say a firm’s risk has increased, the firm must either reduce its bets or set aside more capital as a cushion in case things go wrong.

In other words, the computer is supposed to monitor the temperature of the party and drain the punch bowl as things get hot. And just as drunken revelers may want to put the thermostat in the freezer, Wall Street executives had lots of incentives to make sure their risk systems didn’t see much risk.

I'm sure there's something to this, but let us get at a more fundamental issue: many complex problems in math and engineering and science are too tough to easily solve. What people do, then, is simplify. You put the world into models and approximations that you have a prayer of solving. You drop factors that seem tiny in comparison with the rest of the problem in an attempt to simplify the equations even more. You employ numeric methods to get closer and closer to the "real" answer ... as close as you need.

Unfortunately, your answer is simply an approximation, nothing more. It may be acceptible for your uses if the real world conditions are forgiving enough. But when things get hairy -- you're trying to predict the behavior of materials in the face of quantum mechanics effects or trying to understand how an incredibly complex system, such as the weather or global finance, will behave -- then approximate may not be good enough. If a chip fails, well, you head back to the drafting board. When an economy fails, then you end up with huge banks and investment companies going out of business, oil prices swinging by $25 in a single day as short-sellers have to cover their positions, and governments begging for the right to spend $700 billion of taxpayer money to get their croneys out of the frying pan.

Banks, Bankruptcies, and Economic Reality

noreply@blogger.com (Erik Sherman) — Fri, 29 Aug 2008 11:20:00 +0000

Bettors, speculators, and con men have one thing in common: more often than not they forget the saying, "There's no free lunch." The phrase can be traced back to bars offering free lunch. Of course, you had to pay for liquor or beer (which might be marked up). So there really was no free lunch. Somehow, somewhere, someone paid for the meal in another coin.

To the list of believers in economic fairy tales we can apparently add a good number of businesspeople. As the Financial Times notes, Merrill Lynch has lost $14 billion, after taxes, since the beginning of 2007.

This is equivalent to about a quarter of all the profits, adjusted for inflation, made in the course of the bank’s history as a listed company since 1971 – the highest ratio of recent losses to historical profits among its peers.

That mirrors the precipitous growth in profits preceding it. Between 2003 and 2006, the bank racked up $21bn in profits, more than a third of its total between listing and the credit squeeze. Backed by a buoyant global economy, investment banks could buy up, repackage and sell on assets, while deploying little capital and pushing profitability and leverage to historic highs.

Merrill had gone looking for free lunch in the form of securitized debt obligations - turning groups of loans, like subprime mortgates, into bonds that it could sell ... at least for a while. Relatively little captial went into schemes that promised wealth beyond the dreams of avarice.

But the bill has come and someone had to pay. That payment has extended to all manners of people. Bankruptcy filings have hit the million mark this year, up 29 percent from last year. But as a society we've collectively enjoyed a spree, since at least the early 1980s, of living high off borrowed funds. Sated to a point of bursting and staggering drunk from the bar, we forgot that the bill would come.

Speculators Dominate Oil Futures

noreply@blogger.com (Erik Sherman) — Thu, 21 Aug 2008 20:52:00 +0000

The headlines pretty much says it all, and the details are in a Washington Post story. Here are a few points to consider:

At one time, commodity futures trading was limited to the big companies that used the goods to keep them from becoming another economic tool of wealth collection that would leave the public holding the bag of outrageously high prices.

At one point in July, one comapny alone, Vitol, held 11 percent of all oil contracts on the New York Mercantile Exchange (NYMEX). All that control could have cost as little as a billion in cash, with the rest borrowed.

Financial firms speculating for themselves or clients account for 81 percent of all oil contracts on the NYMEX. Their holdings have risen from $13 billion in 2003 to $260 billion this year.

The drive to end regulation, no matter what the reason for having it, has let companies create unregulated trading exchanges, meaning that no one knows what's going on and, should things fail, it would be like setting off a match in a powder keg. (That's my view, not the Post's.)

Yet another new exchange is opening up - in Dubai - and US oil contracts will be traded without supervision.

And people wonder why they have to go into hock to fill an auto or heating oil tank.

I Hate PR Parrots

noreply@blogger.com (Erik Sherman) — Fri, 15 Aug 2008 16:30:00 +0000

In my work as a journalist, I often send out queries over various services to find sources. (In some of the work I do, this is often the best way to find companies that have had particular experiences or insights that have not already been widely quoted in the media.) Some of the answers from PR people can be useful, many are either slightly or completely off topic, but there is one type of answer that has come to drive me mad: the echo.

The PR person, wanting to demonstrate how perfect his or her client is for a story I'm doing, will take entire phrases of my query and use them as the answer. Here's an example of a query I just sent:

I'm writing about the challenges companies and law firms are finding in patenting and trademarking clean-tech businesses, including strategies and approaches IP lawyers find to be working. Please, this is about the actual IP strategy and not about a firm or company telling about how it is establishing itself in this new area of technology. Some topics might be handling the often interdisciplinary nature of clean-tech or getting inventors to think beyond their own area of specialty.

Fairly to the point, I think. Now here are snippets of some answers I received, with the only changes I make being taking out identifying information:

Would you be interested in speaking with XX of YY who is chair of ZZ practice who can discuss with you the challenges companies and law firms are finding in patenting and trademarking clean-tech businesses, including strategies and approaches IP lawyers find to be working.
I can offer you a XX expert today to speak about the challenges facing companies and law firms re: patenting and trademarking clean tech businesses. We will address the specifics around the actual IP strategy (and the various challenges).
Both groups are working in conjunction with the IP and Trademark groups in this area and can discuss some of the challenges and difficulties companies face in patenting and trade marking clean-tech businesses.

That list of answers and one or two others represented maybe 40 percent of what I received within a few hours of the query being emailed.

It's not that I'm categorically adverse to having something repeated back, but I do expect additional information showing the proposed source's expertise in that area and how this person might add to the discussion. That could happen in a number of ways:

examples where the person addressed the particular problem
a few briefly cogent points on the topic
specifics of background that show the necessary expertise, which means not just working in an area like law, but in the specific subset that is at issue

Simply repeating my words doesn't show that someone is listening. If anything, it's almost a guarantee that the person hasn't.

An example literally happened while I was typing this. One of the above respondents mentioned a lawyer who seemed to focus on financial deals in cleantech - certainly interesting, but not useful when I need to get into nitty gritty IP issues. I answered, noting the person's expertise seemed to be in finance, not patent work. The reply? "Would you be interested in speaking with him and one of his colleagues?"

No, I wouldn't, because you're not listening and don't care what I'm trying to do or whether you potentially make your client look like a horse's ass. If he doesn't have the background to answer the question, don't reply in the first place. If he does, then say so. But don't ignore my question and act like an incompetent. Or does it not matter because you'll bill the client for the time spent on the interaction anyway?

Toxic Banks: Not Just US Problem

noreply@blogger.com (Erik Sherman) — Fri, 08 Aug 2008 03:18:00 +0000

I've heard some people remark that the credit crunch has shown the weakness of US banks as compared to the rest of the world (which generally means Europe, when it comes to the financial industry). I found that hard to believe, because it seemed that some of the names hit hardest were European banks. So I was interested to read in the Financial Times Lex column (sorry, no free link) that sub prime credit write downs by banks have totaled $493 billion worldwide. Of that, $250 billion was in the US, but $221 billion was in Europe, with $22 billion elsewhere.

And yet, the European economy has not taken the same hit as that of the US. The housing bubble in the US has been one factor, but there's been a similar bubble in many parts of Europe - Spain, Denmark, the UK, and Ireland. I'm guessing that the relative strength of the euro has been the reason. But it seems that won't be lasting long:

The US and European economies are of similar size, as are their banking industries, which both have market capitalisations of about $1,000bn. Yet European banking stocks have outperformed since the credit crisis began. So far, US banks have suffered most. The worst is yet to come in Europe.

Those in the US looking for economic salvation by investing overseas are likely to find that the safety is only temporary. Ah, well, misery loves company.

Home Prices Fall - No Surprise

noreply@blogger.com (Erik Sherman) — Wed, 30 Jul 2008 12:35:00 +0000

Two major housing price indexes, a 20-city and 10-city compilation by Standard & Poor's and Case-Shiller, both hit record declines. But there's no surprise if you've been even cursorily following the economic churn in the country.

The "value" that people perceived was a result of demand, over-supply of money, speculation, and a general economic hysteria. Not being grounded in anything truly substantial, it was waiting to evaporate, and now we're seeing that happen. But I actually think this is good news for the economy, getting back to a more realistic state that might allow more moderate but supportable growth.

noreply@blogger.com (Erik Sherman) — Tue, 29 Jul 2008 10:35:00 +0000

There's an interesting article in the Washington Post about oil speculation and transparency. The impact of speculation has become enormous:

Big Wall Street firms representing the interests of pension funds, endowments and wealthy individuals around the country have grown in just a few years from minor participants in the oil markets to their most dominant force.

These financial firms -- whose holdings of oil contracts are now larger than the collective demand of airlines, trucking firms and other companies that need oil to run their businesses -- have become the focus of an intense debate in Washington over whether their exponential growth is contributing to the surge in oil prices.

And, apparently, such people as Ben Bernanke are claiming that speculation has no effect on oil prices because about half the people bet that it will rise and half bet that it will fall. That sounds nice, but my bet is that is a "normal" pattern and not what we've been seeing, because then about half the people at any given time would be losing money. When the swings are as big and violent as we've seen, and fueled by margin buying, those losses will be enormous, pushing a lot of people out, which means you now have a mechanism that is leaning one way, not balanced.

Even if the bets were even, it's the mass of investment that causes the problem, because it has no balancing interest, like the organizations that actually want to use oil, and hence are interested in stability and lower prices. According to Bernanke's theory, at least have the people who are taking positions in oil - which means buyers, not sellers - want the price to go higher, a very different mindset than ever before. I'm guessing that's enough to cause the fluctuations and price surges we've seen.

The Commodity Futures Trading Commission has been tracking some of the investment activity, but is keeping the information secret, claiming that it doesn't want to reveal too much proprietary information about the traders, and that the complexity of the information alone, if made public, could have misled the commodities markets. But wouldn't you think that the people who wouldn't be misled would be the people who actually do this for a living - the traders in the commodities markets?

It sounds like the CFTC is dominated, as one might expect, by the biggest trading forces, which means the speculators. The organization does claim that it "always been and continues to be committed to market integrity and to market transparency." It just has an idiosyncratic way of showing it.