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Category: markets

The Doomsday Machine and The Golden Rule

Published November 26, 2008 by cgerrish

Before the turn of the millenium, back when I was first joining an investment bank, I wanted to do some background reading. One of the must-reads was Michael Lewis’s Liar’s Poker. Of course, we were looking at disrupting the business. But in the over-heated world of the Internet IPO, no one wanted to disrupt anything– there was too much money at stake. Like all bubbles, that one eventually popped.

Our firm had a small part in popping that bubble with a piece of research we produced called “burn rate.” The first crop of Internet companies went public very early in their lifecycles. That meant they had to report their financials quarterly. At a certain point it was a simple matter of looking at cash versus run rate to determine how many months these firms had left. In Internet Bubble 2.0, initial public offerings were not possible, but the principle of burn rate remains the same. If a firm is not at, or close to being cash flow positive, they’re burning cash. This time the fires are behind closed doors, but their burning just as brightly.

Whack-a-mole

But the Internet Bubble is nothing compared to the Real Estate / Sub-Prime Bubble. While trying to get my hands around this Bubble and Collapse, I turned to Michael Lewis again. Lewis’s article, “The End,” in the December issue of Portfolio nails it. The Sub-Prime meltdown is difficult to understand. And when people talk about the “bailout,” it’s hard to understand what exactly needs to be bailed out. Treasury Secretary, Hank Paulson, has come under criticism because he’s perceived to be playing whack-a-mole with the crisis.

Bubblicious

Lewis takes a simple approach to explain the situation. He looks at the other side of the trade. Every trade requires a buyer and a seller. While the vast majority of the nation and Wall Street were buying in to the idea of ever rising real estate values, Steve Eisman, of FrontPoint Partners, was shorting the bubble. The article exposes the transubstantiation of BBB rated debt into AAA rated debt. As Eisman struggles to understand the trades he’s making, we start to understand the Doomsday Machine that Wall Street was constructing. For the bubble to keep expanding, it was important that the emperor was percieved as being fully clothed and regal. People like Peter Schiff were laughed at for trying to seriously address the problem. Risk is at the heart of investing, but in the real estate bubble, risk was grossly misrepresented. The label on the box said it contained wholesome ingredients, higher return with less risk. It was too good to be true, and it was. Bubblicious.

Lewis closes the loop by having lunch with John Gutfreund. Gutfreund was the CEO of Salomon Brothers while Lewis worked there. Liar’s Poker chronicles that time. They were the first i-Bank to go public, created the mortgage-backed security and their BSD’s from the bond arbitrage group went on to found Long Term Capital Management. Investment Banks follow the Golden Rule, he with the most gold makes the rules. Lewis posits that this is the end of investment banking as we know it.

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Track is Expensive

Published November 18, 2008 by cgerrish

Risk

Saying that “Track” is expensive is another way of saying that it’s risky. It’s saying you haven’t solved enough of the technology problem to proceed. Given the circumstances, the current price is too high for the projected revenue.

However, the absence of track isn’t a static problem. A moment will arrive when a player will take the plunge and dominate the market. They will have put enough of the pieces together to see how the story ends. The first one in will have access to the most information about what track means, how to implement it and how people use it. That means they’ll be able to optimize the service faster than followers in the space. As time passes, the price of the technical solution will go down, the revenue opportunities will go up and cash flow will move from investment to revenue.

The question is, at what point do you enter the game? Can you wait for a set of economics that are cash flow positive? Of course, by then, usually the game is over. Unless of course, there’s only one player in the game. Then the cost of waiting is zero. Riskless competition isn’t competition.

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Hambrecht Previews the Next 18 Months

Published September 17, 2008 by cgerrish

Om Malik interviewed my old boss Bill Hambrecht about the state of the economy and the future of the IPO in Silicon Valley. Watch the whole thing. Hambrecht has worked on transparency in the pricing of securities for many years. His ideas about using a modified dutch auction to price initial public offerings are still revolutionary.

Hambrecht’s explanation of the subprime mortgage crisis is one of the clearest I’ve heard. Mortgage backed securities are traded in a dealer-to-dealer market without transparent and continuous pricing. Stocks are priced through a continuous auction on the stock exchanges. When a company has to voluntarily mark down the value of these mortgage-backed securities, they hesitate. When they’re finally forced to mark an asset down, there’s a big jump down in value. That change in value wrecks the balance sheet. Interestingly, it’s not a business or revenue issue– it’s a price/value of assets problem. Hambrecht’s solution has always been to allow the market to discover the appropriate price and make the process transparent.

Hambrecht thinks the consolidation of the bulge bracket investment banks means that big iBanks will only be doing big deals. Their cost structures will dictate a move toward the mega deal. The ground is being prepared for a new crop of boutique investment banks to bring the new crop of small companies public. My favorite quote in the interview? “It’s like 1968 all over again.”

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Passing the Hat through the Network

Published August 31, 2008 by cgerrish

Passing the hat

I recently heard Doc Searls talk about his interest in developing a method to send money to musicians, radio progams and other forms of streaming entertainment. If you like something, you should be able to show it by putting your money where your mouth is. It’s a thought provoking idea that challenges the underlying fundamentals and economics of a well established industry.

Presumably some kind of name space would need to be developed for the recipients of payments– a URI that could be addressed from a distributed set of listening contexts. The basic idea is that the listener can set the terms of the transaction, in some ways it’s like the traditional tip jar or passing the hat. I’m not clear if the intention is to link to existing micro-payment systems or to develop new ones, but presumably there would be more than one transaction mechanism.

Much like Wikipedia and other social projects, the idea of creating a real economics for musicians based on voluntary payment has been met with skepticism. Kevin Kelly draws the boundaries of the economic system in his post 1,000 true fans. The gist of the contention is:

A creator, such as an artist, musician, photographer, craftsperson, performer, animator, designer, videomaker, or author – in other words, anyone producing works of art – needs to acquire only 1,000 True Fans to make a living.

A “true fan” is someone who will buy everything an artist produces. Obviously to yield 1,000 true fans an artist may need ten or twenty times as many regular fans. Kelly’s post attracted a number of responses, including one Kelly noted from Jaron Lanier:

Jaron claims that he has not found a single musician that meets this definition. In other words, he claims that there are no musicians who have risen to a successful livelihood within the new media environment. None. No musician who is succeeding solely on the generatives I outline in Better Than Free. No musician born digital, and making a living in the new media.

Kelly followed up with two posts: The Case Against 1,000 True Fans and The Reality of Depending on True Fans.

Doc Searl’s proposal would shift the responsibility of developing payment modes from the artist to a payment system. This is a key friction point for artists, they’re good at making music not managing micro-payment systems. But for me, another question emerges: if I like the song “While My Guitar Gently Weeps” what are my payment options?

  • The Beatles
  • George Harrison
  • Eric Clapton, for that guitar solo
  • George Martin, as producer
  • Prince, for that guitar solo (RRHOF version)

Who owns which part of a performance? Can they be addressed separately? What about multiple versions of the same tune? What about cover versions? Can a performance be addressed as a complex network? Can we make it easy to pull that one thread from the cloth? Is there a viable Buddhist Economics that can emerge from this confluence of efforts?

The framing of a performance contributes to its total value. This would be true of a performance encountered somewhere on a distributed Network as well. Virtuoso violinist Joshua Bell recently played unannounced in a subway station. That venue, as opposed to a concert hall, altered the audience’s perception of the value of his performance.

Joshua Bell made $32.17 as a busker. He commented:

“Actually,” Bell said with a laugh, “that’s not so bad, considering. That’s 40 bucks an hour. I could make an okay living doing this, and I wouldn’t have to pay an agent.”

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