Bold Ventures Forum

Is the Recession Over? What Part did Mark-to-Market Play?

2009-04-02T18:14:00Z

Today the Financial Accounting Standards Board (FASB) voted to ease one of the accounting standards that is used in the complicated process of determining the value of assets owned by financial institutions.

When this happened the Dow Jones Industrial Average immediately traded up about 300 points and certain stock market pundits began proclaiming "The Depression is over!" - clearly, this decision was important and we will attempt to explain why:

The business health of financial institutions is measured by the value of the assets they own. When a bank makes a mortgage loan it puts forward the money to buy the house and allows you to live in that house and call it yours as long as you make timely mortgage payments according to your mortgage agreement. Your house is pledged to the bank as collateral for your mortgage loan, which means that if you do not pay your mortgage the bank will claim ownership of the house.

The fully collateralized and current paying loan is an asset for the bank and it has a market value. If you do not make your mortgage payments, your loan declines in value but that value is replaced by the value of the collateral, your house. One way or another, the bank will eventually get most if not all of its money back either through you paying off your mortgage or through the bank reposessing and selling the house.

Some banks are considered healthier than others and this impacts their ability to borrow and their cost of borrowing money just as your own credit score impacts your ability to borrow money to buy a car or house. As mentioned above, the health of the bank depends on the value of the assets it owns.

During times of financial crisis the market value of these assets will temporarily decline and that can damage the bank's ability to borrow money to finance its operations because, until today, the bank was required to state the value of its assets according to what the current market would pay for them. When the market value of a bank's assets declines, it is said that the bank's capital position has weakened - and it doesn't matter whether this weakening is only temporary due to a crisis.

The idea of marking-to-market during times of crisis means that the bank may not be able to get back the money it has loaned if it has to immediately sell off its assets, even though over time it may still be able to recover all of its money by either waiting for the loans to pay off, selling the loans, or selling the collateral. In truth, there may be no reason to sell off these assets and therefore there is no real need for the bank to worry that it won't get its money back. As soon as the crisis is over, the assets may return to their previous value and all will be well.

When Fed Chair Bernanke and Treasury Secretary Paulson marched into a meeting with top Government officials and told them unspeakable tales of financial collapse and ensuing misery, what prompted this action was the market-wide realization that if banks and certain other institutions were to mark their assets to market, their capital positions would look extremely weak and their creditworthiness would be greatly diminished. In other words, their normal borrowing activities became impossible because they were forced to value long-term hold assets at current market value.

Since the FASB eased the mark-to-market standard to allow financial institutions to mark long-term hold assets to a valuation model that more accurately reflects their true value over time, it has suddenly resulted in an improvement in the capital positions of most of the major financial institutions. This should help to ease the credit crisis and allow funds to return to a more normal flow between financial institutions and, eventually, should result in their ability to work out some of their problem loans rather than write them off immediately.

So easing mark-to-market restrictions has helped ease the current financial crunch, but the reason the mark-to-market provision was created in the first place was the tendency of banks and other financial institutions to assign totally unrealistic values to their non-performing assets in order to keep the dismal condition of their capital position secret. That is why, amid all the optimistic talk today, you are also hearing from people who are proclaiming that changing the mark-to-market rules will allow the financial institutions to misrepresent the soundness of their financial health.

Management Failure on Wall St

2009-03-31T16:55:00Z

As we find out more about the AIG situation, the more amazing it seems to be. However, having been a 'Master of the Universe' for over twenty years, I must say I am not surprised. There is a thoughtless quality to much of what Wall St has become. It wasn't always that way.

It amazes me that Edward Liddy allowed his people to be thrown under the bus when he so easily could have stepped forward and explained that the people getting paid were people brought in to unwind the Credit Default Swap mess. It is also amazing to me that he didn't have enough sense to make sure their compensation wasn't called a 'bonus'.

Something happened on Wall St during the 1980s. Where once there had been a patrician prudence to the character of Wall St, in its place there grew a greedy arrogance that completely eclipsed the best interests of the clients and the all-important foundation of trust that enabled billions of dollars to be traded on word of honor alone.

The entire AIG mess was caused by weak management that didn't stand up to rogue employees because they were making a lot of money for the firm. The same thing happened at Drexel Burnham Lambert when Fred Joseph didn't have the guts to fire Michael Milken.

I loved working on Wall St. There is no place like it that I have ever been because so many of the people you work with are extremely bright. Unfortunately, it is a standard complaint that the top managers are often not the brightest bulbs in the chandelier. This is because the geniuses are all doing the deals and don't want to be bogged down with dull management duties.

It used to be that the Partners or the Boards would demand prudent adherence to certain conservative leverage ratios, but as the products became more exotic it was more difficult for many of them to decipher the risk involved, so they sometimes held their questions for fear of looking stupid. I remember one particularly brilliant mathematician who set out to devise a way to hedge Corporate Bonds. He came up with all kinds of formulas and charts and assured everyone it would work. Those of us in the trenches knew it would never work, but he had the department managers snowed. Fortunately, a few of us sat him down and pointed out why his idea wouldn't work before the firm dropped a $billion into the scheme!

Wall St really needs to be cleaned out. Much of it is currently like having a bunch of teenagers running a munitions factory - it needs adult supervision again.

AIG, Bonuses, and Stupid Decisions

2009-03-18T16:59:00Z

It used to be that 'bonuses' were given out of company profits. If the company didn't make money, no bonuses were paid

Even when your department was profitable, if the company lost money you did not receive a bonus. Your department's profits went toward keeping the company afloat by filling the gap between revenues and expenses. This was a good practice that produced strong companies that did reliable business because it created an internal culture of cooperation for total enterprise excellence. If your department was profitable but one of the other departments was losing money, it was in your best interest to try to do whatever you could to help that department get its act together.

At some point during the 1980s companies started to assign profit/loss accounting to individual departments and, sometimes, to individual producers. This created internal competition in the company between departments trying to out perform each other. This was thought to be a good thing but, in fact, it destroyed a lot of very profitable business.

An example of the dark side of internal competition: One evening a client and I were eating sushi at Hatsuhana in New York. He complained that because his fund's investment indenture limited his investments to U.S. Government guaranteed or fully collateralized investments, his short maturity fund could only invest in Treasury Bills and 2-year Treasury Notes while his competitors at other investment advisors were buying high quality commercial paper and making at least 25 basis points more in yield. We applied our brilliant minds to this problem and decided that auto loans and credit card receivables would be great collateral for what we called Collateralized Commercial Paper. So the next day I went back to my firm, a top-tier institutional broker/dealer, and proposed we create a new product: Collateralized Commercial Paper. The Corporate Finance Department informed me that they wouldn't be interested in working on the project because they would be doing the legal structuring work of creating the product and selling the idea to companies that might want to issue this Collateralized Commercial Paper, but the Commercial Paper Desk would get credited with all the profits. They knew it would be extremely profitable for the company but they didn't care because it wouldn't benefit their particular department. I reported the unfortunate news to my client who took our idea to Merrill Lynch. A couple of months later Merrill issued $8-Billion in Asset Backed Commercial Paper which was hailed as a brilliant and phenomenally profitable new financial product.

This is how we end up with outrageous situations such as paying huge bonuses to departments that created such enormous losses that they threatened the entire World financial system, as we see with AIG.

Whose great idea was this 'individual department P&L' system? Not only that, but whose idea was 'retention bonuses' that allowed the recipients to collect their money and leave the company? Does this idiocy fall on the shoulders of Human Resources? As a former executive in big-time business, I often found HR policies to be naive, ill informed, and arrogantly self-protective. Somebody in the company must accept the responsibility for negotiating faulty contracts that benefitted only the employees who grabbed the money and ran. While Barney Frank grills the top executives of AIG, perhaps he should be looking at the HR Department and its legal staff for the answer to why this happened. I have worked with these 'best-of-the-best' executives and I know them to be often over rated. What usually differentiates them is their attornies' negotiating abilities.

It is vital that we return our business culture to reality. What has happened is not complex at all. It is merely a situation where fast talking negotiators created an unrealistic imperative that foolish folk bought without fully understanding how unrealistic it truly was.

Why the SEC Didn't Catch Bernie Madoff

2009-03-17T18:26:00Z

I have been peripherally involved with the SEC Special Advisory Committee on Smaller Public Companies. The reason I got involved is because I became outraged while watching my SME clients struggle with SOX compliance requirements appropriate for a Fortune 500 company. Of course, the outcome remains less than what was hoped.

The SEC is made up of recent law school graduates and accountants. These people do not understand the workings or the culture of Wall St. and are too often impressed by the marble floors and fine art, which we all know have nothing to do with the quality of the firm. How many times in the past have we seen representatives of the SEC become bamboozled by the likes of Ivan Boesky, Michael Milken, and now, Bernie Madoff? They are also bamboozled by complex financial products that any experienced denizen of Wall St can tell you won’t work.

On the other hand, they torture entrepreneurs who are struggling to build a business and create value for their shareholders.

There is clearly a need to split the SEC into specialized groups with experienced people directing the efforts. There needs to be a separate group of investigators who know enough to pull out a copy of the Wall St Journal to check to see if the prices Bernie Madoff claimed on his transaction tickets were actually the prices traded that day. There needs to be a separate group of investigators who understand that when everyone is hedging, hedges don’t work. There needs to be a separate group of investigators who understand that while Enron can set up thousands of distant subsidiaries in which to hide their secrets, a struggling entrepreneur can barely maintain a 3-room headquarters office.

Some common sense and experience must be applied.

The people who operate the SEC do not love our financial system. Being small people, they love sitting in big chairs. I love our financial system. I love the memory of watching two equity block traders getting all mushy and misty eyed at Harry’s, talking about how wonderful it is to be able to trade hundreds of millions of dollars on one’s word of honor alone. I love the memory of sitting at my place on the trading desk, hardly daring to breathe while watching the door to the corner office where important leaders from the top Wall St firms were meeting to figure out what to do to avoid a global crash in the wake of a major bank failure. I love the memory of helping my clients immunize their pension fund portfolios. I love the memory of everyone working together to create excellence. There is much to be said about the sterling high minded qualities of Wall St, but there is also much to be said about the crooks. Those of us who love our financial system have always been able to spot most of the crooks. Unfortunately, those who hate our financial system miss the crooks every time because they are too busy trying to figure out why people on Wall St will work 12 to 18 hours a day under high pressure conditions and extremely high goals. They can’t understand why people will do this, because they don’t understand what it really is to love what you do.

Like so many shallow and inexperienced people, they are infatuated with the sex and distrust the love.

How to Negotiate With a Venture Investor

2009-03-13T19:19:00Z

I have recently been arguing with an entrepreneur about how to approach the subject of company valuation when talking with a potential investor.

My suggestion is always to let the investor put forward a valuation and you can then begin your negotiations.

The best way to learn how to negotiate effectively is to try to sell a diamond in the Diamond District. As all good diamond merchants know, the person who quotes a price first, loses.

The way you start the negotiations is the most important part of the whole experience! If you want to make a big mistake you go into a store, plunk down your diamond, and say you want $15,000. The merchant will either say yes or no, but you really don't know what axe he has in the deal, and because of this, you don't know if $15,000 is too expensive or too cheap a price. You have spent your time and energy, revealed your deal, and made either a good or bad impression on someone you might be able to do future business with - and you have received nothing. Or, you have sold your diamond at possibly a very cheap price, and you will never know.

The smartest way to start this negotiation is to go into the store and nose around asking questions. Remember the TV show Colombo? He was a detective who solved the unsolvable crimes by wandering around asking questions and appearing naive. That is what you want to do because your most valuable tool is always knowledge. So you keep looking at diamonds and asking questions that will draw out information. Your goal is to [1] know whether the merchant is looking to buy any diamonds today and what kind [2] what price diamonds similar to yours are selling for, [3] what the market for diamonds is doing in general, [4] what problems the merchant has that you might be able to solve (in other words, will he give you a better price on your diamond if you buy some saphires), and [5] what style of business the merchant does and whether you like or trust him.

Armed with the above knowledge, you can either repeat the exercise at another gem shop or two, or you can pull out your diamond and say "What do you think this is worth?" and if he wants your diamond, he will tell you. Then you ask what he would pay for it.

The diamond merchant will do anything to avoid giving you a price because he wants to be able to buy your diamond for a low price. By this stage of the negotiations you have a little information that may or may not be correct, but at least you have some knowledge. So you can formulate a price that you believe to be too high, and when the merchant says "No!" and walks away, you know the price is too high. So you act naive and offer a lower price. If the merchant grabs your offer immediately you are probably selling at a low price. However, if you need to sell the diamond even a low price, as long as it meets your need, is okay. This goes back to the old win-win negotiation theories.

Applying this method to negotiating with an investor, you begin by asking for advice about your company. Most Angel Groups will put you through a 'boot camp' which serves to prepare your knowledge base in much the same way questioning the diamond merchant gave you knowledge of price and the merchant's interest in buying.

Even though the very most important part of the negotiation, in YOUR mind, is the amount of money you will get, the most important part to the investor is whether s/he will receive any return on this investment and whether it will end up being nothing but a big headache!

Put yourself in the shoes of your investor: If you are going to give someone $1-million+ you want to have some feeling that person is going to talk with you if they hit a brick wall. You want that person to be wise enough to be looking for the value-add investor. You don't want to give all that money to someone who is so stubborn and defensive that s/he will be difficult to work with and might spend the money incorrectly.

As an entrepreneur, your goals are much the same unless you are too inexperienced to appreciate an investor who adds value to your company beyond the investment amount. Money is not the only thing your company will need, after all.

So, when negotiating with your potential investor, proceed on a win-win basis and do not make any demands or set any firm price until you have acquired as much knowledge about the investor's interest as possible.

Start-Up and Small Business Predictions for 2009

2009-01-05T15:25:00Z

The Economy - Regardless of loud claims of another Great Depression on its way in 2009, that is unlikely to happen unless the US ceases to be regarded as a ‘safehaven’ for the World’s money. The domestic US economy should hold up because there are safety nets in terms of deposit insurance and social services that will help avoid some of the more drastic effects experienced during the Great Depression, and offshore investors will continue to invest in the US, financing the economic restructuring because of its safehaven reputation. Nevertheless, the US Economy will continue to decline until it begins to bottom in Summer or Fall of 2009. The recovery will be slow and may take until late 2010 or longer.

Outlook for Start-Ups – Global economic difficulties favor the flow of investment money to the US. VC money will continue to get more conservative, focusing on companies with revenue history. Wealthy individual investors will underweight hedge funds, the stock market and real estate, and will focus on local small business and start-ups as they did during the 1950s. Smaller Angel Groups will proliferate as a few wealthy friends join together to form investment partnerships. Green products and services, alternative energy, cost cutting technologies in healthcare and manufacturing, and basic businesses will receive their investment., People will favor investment in infrastructure over investment in a managed mutual fund. Investors will want to take a hands-on interest in their investments. They will want to watch ‘their’ bridge being built. They will also want their money to do broad social good so venture philanthropy will expand.

Unemployment – Although reported unemployment at the end of December 2008 is approximately 6.7% or 4.5-million people, many analysts argue that contract workers, consultants and freelancers who have been let go or are unable to find work, plus all those workers who have exceeded their unemployment benefits, bring the real number closer to 12%. In 2009, layoffs in retail, business and consumer services, commercial real estate, consumer durables manufacture and related industries, and State and Local Government will bring reported unemployment to approximately 8.5% with total unemployment, as defined above, ranging as high as 15% by some reports. Industries that will do well and provide employment opportunities are collection agencies, debt restructuring, liquidation services, legal services, green products and services including alternative energy, heavy infrastructure construction, and other similar industries

The Bling-Bomb - Look for luxury goods to lose their attractiveness as people attempt to sell their expensive cars and other belongings for spending money. Only the elite jewelry stores will remain in business while mall jewelers will go out of business. It will become unseemly to display lavish spending and people will be more value conscious in their purchases. While those with significant wealth will continue to buy luxury items, people of average wealth will no longer be a prime target market for upscale products. Similarly, entrepreneurs who display lavish spending habits will receive scrutiny from their investors.

Real Estate – The real estate cycle is historically one of the most reliable, with approximately 17 years cycle length. This would put the next peak in home prices in approximately 2022 and the bottom sometime after approximately 2011. In 2009 commercial real estate will suffer. Shopping malls and downtown areas will have significant numbers of vacant stores. Industrial parks and office buildings will experience similar vacancies and late in 2009 and early 2010 this will begin to benefit business start-ups with move-in promotions and low rents

Big Business – 2009 will mark the loss of some brand name companies similar to the experience of the early 1980s when we lost companies like Sperry, Remington, RCA, Smith-Corona because of the advent of personal computers. Companies seen as more in touch with the environment will rise in their places. New technology that favors increased efficiency in design, construction, maintenance, manufacture, management, and communication will replace older methods.

Small Business – 2009 will be a good year for small business because small business will be able to operate without the burden of legacy costs and layers of bureaucracy. Green products and services, efficient energy technologies, technology that promotes cost efficiencies in the rebuilding of our infrastructure, biotech companies that create cost efficient medical test and treatment products, and new communications products developed out of Web 2.0 will rise to replace old guard companies.

Retirement – History will show that the only generation able to take full advantage of the dream of retirement was the parents of the Baby Boomers. Only a portion of the Baby Boom will retire fully. Most will carry on with part time work and a large percentage will have their own businesses or will invest in local start-ups. Tech and business savvy Boomers will find themselves desired employees because their employers will not have to pay health and retirement benefits. 2009 will mark the beginning of this trend.

Employment Benefits – Another beginning trend will be the gradual disappearance of employer paid health and retirement benefits. Employees will choose continued employment over benefits. The US government will begin the creation of a very modern and highly efficient health system using new technologies currently in development.

North America – With the decline in the price of oil, significant problems have arisen for Mexico and, to some extent, Canada. It may become necessary for the creation of a North American trade currency in order to keep our neighbors economically stable. Whether this will obviate the $US, remains to be seen. With regard to the US economy, some types of manufacturing will return to the US and it will be kept cost competitive by the use of technology. Facilities will decline in price and State and Local Governments will be willing to offer excellent incentives to companies to do their manufacturing domestically.

Miscellaneous Possibilities :

Dollar Decline – If the $US declines against other currencies it will favor US manufacturing and export of goods and services.
Higher Energy Costs – If the price of oil rises it will favor US manufacturing, alternative energy development, new oil exploration, North American cooperative trade, technology, and biotechnology.
Gold Standard – If there is a return to the Gold Standard as a backing to the $US it will favor investment in the US, low or no inflation, gold mining, development of alternative energy, new digital and mechanical technologies, infrastructure, and biotech.

What Happened To The Recovery Billions?

2008-11-20T15:14:00Z

I understand how you would have compassion for those poor people who got talked into bad loans by mortgage brokers who were primarily interested in making as much commission as possible. It used to be that the real estate broker filtered out people who could not afford to buy certain homes and the mortgage broker filtered out people who could not afford to pay those mortgages. It used to be that a buyer needed to put a certain percentage down to buy a house. It used to be that if you could pay for a 30-year fixed-rate loan, you could get a 30-year fixed-rate loan.

Things have changed and some people definitely got suckered in.

The Recovery Billions were supposed to be used to buy distressed assets from the banks so the banks could continue lending without having to deal with the ‘distressed assets’. The government would then take over working with the homeowners to help them stay in their homes.

Unfortunately, many of the loans are not ‘assets’ anymore. Some are loans on houses that have been abandoned. Some are loans to people who don’t have a hope of paying even deeply discounted monthly payments. There is also the problem of the steep decline in the values of homes. There are homes for sale on my block that were sold for $600,000 a couple of years ago but have been on the market for months at $400,000 and have no hope of selling because they are only 800 sq ft cottages and should be worth no more than $250,000 if you take their value 5 years ago and apply even a very aggressive price appreciation factor. So, you have a lot of mortgages for $600,000 on houses only worth $300,000. This is a big problem. Why stick the taxpayers with that mess?

If the Recovery Billions are spent on buying these worthless assets, it is just money given to the banks that made these loans, and since the assets are worthless, we would never get that money paid back. If we ‘invest’ in banks, we give them the money to deal with those assets, and part of the deal is for them to pay back the American taxpayer. One of the reasons we are in this financial mess is our government’s willingness to put taxpayer money out to ‘friends’ with no requirement that the money be paid back. These programs always look good because they are couched in terms of ‘helping the poor people who are suffering’, but they really do no such thing.

If the Recovery Billions were spent on buying loans, it would have taken months and $millions to identify the loans to buy and run them through the bureaucratic process.

When we invest in the banks, we are actually strengthening their capital positions which have declined because they have been forced to write down the value of their loan portfolios. This allows them to retain their credit ratings and that allows them to borrow money without paying a premium for declining credit. It also allows them to tolerate the problem loans and work with the homeowners. In other words, it removes the urgency to write off the loans and get them off the books, which makes it possible for the banks to work with the borrowers.

Oil - Truth? Or consequences?

2008-10-27T16:46:00Z

As I write this, the price of oil is threatening to sink below $60/barrel. That has me thinking about what will happen to all the new drilling that has started in areas where it is only financially feasible to drill when oil is trading above $100/barrel. In fact, new exploration spending is expected to decline 15% over the next year according to Petroleum News.

What does this mean to the much aclaimed oil sands of Canada and our own oil shale deposits? What does this mean to the huge finds in the very deep water areas? Will these all be too expensive to develop? And what does this mean to "Drill, baby, drill"?

I am beginning to think we will see another Petroleum Industry shake-out that may not be as large as what devastated Texas in the 1980s, but will nevertheless result in unemployed workers, abandoned houses and bankrupt companies. We are told this is because demand is down and the speculators are driving the commodity prices down. I am skeptical. Something tells me to wait until after the Election to declare the Oil Price Crisis over. After all, it is in the Petroleum Industry's interest to support the election of John McCain, and it could easily be done by dumping a little supply on the markets just in time to drive gasoline prices back under $3/gallon for the Election.

Gas prices are there now. Does that mean people will start buying Hummers again? Will Hybrids all moulder on the lots at car dealerships? Will General Motors stay in business? Will the Alternative Energy Industry be quashed? I am not so sure General Motors should stay in business but I sincerely hope people are smart enough not to abandon alternative energy development. Personally, I am hoping those cute little high mileage cars build up on the lots and go on sale! I have my eye on a white Honda Fit, and would like to make a good deal.

Lower gas prices should mean lower prices on groceries, but I haven't seen lower prices at the supermarket and I haven't yet seen trucks making as many deliveries as they used to. Inside the store I don't see shoppers with full baskets, either. I also don't see anyone driving around to the yard sales here in town on the weekends. And while the unemployment numbers continue to climb, I kind of doubt that lower gasoline prices will usher in a new wave of prosperity.

If the stock market falls to about 7800 on the Dow Jones Industrial Average, the market will have declined the same percentage amount as it did in the Great Crash of 1929. That means there is a lot of blood on the streets in terms of lost savings and retirement funds. This time around people won't be losing their bank deposits, their company plan pensions, or the cash in their brokerage accounts. However, the losses are in their 401-K plans and personal investment accounts. Even the very wealthy are hurt. On 60-Minutes, T. Boone Pickens admitted to losing $2-Billion and rumor has it that Buffet is down multi-$Billions as well.

Folks are pretty much broke. Lower gas prices help, but times are still going to remain difficult and will probably get worse. What will weigh heavily in the future will be the disasters taking place in foreign countries that depend on the United States as a consumer of their products or services. Even Dubai is having a problem with money as oil prices decline and US and European companies close their expensive offices and resort to meetings via webinar and conference call. Even China and India are experiencing serious declines in their growth, and this might prove to be a much greater problem than one would expect because their huge populations have become used to higher wages and being able to afford to buy consumer goodies like computers, cell phones, and cars. Disappointing these people, who have histories of violent civil uprisings, may prove disasterous.

I don't have the answers but I suggest asking questions and thinking about what the answers might be. It is one way to prepare for what the future might hold. It is also one way smart people spot opportunities, and opportunities will be plentiful for those who are aware.

Whew! We are all still alive ...

2008-10-24T07:00:00Z

What happened to the total disaster that had been predicted only a few weeks ago? It was supposed to happen by now if we didn't do exactly as we were told. What happened? We are still alive. We are only nearing the greatest percentage drop in the Dow, from the high of a year ago, since 1929. We did exactly as we were told. We gave Hank and Ben everything they asked for and saved ourselves from total obliteration ... or did we?

The answer is that the disaster has been happening since the beginning of 2008 but Ben Bernanke and Hank Paulson only got worried about it when it began happening to their friends.

Everyone I know has had their credit lines cut and their interest rates quadrupled, and some have had their credit cards abruptly closed. The better the payment record, it seems, the more likely the interest rates would be raised. At the same time, the banks are busy throwing in all kinds of new charges and rules that result in even more new charges.

Nobody is sending me emails about refinancing my mortgage, anymore. Now the emails are about clearance sales. The alcohol and drug treatment programs are new in the spam filter. They seem to be outnumbering the Viagra ads, which is interesting from a sociological standpoint.

Alan Greenspan is shocked, SHOCKED to think that there just may be a tiny flaw in his reasoning. I only wish someone in Washington D.C. had come up with this realization a year ago when all the rest of us did. But these people all live in Penthouses many stories above all the rest of us way down here on ground level. The 'Penthouse People' only get worried when the mess is so deep and pervasive that it reaches their lofty lifestyles. And now that they are aware of the mess, they are worried that it might include them.

The birth of the neo-investment-bank

2008-09-26T15:20:00Z

As a former Steely-Eyed Bond Woman / Master of the Universe turned entrepreneur / start-up consultant, these hearings on the ‘Bailout Package’ are causing me an identity crisis!

My Master of the Universe identity keeps jumping up cheering “That’s our Hank!” It is quite clear that he is creating a super-institution to hire all his friends and most of the out-of-work investment bankers; a neo-investment-bank that has at last found the ultimate deep-pockets client: the US Government. Oh, it warmed my cold black heart as I listened to his promise to take $700-Billion, apply the secret sauce, and VOILA! Typical of Government workers, the Senators ruined it all by wanting to know exactly what VOILA would be in terms of results. That is their problem: no creative vision.

My entrepreneur identity, on the other hand, is mad as Hell and not going to take this anymore! I am outraged that, while I and my clients go without our pay in order to keep our companies afloat during these difficult economic times, there seems to be a lily-livered reluctance to ask the same sacrifice of the C-Level executives at the banks, brokers, insurance companies, hedge funds, and Fortune 500 corporations. These are the people who are benefitting from this Bailout Plan. These are the companies that depend on the credit markets. For months now there has been very little credit available to companies under $500-million in revenues, and nothing available to those of us who operate more modest enterprises. There also seems to be a fantasy-based thought that applying a little secret sauce will keep house prices from declining further. Where is the reality, here? If 5 years ago people needed interest-only loans in order to support the monthly payments on houses at prices back then, how can they possibly afford homes that are still at least 50% higher in price, now that everyone is broke and losing their jobs? Hank and Ben need to live on $50,000 a year, paying for their own commute costs, their own food costs, their own lifestyle costs. They just do not have a clue about what is going on at street level - and I do not mean Wall Street level.

Like deer in the headlights

2008-09-23T15:33:00Z

I would personally feel a lot more confident in the Treasury/Federal Reserve proposal for a way to avoid total breakdown in our financial system if Paulson, Bernanke, and Cox didn't squirm, blanch, stumble over their words, and in general look like teenagers caught drinking and smoking out behind the gym.

These are clearly men who are not used to being questioned. They are also men who are trying to apply their sophisticated understanding of our securities markets and financial system to a problem that was created by financial amateurs who, over the years, were mostly concerned with maintaining a political image for themselves.

It is easy and looks good for a Senate Banking Committee member to attack the greed of Wall Street as the cause of all our ills. Unfortunately, attacks made for the benefit of the Press, and forgotten later when it is time to enforce action, are as much a part of the cause of our current financial system crisis as any self-interested behavior found on Wall Street. I remember many unpleasant grillings of Alan Greenspan who took pride in answering in the most obfuscating language possible. This is just one example of how our governmental system of checks and balances has become perverted into a political public relations tool.

The problem started after 9/11 with President Bush telling people to go out and spend money. Then he encouraged Alan Greenspan to maintain historically easy credit for over 5 years which made it possible for people who were struggling due to the dot-bomb and 9/11 to buy a house for approximately as much as they were paying in rent, if they could come up with a downpayment.

So far, things seem benign enough. Sure, we didn't need to goose credit for so long but the easy credit made the average citizen feel wealthy. One could borrow money against the ever-rising value of one's house and spend it on wonderful things made in China and sold here for very inexpensive prices. Life felt good.

The really bad stuff starts with the real estate agents who pushed overpriced houses on underqualified buyers, and the mortgage brokers who fudged the facts on loan applications. All this is the root cause of our present economic disaster. Real estate agents and mortgage brokers are the quality control filter that is supposed to keep unqualified buyers from getting into the system and creating bad loans. By the time the loans reach Wall St they are just files of paperwork. Wall St depends on the real estate agents and mortgage brokers to perform their work in an honest and professional manner. Unfortunately, they lied and cheated in order to gain large commissions. If anyone destroyed the American Dream it was the greedy real estate agents and mortgage brokers.

It is so easy to point fingers at the Wall St brokers and big banks. Yes, they deserve part of the blame for riding the gravy train but the locomotive on that train was the local real estate conspiracy where the agent pushed buyers into overpriced houses, the appraiser went along with the scam, and the mortgage broker fudged the facts in order to write the loan - all driving ahead at full speed in persuit of the almighty commission. That was the locomotive on the gravy train and it was fueled by Alan Greenspan's easy money.

The DRAFT Rescue Plan - Translated

2008-09-20T18:38:00Z

Here it is, the DRAFT of the financial system rescue plan as proposed Friday, September 19th.

LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY TO PURCHASE MORTGAGE-RELATED ASSETS

Section 1. Short Title. This Act may be cited as ____________________.

Sec. 2. Purchases of Mortgage-Related Assets.
(a) Authority to Purchase.--The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States. [This is the most important statement in the document. Why? Well, all you need to do is take a look at the bottom of the page where it defines "the United States" as the States, territories and posessions of the United States and the District of Columbia. What is important about that little distinction is that it limits the relief to those funds inside our own borders and leaves out all the hedge funds and market manipulators that domicile themselves outside our borders in order to avoid taxes. ]
(b) Necessary Actions.--The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:
(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;
(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;
(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;
(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and
(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.

Sec. 3. Considerations. In exercising the authorities granted in this Act, the Secretary shall take into consideration means for--
(1) providing stability or preventing disruption to the financial markets or banking system; and
(2) protecting the taxpayer. [At last! I think this may be the first time I have ever seen such reference in any of these types of proposals.]

Sec. 4. Reports to Congress. Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.

Sec. 5. Rights; Management; Sale of Mortgage-Related Assets. [This section gives the Secretary of the Treasury the authority needed to step in and manage, buy and sell the assets as needed.]
(a) Exercise of Rights.--The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.
(b) Management of Mortgage-Related Assets.--The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.
(c) Sale of Mortgage-Related Assets.--The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.
(d) Application of Sunset to Mortgage-Related Assets.--The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Sec. 6. Maximum Amount of Authorized Purchases. The Secretary's authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time

Sec. 7. Funding. For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

Sec. 8. Review. Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency. [This appears to exempt the Secretary's decisions from interference by any legislative or court pressure aimed at protecting special interests.]

Sec. 9. Termination of Authority. The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.

Sec. 10. Increase in Statutory Limit on the Public Debt. Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.

Sec. 11. Credit Reform. The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.

Sec. 12. Definitions. For purposes of this section, the following definitions shall apply:
(1) Mortgage-Related Assets.--The term "mortgage-related assets" means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.
(2) Secretary.--The term "Secretary" means the Secretary of the Treasury.
(3) United States.--The term "United States" means the States, territories, and possessions of the United States and the District of Columbia.

Financial Disaster - How It Will Impact You

2008-09-16T03:05:00Z

Let's get things straight. What we have here is a credit crisis.

A credit crisis is caused by so much borrowing on credit that the borrowers find themselves unable to meet the payments on their borrowings and, as a result, the lenders stop lending and start doing anything they possibly can to recover the money they lent.

The lenders are mostly interested in recovering as much money as possible so they take aggressive steps to recover money from all their borrowers, not just the ones having trouble making payments. These aggressive steps are part of what creates the crisis because they involve increasing the interest rates on all loans, whether current or in default, and they involve stepping up collection practices that include additional fees and pressure on all borrowers. Assuming most people monitor their borrowing, keeping it within their ability to pay; when their interest rates are tripled and their credit limits are lowered so the lender can charge overlimit fees, some of these responsible borrowers will find themselves unable to pay the additional monthly payment amounts and will fall delinquent.

When borrowers with good credit ratings try to refinance their credit cards and other loans in order to lower the monthly payments or avoid some of the fees, sometimes they are unable to find a lender to accommodate them. When lenders stop lending and instead focus on collecting, you have a credit crisis.

The current credit crisis was not caused by sub-prime mortgages. It was caused by too much credit outstanding, which resulted in an increase in delinquent loans due to borrowers not being able to pay their monthly payments. Sub-prime real estate loans were only a part of the problem. They were merely the most newsworthy part because when borrowers are unable to pay their mortgage payments, they lose their homes and this is the kind of drama news reporters love to cover. However, consumer loans and business loans, including credit cards and auto loans and equipment loans and inventory financing and all other lending are all part of the problem, too.

If it were only a matter of borrowers paying back their lenders, this would be a simple slow down in the economy and the news stories would be limited. What makes this front page news is the fact that all these loans have been packaged into groups of similar loans like eggs get packaged into egg cartons, and sold to Wall Street investment bankers.

Banks and finance companies are in the business of lending money so borrowers can buy assets. Wall Street investment bankers are in the business of selling assets to their customers. Loans are considered assets because until the loan is paid off the asset it allowed the borrower to buy is, theoretically, the property of the lender. When you take out a car loan, until you pay it off the ownership of the car remains with the bank or finance company that made the loan. When Wall Street buys packages of loans they are actually buying packages of miscellaneous assets that all fall into a broad category such as house loans, car loans, inventory loans, etc. Wall Steet knows a certain percentage of these loans will not pay off so, going back to the example of eggs packaged in a carton, Wall Steet mixes all the loans together and makes omlets, hardboiled eggs, deviled eggs, egg salad, mortgage backed bonds, pass throughs, CMOs, CDOs, etc. in order to spread out the risk. So, Wall Street turns these packaged loans into securities and sells them, as assets, to investors. Because these securities are derived from a combination of basic loan assets, they are called derivatives.

Getting back to the eggs, again, when Wall Street makes omlets and egg salad it needs to add other ingredients to the basic eggs. Interest rates will fluctuate up and down over time, so in order to keep the value of the underlying package of loans stable, Wall Street will add hedges that protect against falling interest rates and other hedges that protect against rising interest rates. Depending on the underlying loans, they may also hedge against currency fluctuations or borrowers' failure to pay or other risks to the stability of the value of the packaged loans. These hedges are also called derivatives because they are derived from the combination of short and long positions in other basic assets such as Treasury Bonds and currency positions and contracts with other investors who promise to pay additional interest costs or insurance companies who promise to insure the delivery of inventory or the original borrowers' ability to pay.

Yes, this is a long explanation. It probably seems as though it is not speaking to the advertised point which is how the current financial disaster will impact you. Do not dispair! We are getting to the point:

(1) If you have borrowed money you should check to find out whether your lender may lower your credit limit, increase your interest rates, mark your underlying asset value to market, demand accelerated payment, or call in the loan. Even if you are current in all your payments, you must remember that as the crisis deepens, which is likely, you may find yourself faced with repayment requirements that you hadn't expected when you borrowed the money in the first place. This is what caused the sub-prime mortgage defaults. The borrowers had expected to be able to either sell their houses at higher prices or refinance their mortgages into 30-year fixed rate mortgages once their houses had risen 20% in value. These borrowers fell delinquent when they failed to sell their houses or refinance prior to the upward adjustment of their mortgage payments. In other words, they had failed to monitor the circumstances surrounding and affecting their borrowings.

(2) Your banks, insurance companies and investments, their banks or insurance companies or investments, and the banks and insurance companies and investments of your customers, creditors, lenders, landlords, neighbors, municipalities, employers, friends, and family may be on the brink of failure. You may own investments that depend on the performance of an insurance company that is in danger of going bankrupt, like AIG. You may have borrowings that will be called or altered in an unpleasant way because your lender has been liquidated or sold, as has happened with Countrywide Financial and IndyMac bank. You may find yourself out of business because one of your customers fails to pay or you may lose your job because your employer is cutting back or going out of business altogether. It is always better to ask questions of your banks, insurance companies and investment advisors than to live in ignorant bliss.

(3) It may be years before your business or your lifestyle returns to what you have come to regard as normal. Credit may or may not be available to you in the same amount at the same terms. In fact, your business model or revenue model may change. You may not be able to buy certain things you had grown to consider essential to your lifestyle or your business. Take a look at areas of your business and your lifestyle that could change as a result of this credit crisis.

It pays to be aware. Too many news stories focused on the drama of foreclosures and not enough news stories focused on the tightening credit conditions and how they impact all areas of the financial system. Many investors discovered that their investments were wiped out because they didn't consider the impact of mortgage defaults on the derivatives that their mutual fund managers or hedge fund managers had bought into their portfolios. Many businesses are surprised to find that they cannot finance their inventories or the shipments of goods that they are expecting are being delayed because some bank or insurance company has failed or the terms of the letter of credit on the imported goods have changed.

With any sort of luck, we may be fortunate and not experience any additional deterioration in the financial system either here in the United States or elsewhere in the World. All of the possibilities I warn of may never happen and we may never remember these difficult days. On the other hand, what we have experience during the month of September in 2008 may turn out to be the period that history will point to as the beginning of a great and enduring change in the World. That is why it is a good idea to know how the current financial crisis will impact you personally.

Lehman and the Invisible Miracle

2008-09-15T03:33:00Z

We are about to witness a miracle nobody will know is happening.

As Sunday night moves West toward Monday trading in Asia, it appears that the markets are perfectly healthy and even a bit optimistic. This is just not a logical reaction to the bankruptcy of one of America's leading 'top-tier' investment banks. Lehman was an underwriter, managed huge institutional money, created derivatives, advised on and transacted huge corporate finance deals, and had its influence in every part of the wealth and power circles all over the World. The very idea that Lehman can go bankrupt without huge financial impact on every level of the financial system is just not logical - not logical at all.

In fact, the financial system will be in wild turmoil but it will be taking place beneath the surface - if all goes as planned. There will be very little if any hint of this wild termoil visible on the surface. Most of the World will never know anything at all is happening much less one of the momentous and potentially disruptive events of the last 80 years, and the reason for that innocent bliss is the frantic work and dealmaking that has been done over the weekend by the important people of the World financial system. All any observer would notice is the lines of black call-car sedans lined up in front of Lehman Brothers or the New York Federal Reserve Bank or its counterpart in Washington D.C.

There is nothing quite so impressive as sitting on a Bond Desk at a major investment banking house during a crisis. During the mid-1980s, a particularly active period of time during which there were several important crisis situations similar to what we are now experiencing in our financial markets, I happened to be working for a house where the Head of Trading was also the current President of one of the important industry associations - as I recall it was the Securities Industry Association (SIA). Very important trade association made up of very important people.

I remember several tense times during those days. Each time was the same: As we all sat there in the resounding quiet, the traders carefully avoiding picking up their phones even though their boards were lit up like Times Square, we kept a wary watch on the door to the big corner office. Important men had arrived by ones and twos and had disappeared into that office of the Head of Trading.

We could feel the power of the important men gathered in that room. It soaked right through the walls and made the trading room air heavy.

Eventually, the door opened, a billow of smoke came out into the trading room, and the important men all filed out quietly, but quickly. They had things to do.

Heck, the Plunge Protection Team has been operating since the very beginning of Wall St. It is nothing new and it is mighty impressive in action.

Suddenly trading desks all over the World begin to make the adjustments. Only the major players are involved. This one buys Treasuries from that one. The other guy does a series of repos. Someone else sells Treasuries. These positions are liquidated and others are bought. Everyone carefully carrying out the enormous adjustments being made to the World financial system, little by little in reaction to market movements wherever the markets were open. And it continues carefully, for hours and sometimes for days, as all the rest of us sit and watch. Not daring to take a breath.

Tomorrow will be interesting. If you watch closely you may get an idea of an undercurrent of tension. Hopefully you don't see anything more than that. Anything more evident will not be good news because if the careful trading gets out of control, we will have a big problem that will cause serious harm to nearly everyone involved in the financial system.

Full Faith and Credit

2008-09-14T18:20:00Z

I received yet another question from a business friend who is clearly smart enough to be thinking about the unthinkable.

The question went something like this: "How do I protect my money if I have several hundred thousand dollars in weekly cash flow requirements such as bill paying and payroll? These amounts exceed the FDIC deposit insurance but keeping my money in ten different banks is a serious problem for me from a logistical standpoint."

This is a particularly good question when one looks at the 'Lehman Experience' which was clearly a disappointment to all those Lehmanites who expected that their company, like Bear Sterns, would be bailed out by the Feds. Well, it wasn't. The Feds just cannot create enough money to bail out every firm that goes kablooey.

Some people are looking at the recent takeover of FNMA and FHLMC as an indication that the US Government stands ready to apply its 'Full Faith and Credit' guarantee to its Agencies, which had previously only been able to rely on a 'Moral Obligation' guarantee. However, if the Lehman Experience is any indication of the future, we may indeed have some problems ahead.

The BIG question is: Does the Full Faith and Credit guarantee apply to the account insurance agencies such as FDIC (www.FDIC.gov) and SIPC?

I was curious enough about this to check out the FDIC website, and found this:

http://www.fdic.gov/regulations/laws/rules/4000-2660.html

Full Faith and Credit of U.S. Government Behind the FDIC Deposit Insurance Fund FDIC-87-36 November 9, 1987 Alan J. Kaplan, Counsel

Your October 7, 1987 letter asks whether the full faith and credit of the United States Government stands behind the Federal Deposit Insurance Corporation and its deposit insurance fund. You noted that in my earlier letter to you, dated August 26, 1985, I stated that a joint resolution of Congress (H.R. Con. Res. 290) adopted in March 1982, which reaffirmed that the United States pledges its full faith and credit behind the federal deposit insurance funds, may have served as a moral pledge on the part of Congress to support the deposit insurance funds should they ever need it, but, because of its status as a non-binding resolution, did not serve to create any legal liability on the part of the United States Government to support the funds. You now ask whether Congress has passed a statute that makes the United States Government legally liable for any and all obligations of the FDIC.

Title IX of the Competitive Equality Banking Act of 1987 ("CEBA"), signed into law by President Reagan on August 10, 1987, provides:

TITLE IX–FULL FAITH AND CREDIT OF
FEDERALLY INSURED DEPOSITORY INSTITUTIONS

SEC. 901. REAFFIRMATION OF SECURITY OF FUNDS DEPOSITED
IN FEDERALLY INSURED DEPOSITORY INSTITUTIONS.
(a) FINDINGS.--The Congress finds and declares that--
(1) since the 1930's, the American people have relied upon Federal Deposit insurance to ensure the safety and security of their funds in federally insured depository institutions; and
(2) the safety security [sic] of such funds is an essential element of the American financial system.
(b) SENSE OF CONGRESS.--In view of the findings and declarations contained in subsection (a), it is the sense of the Congress that it should reaffirm that deposits up to the statutorily prescribed amount in federally insured depository institutions are backed by the full faith and credit of the United States. {{4-28-89 p.4278}} While any final conclusion on this matter rests with the Attorney General of the United States and ultimately with the courts, it is our opinion that Title IX of CEBA merely represents an expression of the intent of Congress to support the FDIC's deposit insurance fund should the need arise. Title IX does not change any existing underlying law. It does not amend the Federal Deposit Insurance Act, nor does it or any other provision of CEBA alter the method by which the FDIC is funded. The FDIC continues to receive no government appropriations, and its funding continues to consist entirely of its income obtained from insurance assessments and from the return on investments made in government securities. In addition, the FDIC's statutory authority to borrow up to $3.0 billion from the Treasury remains unchanged.

Regarding SIPC, here in their own words is the answer:

"Though created by the Securities Investor Protection Act (15 U.S.C. §78aaa et seq., as amended), SIPC is neither a government agency nor a regulatory authority. It is a nonprofit, membership corporation, funded by its member securities broker-dealers."
http://www.sipc.org/who/statute.cfm

The Power of One

2008-09-08T14:47:00Z

This weekend I ran into a delightful person who I had not seen in a few years. After the usual 'how-are-you' exchange she mentioned that she had been reading my blog. For a moment I was tempted to look behind me to see who she was talking to, but she was definitely talking to me. So, I want to take this moment to announce that AT LEAST ONE PERSON is reading this blog! No wonder the New York Times is having difficulties ...

I ran into my audience (please forgive me while I enjoy my fame) while attending a meeting of shareholders. It was one of those events every investor hopes to avoid because it marked the announcement of a turn-around attempt by a group made up of one of the Founders, a member of Senior Management, and several shareholders. Also involved were a few hundred worried shareholders who also were about to become actively involved in the turn around, in one way or another.

Here were all of these people about to spring into action to save this company that had become insolvent mostly through the actions of one person.

I find that whenever a company gets into trouble it is usually because one person refuses to listen to the concerns being voiced by a multitude of company managers, vendors, advisors, shareholders, and etc. It is always difficult to understand why certain people will stubbornly resist the advice and demonstrated concern of others who are sincerely trying to help. Sometimes these stubborn individualists even take on a Pied Piper quality, leading (or rather MIS-leading) a group of enthusiastic supporters along a path of action that is so clearly marked with disaster signs that, when one looks back on the experience, one wonders why nobody in the support group foresaw the brick wall at the end.

It seems that each time things get difficult for a company we go through a series of blame games in which everyone looks surprised and points at the CEO or Chairman or CFO. I had always thought it was just a way people tried to excuse their own complicity, but now that I am involved in turning around such companies I can assure you that often the fault often does lie with the unilateral decisions of one person who, because of some personality quirk involving pride, fear, or hope, has steadfastly presented a benign picture to all involved until, one day, everything starts to crumble.

The sad thing is that in almost every case one will find that a small solution would have set up a trend toward success. Unfortunately, as the 'decider' continues to obscure the real truth and continues to make unilateral decisions, the small problem gets larger and larger and eventually results in failure.

Another sad thing is that it seems almost impossible to keep these stubborn individualists from making unilateral decisions. They are very adept at signing contracts over the weekend and then letting everyone know after the recision period has expired. They quietly carry on negotiations by themselves, and when the news breaks, nobody else in the company knows enough about the facts of the deal to make any objections.

What are some of the signs that somebody is leading the company astray? And what can one do about it?

Secret financials. The first sign that should raise a red flag is when only one person in the company's management group can access the financial records. It seems obvious enough, but many companies are run this way, assuming that the person in charge of the finances is going to always make the best decisions. It is never pleasant to be told "no you cannot do that" but some people will go to great lengths to avoid a "no" answer. They are not necessarily skimming from the bank account or doing any other dishonest things. Often they are merely making bad decisions.

Autocratic management style. Nobody is smart enough to be always right. These stubborn individualists are not only intolerant of questioning or critical advice, they are also convinced that if they say something, it must be true. Again, this does not mean they are bad people. It can just mean that they are overly self confident. Often these people appear as benevolent caretakers, acting like parents rather than corporate officials.

Rosey reports. Every company has its bad times as well as its good times. When all that is revealed is the good news, it should be a sign that some things are being hidden from view. Again, these actions are often a result of the stubborn individualist's desire not to make anyone upset.

I hope a pattern is becoming evident. It is what created the old saying "The path to Hell is paved with good intentions." When someone in the company is openly unpleasant and evasive in daily business dealings, everyone in the management team maintains a close watch on the financial and legal affairs, catching any problems before they develop. However, perfectly nice, charming, well-meaning people are often the sources of disaster because everyone assumes they are acting in the best interests of the company. In fact, they usually firmly believe they are acting in the best interests of the company, so it is very difficult for the management team to comprehend the approaching disaster - it usually is presented in such optimistic terms.

It is easy for me to warn everyone to watch for these signs. In fact, you may be thinking of a certain company with a certain person who fits these signs. Unfortunately, that is where the easy part ends. How does one prove that disaster is on the way? How does one prove that this person is making unwise decisions without conferring with anyone else? The obvious solution is to demand more company meetings, but stubborn individualists are usually too busy to attend these meetings.

Solution to the Hostage Mentality

2008-09-04T17:42:00Z

First I was captured by the Olympics, and held hostage for ten days. I finally fought free and began to live my life again when along came the Democrats to chain me to my television for most of the next week. I had barely escaped when John McCain named Sarah Palin as his running mate, ensnaring me in Republican politics, Hurricane Gustav, and finally, the Republican Convention. I am making a break for it tonight after McCain's acceptance speech.

After all these weeks of captivity I find myself a bit uninspired. It is a little like trying to get back to work after a long vacation but it is more a lack of inspired creativity since I have been working all along.

When you are an entrepreneur you need to be on top of the creativity game all the time. You need to be constantly thinking of something new, in addition to doing whatever it is that you need to do every day to keep your business moving forward. Without coming up with new ideas on a regular basis you will find your business falling behind the competition and eventually falling out of business.

Creativity is the life blood of entrepreneurship, so successful entrepreneurs should develop sources of creative inspiration. I just found a really good source: Stanford University's eCorner(short for Entrepreneur's Corner). Check it out. It has videos of speeches from some of the top minds in business, economics and finance - videos you will not see anywhere else. It is a great way to spend a few minutes of coffee break and will invigorate your brain and get you out of the hostage mentality.

Why don't hedges work when everyone is hedging?

2008-08-15T16:27:00Z

WHEN EVERYONE IS HEDGING, HEDGES DON’T WORK.

That is a very important concept that few really grok.

Hedging is based on the simple idea that in any given market, some things go up in value and other things go down in value. For example: When our interest rates are high, other central banks and institutional funds want to own our bonds so in order to do that they have to buy our dollars first and use those dollars to buy our bonds. Because they are buying our dollars to use in buying our bonds, our dollar rises in value. It specifically rises in value against the currency that is being used to buy our dollars. So, if Japan is exchanging yen for dollars, the dollar will rise vs. the yen.

This brings up a situation where smart business school graduates on the trading desks think that when our interest rates go up our dollar will always go up and the yen will always go down. So they set their hedges accordingly. Higher interest rates mean our bonds are dropping in price. So when a fund buys a bond they put on a hedge against it dropping further in price. This means that they have a choice of two actions:

[1]buy something that will increase in value as the bond declines in value or

[2] sell something that will decrease in value as the bond decreases in value.

So, given that our interest rates are rising, the following must be true:

---Bond prices are declining

---Dollar is rising

---Yen is declining

In our simple hedge explanation, if one wants to protect one’s portfolio from declining bond prices while at the same time enjoying the higher interest income, one would either buy Dollars or short Yen. If it takes less output of cash to short Yen, then that is what is likely to happen. And this helps the hedges look like they are successful because when the Japanese sell their yen and buy dollars they set up the basic relationship between the currencies that states ‘when the dollar rises the yen falls’ and further shorting of yen by the hedgers causes even more pressure on the yen. More downward pressure on the yen means that the hedge makes money to offset the decline in bond price.

HOWEVER a crisis arises that throws doubt on the creditworthiness of our bonds. Bonds drop in value as people demand higher rates/lower prices. At the same time people who are spooked by the credit crisis in the USA start selling dollars and moving to the yen as a safe haven. This is very attractive because they can buy cheap yen. Now the yen starts to rise in value because people are buying yen and the dollar drops in value because people are selling dollars to buy yen.

You hedged your bond against a decline in price by selling yen. Now your bond is declining in price and your previously successful yen hedge has turned upside down and you are losing money on your short sale because the yen is rising in value! Your only choice is to buy yen to cover your shorts.

Everyone has bought bonds to get higher interest income, hedged by selling yen, and now they are madly trying to buy back yen to cover their shorts and the yen is going through the roof! Everyone hedged using the yen, and everyone is getting killed!

When everyone is hedging, everyone goes broke!

2008-08-12T15:12:00Z

It is now time to talk of derivatives.

What is the connection between our current credit crisis, hedge funds and derivatives? Well, to answer that question I must first tell you what a derivative is, actually.

Most people think they know what a derivative is, but when asked to explain it they go blank. No problem. Today we will build a derivative. Please note that the numbers and rates and percentages are all just for simple example purposes. Big computers figure out these things and there is no way we can explain derivatives in an understandable way if we go into the realms of exactness. [To the professionals who read this, please remember that very few people understand the complex concepts necessary to a real professional explanation. Our goal is to help them understand.]

There are lots of different kinds of derivatives. Some are created to hedge a big insurance company portfolio, some are created to hedge the borrowing costs a bank incurs on its Certificate of Deposit [CD] accounts, and some are just put together to provide certain types of investment income. We will build a simple hedge derivative.

First, we will start by quoting an old Wall St. maxim: Bonds and stocks move in opposite directions.

That is a bit misleading. What it means is when interest rates go up, stock prices go down. Armed with this knowledge, we are going to build a derivative to protect your huge stock portfolio. If we know the stock prices in your portfolio are going to decline on average about 8% we can figure that we should buy a Treasury Bond that yields 8% and we will do just fine. But where will we get the money? Oh, that's right, we can borrow against the value of our stock portfolio [margin].

Stock Portfolio worth $1-million

We borrow $500,000 on margin and buy $500,000 T-Bonds

So we do that, but we only have half the money needed. Hmmm And there is another problem: If interest rates are rising, the dollar price of the bonds are dropping and we aren’t doing this to lose more money. But we can fix that by shorting T-Bonds so when their dollar price goes down, we make money. The problem is that we are paying interest on all the borrowings and covering margin calls along the way, therefore we have to short MORE than $500K in T-Bonds so we short $1,000,000 T-Bonds. But our derivative is only covering about half the expected loss in the stock portfolio. So, we need to do something else to cover the rest of our expected loss.

Since we need more money to do this, we margin the T-Bonds at 80% of value

T-Bonds worth $500,000

We borrow $400,000 by margining the T-Bonds

Now we have $900,000 [$500K from the stock + $400K from the bonds] in borrowed funds all supported by the value of the stock portfolio, which will go down.

And we just sold short $1,000,000 in T-Bonds, which adds $1,000,000 in imaginary money to our cash [and $1-million of imaginary money to our monetary system].

Using this $400,000 plus the $1,000,000 from our short sale of T-Bonds, we buy $US currency futures because we know that when US interest rates go up, the $US rises in value so we expect to make some money off that rise in the value of the $US, but just to make sure we make enough to cover the loss we expect on our stock portfolio plus all the interest charges on our borrowings we also sell short the EU because the EU and the $US have an inverse relationship [but of course we must sell more EU to cover the costs of borrowing and margin calls]. In $US vs. EU trading, when one goes up, the other goes down ... most of the time.

$1-million in stock hedged with

$500,000 in T-Bonds, hedged with

$1,000,000 short in T-Bonds, plus

$1,400,000 in $US currency futures, hedged with

$3,000,000 short EU currency futures

From our original $1,000,000 in stock we now have approximately $6-million in imaginary money supporting it, of which we have an extra $3-million, laying around collecting interest from T-Bills, that we can use to pay margin calls and interest charges. Cool, huh?

Hedge funds are investment companies that hire a bunch of smart people who know how all of the above works, and have big computers to figure out all the relationships between bonds, stock, currencies, etc. Historical data on those relationships is stored in the big computers and is massaged by complex mathematical formulas that are designed to account for any number of things.

The thought process behind all these strategic models and mathematical formulas is the maxim: History repeats itself. Of course, many of the people who live by this maxim have been proven wrong, but this doesn't worry the hedge funds. They are secure in the knowledge that they are the ones who are proven right.

Hedge funds put together derivatives designed to make money by creating relationships like those described above - but the complexity of the basket of investments is MUCH LARGER and the imaginary money created is in the $billions or perhaps $trillions.

There is another old Wall St. maxim: When everyone is hedging, hedges don't work.

For some reason, few people pay attention to this maxim even through it is one of the truest of the true. That is where the BIG PROBLEM starts. When one of the many hedges in a derivative fail to work as planned, it sets off a chain reaction of altered relationships that can actually prove out to be more beneficial. However, the chain reaction can also result in a big disaster.

And that is what is worrying people these days.

The reason I am bringing this up is an interesting article on Urban Survival (Aug 12 edition) that talks about what is happening in the financial markets to cause the huge losses we see in the news about our biggest financial institutions. Although the explanation is, like mine above, a bit simple compared to the complexity of the situation, it gives one a good idea of what is happening. Specifically, there is no vast conspiracy. It is simply a small matter of the traders taking an inch here, and another inch there, and over time we find they have taken nearly all the inches and now everyone wonders why our markets are way out of balance. It is a lack of firm regulatory oversight that has caused the problems we now see.

The regulators looked the other way when real estate agents and mortgage brokers put people into homes and mortgages they couldn't afford.

The regulators looked the other way when the mortgage bankers packaged these loans and sold them into the financial markets and the regulators looked the other way when the securities backed by these loans were sold to investors.

And because the regulators were not doing their jobs, they are now standing up tall in outrage, calling for even stronger regulations instead of enforcing the regulations we how have.

Worried about your job? Recently laid off?

2008-08-08T16:06:00Z

My business always does well during difficult times in the economy because when people get laid off, or even when they are worried about the possibility, they decide to start that business they have been thinking about. Usually they have a severance package that includes enough to live on for a few months plus pay the expenses of planning the business and seeking funding in a 'Friends & Family' funding round

This year has been different. People are worried. People are getting laid off. I have never been so busy, with lots of people approaching me each month touting excellent business ideas. The difference has been that few people have any money to live on much less spend on my services.

To make matters worse, those who insist on going out for Venture Capital Fund financing are finding that the VC funds are not anxious to write checks.

Over the years, I have developed significant relationships with groups of wealthy investors who prefer to operate individually rather than in Angel Groups or via investments in Hedge/Venture Capital Funds.

These individual investors are snapping up some extremely promising investments that the big funds and private capital groups are missing because of their reluctance to place bets.

One thing that is definitely impacting the availability of money in the start-up area is the difficulties experienced by the Hedge Funds, many of which are tied to the VC Funds in some way. Many Hedge Funds depend on derivatives to create their high returns, and as a result, many of those Hedge Funds have lost a lot of money and clients. Some of them have restricted withdrawals.

I am having a lot of fun working with these independent individual investors! They are often the ideal investors because they bring a willingness to get involved in a good way with their companies. I have found that the 'investor organizations' such as the Angel Groups and VC Funds are not really very useful except for the money, which is often difficult to pry out of their tight fingers. Individual investors tend to be people who have experience or active interest in the industries where they invest and they usually have wonderful contacts that they enjoy bringing in to help.

Without a doubt, the most important thing that a start-up needs is help - advisors, experienced professionals who will work for fun/equity, contacts into the marketplace for rapid development of revenue streams and potential strategic partnerships.

I would encourage those thinking about starting a business in this environment to

[1] Think creatively - don't fall for the old Angel/VC route

[2] Find REAL professionals to work with. There are so many people who claim to be 'investment bankers' who have no experience. They don't even know that the correct term for what they claim to do is 'corporate finance'!

[3] Be teachable. Many of us who do this work for a living are not 100% sure what is going to work and what won't during these difficult times, but we sure know more than you probably do. (This is also one way to tell the professionals from the wannabes - the pros will tell you what I have just told you and the wannabes will tell you they can get you $30-million by next Tuesday].

Always remember: There is no such thing as "$30-million by next Tuesday".