Musings of an Entrepreneur

                                                 

It annoys me to no end that even as banks have massively diluted their shareholders to raise capital, they are still paying dividends. In the current environment they should focus all their efforts on capital preservation. They should completely eliminate their dividend. Besides, given the number of new shares they have issued, cutting the dividend per share by a certain percentage, does not decrease the cash outflow by that percentage.

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Vanity Fair has a fascinating article on Rupert Murdoch. Michael Wolff has been given unprecedented access to Murdoch for an upcoming biography. I was surprised by the picture that emerges of him as a man. He seems much less well thought through than I imagined.

Read the article at:
http://www.vanityfair.com/culture/features/2008/10/wolff200810?printable=true&currentPage=all

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It’s very rare for former heads of states to play a meaningful role in world affairs after their presidency. In fact, their employment option is often limited to tours on the speaker circuit. The Clinton Global Initiative is a welcome exception.

I had the privilege of attending the inauguration on September 15-17, 2005 and have been impressed with all they have accomplished since then. I also respect the work they have done with their Millennium Network to broaden their appeal beyond donors who can afford to pay $15,000 to attend their annual meeting.

I especially admire the launch of MyCommitment.org. The Clinton Global Initiatives has always been about making a commitment to better the world. In fact people who make commitment and do not honor it are not invited back. It’s a great idea to open up the concept to everyone and anyone and to publicly recognize the commitment and difference that individuals can make.

Many sites from Wikipedia to Yelp have recognized the potential of empowering their users and publicly recognizing their contribution. I am glad charities are opening up to it as well!

I look forward to impact of all those pledges in the years to come!

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Dear American:

I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude.

I am Ministry of the Treasury of the Republic of America. My country has had crisis that has caused the need for large transfer of funds of 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you.

I am working with Mr. Phil Gram, lobbyist for UBS, who will be my replacement as Ministry of the Treasury in January. As a Senator, you may know him as the leader of the American banking deregulation movement in the 1990s. This transactin is 100% safe.

This is a matter of great urgency. We need a blank check. We need the funds as quickly as possible. We cannot directly transfer these funds in the names of our close friends because we are constantly under surveillance. My family lawyer advised me that I should look for a reliable and trustworthy person who will act as a next of kin so the funds can be transferred.

Please reply with all of your bank account, IRA and college fund account numbers and those of your children and grandchildren to wallstreetbailout@treasury.gov so that we may transfer your commission for this transaction. After I receive that information, I will respond with detailed information about safeguards that will be used to protect the funds.

Yours Faithfully Minister of Treasury Paulson
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Seen at: http://www.boingboing.net/2008/09/22/hank-paulsons-bailou.html

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I am not usually a fan of his style, but in this case, his outburst was justified and eerily prescient!

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By Steven E

Worst financial crisis since the Great Depression? Yes—but don’t be cowed by talk of calamity. Disasters call for prudence and circumspection, not frenzied action. Congress, in particular, must carefully consider the downsides of any bailout plan before granting the Treasury department the unprecedented, unfettered, and certainly un-American power to nationalize private assets of dubious value with $700 billion of public money—a monumental sum that eclipses even the cost of the Iraq war. For congress, waiting a few weeks to legislate a solution does mean protracting the current crisis. But there is no reason to believe that the world economy would collapse in that time. On the other hand, it is reasonable to believe that implementing the proposed bailout plan may have long-term adverse effects on capitalism. The solution congress is about to legislate will foster corruption, increase market volatility, address the effects of a problem rather than its cause, and it sets a dangerous precedent. None of these shortcomings are being discussed by the press.

1. It will lead to corruption.
   Laws that govern securities trading are designed to prevent malfeasance and self-dealing. These regulations don’t apply to the Treasury department because the department was never intended to transact with the private sector. Having the Treasury department bid on private securities would be a mistake. The department has no checks and balances. We’ll see cronyism in the distribution of these funds. At the same time, there will be no provisions for judicial review, public contests, or appeals. The process will be secretive, undemocratic, and anticapitalist.
2. It will not resolve market volatility, and may increase it.
   The lack of transparency that is bound to accompany the infusion of $700 billion into the economy—more specifically, into firms that took down our economy—will rally some investors sometimes and disappoint others. The point is there will be more surprises, not fewer.
3. It addresses the effects of problems rather than their cause.
   This bailout addresses the effects of serious problems (declining house prices; defaulting mortgages; a drying credit market) but ignores the cause of those problems (regulatory missteps). An approach that offers the veneer of financial security without addressing the roots of instability amounts to a formula for disaster. A sudden flurry of liquidity in the credit markets can lead to a bout of foolish borrowing by distressed corporations. Financial institutions may repeat some of their earlier mistakes.
4. It sets a precedent. This begins with $700 billion, but who knows where it ends?

The entire country is faced with an economic catastrophe. Two men—Henry Paulson and Ben Bernanke—say the solution is to have every American lend $2000 to a secretive governmental agency. This is not our only option. We can think of others. Ask yourself this: Even if all the Bush administration’s hyperbole about financial mushroom clouds is true, even if that rhetoric weren’t suffused by the administration’s ignoble history, even if Henry Paulson and Ben Bernanke were the two most capable, trustworthy men on the planet (and yes, they are capable and trustworthy, but in a few months a new administration will take office and there may be a new treasury secretary), even if a solution were absolutely necessary to avert a full-scale depression—even if all that were the case, wouldn’t it still be preferable for congress to take time to evaluate other options? This solution may prove more dangerous than the problem.

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By Stacie Rabinowitz

So I mentioned to Fabrice that I had been explaining credit default swaps to a friend of mine without a finance background, and he asked me to be so kind as to explain it to those of you who are also a bit in the dark about what these things are. Mostly because he’s too lazy to do it himself :)

To put in the usual caveats: I took finance in business school, and I’ve run this by enough bankers who agree that I seem to know what I’m saying that I’m pretty confident I have my facts right, but I have never worked with them in real life and so would love any corrections from those of you actually in the industry. Also, I am going to try to explain why I think there should have been more red flags raised about them. Yes, I am sure they had a valid functional purpose for a small base of consumers, but I think that at this point we can all safely agree that they were overissued and overtraded and in my opinion there were some warning signs to this long before banks started going under.

So what exactly is a credit default swap? Mechanics aside, functionally it is like an insurance policy for a bond. You pay someone a small premium so that if the company that issued the bond goes under, you at least get some of your principal back from this second party. It’s kind of like if I lent Fabrice money, and even though he was paying me interest on it, I was worried that with his risk-loving lifestyle he might die before he could pay me back. So, if I took out a separate insurance policy on his life so that I got my principal back (or a portion of it) in the event of his death, that would be a credit default swap.

Problem #1: A credit default swap is not actually a swap. I’m sure that the mechanics of the transaction make it a swap, but functionally it’s really an insurance policy. You can tell because many banks were making a lot of money off of them, and theoretically swaps are supposed to be zero-cost: you swap the returns on two assets, but you are also swapping the risks, and therefore the compensation for them. A typical swap: Fabrice is a French citizen, I am a US citizen. I have a company I want to start distributing wines in France, but I need French citizenship to get government approval because they’re so particular about their wines. Fabrice wants to copy someone’s successful French company in the US, but he doesn’t get the best tax breaks because he’s not a citizen. So I start Fabrice’s company, he starts mine, and we agree to swap the returns. They’re equally risky ventures, so we don’t exchange any additional money. The fact that so many people were making money off of these credit default “swaps” should have alerted someone to the fact that they were not really paying off like swaps at all, and the fact that they were being called swaps anyway, hiding their true function, meant something fishy was going on.

Problem #2: Corporate bonds pay more than US Treasury Bills (the so-called “risk-free” asset). There is a decent probability that corporations will go under and not be able to pay back their debt, whereas there is a much smaller probability that the US government will. This difference is why corporate bonds pay more than US Treasuries – investors are being compensated for their risk. The more likely a company is to go under, the higher the payouts to the bondholder because of the higher the risk the investor is assuming. Now, if I’m paying someone money to insure my bond, I am trying to buy away that risk. The value of the insurance payment should be exactly equal to the difference between the payoff to the bond and the payoff to a Treasury Bill. If I wanted to be protected against my investment counterparty going under, I should have just bought a Treasury. To use the Fabrice example from above, if I was worried he was going to die before he was able to pay me back, I should have just not lent him the money. Expected payoff from Fabrice = Value of payment * (1-probability of his death). To make this equal to the amount I could have gotten investing my money in a Certificate of Deposit at a bank, I would have to charge him extra to compensate me. This extra would be exactly equal to the insurance cost, since the company would only sell me a policy for Value of payment * (probability of his death) in order to make money. So if investors are finding it more valuable to buy the bond + CDS instead of a simple Treasury, it means that something in the market is probably mispriced. And in finance, mispricing either gets cleared out really quickly or leads to big trouble.

Problem #3: The market for these devices has been reported to have been huge multiples of the value of the underlying assets. In other words, there is $1000 being floated around in investments that pay off in case Fabrice dies based on him not being able to pay back my loan, but the loan was only $50 to begin with!

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There is a great series of interviews on the topic of happiness on Ted.com.

Check them out at:
http://www.ted.com/index.php/themes/what_makes_us_happy.html

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Tropic Thunder is very funny!
Given my travels in the past month, I am falling a bit behind in my movie watching, but I just had the opportunity to watch Tropic Thunder down here in Buenos Aires and I very much enjoyed it. Robert Downey Junior’s performance is amazing and Tom Cruise is hilarious. I bet Tom Cruise would rekindle his career if he took on more roles like this one.

A comedy in this genre is extremely difficult to make the fine line between being ridiculous and funny, but they pull it off with brio. After watching the movie I felt elated and happy all day long!

Go watch it!

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It will never displace traditional news, but Twitter is excellent for confirming earthquakes and other disasters, natural and unnatural. Last week-end, you could confirm an earthquake took place in the Bay Area 10 seconds after it happened! This was well before anything go across the news wires.

Many other interesting and unexpected uses of social networks will emerge.

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