Financial Watergate
It’s taken 3 years for us to uncover the details of what should go down as one of the most disturbing periods of government action since Watergate.
In 2008, as the financial world stared at the precipice, our government acted as follows:
Hank Paulson – Secretary of the Treasury at the time, was providing hedge fund managers (many of them Goldman Sachs alumni $GS) with non-public information about how bad the crisis might become and how the Treasury would likely wipe out the common and preferred stocks of Fannie Mae and Freddie Mac.
The Federal Reserve – was secretly lending a total of $7.77 trillion to banks around the world with the vast majority going to the largest US Banks. These below market-rate loans provided the recipent banks with an estimated $13 billion in profits and again raise questions about how the Fed chose who would survive and who would fail during the crisis. The fact that the Federal Reserve and large banks fought against this disclosure for more than two years was likely a move to prevent this new information of exactly how bad off the banks were from being incorporated into the already passed Dodd-Frank reform bill.
Congress – Rep. Spencer Bachus, a ranking member of the House Financial Services Committe attended a highly secretive evening briefing with Ben Bernanke and Hank Paulson where they described how the global financial system was close to meltdown. The next morning he use options to establish a short position on the Nasdaq 100.
Any of these acts individually have to deeply shake the average citizen’s already low confidence in our government and the fairness of financial markets. Combined, they are a devastating blow that may significantly damage the value of the financial services industry for years to come.
Retail trading is especially vulnerable to a reduction in the public’s perception of the market. The charts of $SCHW, $AMTD and $ETFC look like no one is expecting the public to return in great numbers to the market any time soon. Given what they now know, who could blame them?
Debt – The Opiate of America
Debt is a drug. Not one of those “good” drugs they advertise on TV which promise to cure you of some horrible disease while only subjecting you to dizziness, nauseau and an upset stomach. No, debt is much more clever than that. Debt is a bonafide opiate – extremely addictive and able to manipulate our mind. It gives us the warm and fuzzy feeling that we’re saving money and ‘doing the right thing’ while we’re spending more than we could ever imagine. The withdrawl symptoms are brutal, like an opiate.
We want to avoid debt, we really do, but its peddlers are everywhere. When we go to college, we’re offered government guaranteed loans with deferred interest – our first hit. When we buy a car the first conversation is about ‘financing’. When we need a place to live we’re taught about ‘good debt’ and deducting mortage interest. By the time we look up, we’ve already spent the majority of our near term future income. We’re complete junkies.
We decide to get smart about money, cut back on the ‘foolish’ things that we feel guilty about – nice meals, vacations, massages, etc. With a little self restraint we’re now saving an extra few hundred $’s a month. Like a junkie who is using less often, we start to feel better about ourselves. We can beat this.
Then it happens, not immediately as even debt cannot penetrate our iron will when we first start something. It waits quietly in the corner, until just the right moment. When we have quietly begun to tire of our self-imposed austerity. We are tired of being ‘good’, frustrated that so much of our hard earned money goes to pay off so little of our outstanding balances. At this exact moment, when our guard is down just a little bit, it pounces.
Not in the way a lion pounces, this is much more subtle. It plants in our head the seed of an idea. The idea of a new car. We can’t stop thinking about it. How much happier would we be if we had the latest model? It looks so nice in the brochure. It’s practical too. It has more room for the family, has more airbags than our current car. It also comes with a new warranty and maintenance included. We’ll save money on repairs over the next few years.
Don’t we deserve it? We’ve been working so hard, we’ve been so good. Forgoing all those guilty pleasures for all these months. We definetly deserve a reward.
How much will it cost? That’s the best part. The dealership is running a low interest finance special and by going with a slightly longer term loan the cost is only $100 more per month than our current payment. $100 a month? For all of this? How can we say no? Afterall, we’re saving more than that by forgoing our guilty pleasures. Even after buying the car we’re still saving more than we were before we decided to ‘get smart’ about money. How very clever we are.
But we are wrong. We have been fooled again into spending tens of thousands of dollars over the next 5+ years in return for saving a few hundred dollars over a few months. And yet we think we have won.
And we are still addicted.
Thankful for the US Dollar
With the chaos that is raging around the Euro, I’m more grateful than ever that I was fortunate enough to be born in the US. Having lived my entire life in the US it’s easy to lose sight of how lucky we are to be in such a wealthy and stable nation.
While the 2008 credit crisis felt to us like an economic disaster, it was a mere blip compared to what happened to Iceland, Ireland and may soon occur in many of the other European nations. I can only imagine what choices will face many Europeans if the Euro dissolves.
Will their bank go under? If so, will the government bail it out?
If their bank account is denominated in Euros, will they be forced to convert to a local currency?
If they’re forced to convert, what will be the conversion rate?
How will their new currency compare to either what’s left of the Euro or other major trading partners (US, China, Germany, etc.)?
How much buying power will they lose?
If they work for a multinational company, what currency will they be paid in and what will their salary be going forward?
Will there be riots? Will their government fall?
What will happen to their private or public pensions?
What about their investments?
The permutations are endless and none of these questions are likely to have good answers anytime soon. Whiles its easy for us to look at the breakup from a distance and observe we shouldn’t lose sight of how many citizens living in “1st world countries” are looking at the very real possibility of a significant reduction in their financial well being.
Facebook’s most important product – YOU
With the exception of their short lived “Facebook deals” experiment, Facebook has never asked me for money. They don’t send me emails promising powerful new time saving features if I only upgrade to the “premium” version of their product. They never tell me how I can communicate with people all over the world for less than 50 cents a day. I don’t wake up one morning to discover that my version of Facebook has been replaced by a newer, shinier one with a car payment sized price tag. Instead, Facebook promises its users that “It’s free and always will be”.
Instead, Facebook spends its time and energy acting very much like a traditional media company by convincing corporations to send them large sums of money in return for displaying advertisements to their 750 million users. In essence, this part of Facebook’s business is not dissimilar from the traditional TV model of creating shows that create a large enough audience to attract sponsorships/advertisements. Except in Facebook’s case, they don’t actually have to “create” any of the content as their users do it all for them, for free. Not only do their users create the content for them, but the more they fill out their profile, the more valuable they make themselves to advertisers willing to pay a significant premium to target increasingly specific target audiences (i.e. high school football players in northern california).
As pressure begins to mount on Facebook to continue growing its business at a rate that will justify recent valuations and the eventual IPO, there are multiple paths it can take to increase advertising revenue. The first is to increase the amount of time you (and other Facebook users) spend on the site as total amount of time spent on Facebook is the amount of inventory Facebook has to sell. The second is to increase the value of their inventory by collecting more and more granular information about each user so they can be targeted more effectively. The third is to increase the total number of Facebook users – but this will become increasingly difficult as Facebook reaches saturation in its more mature markets.
The problem with this scenario is that its sets up an inherent conflict of interest between Facebook and you. New features that make your time spent on Facebook more efficient and reduce the total amount of time spent on Facebook may be a positive for you, but are a negative for Facebook the company as it reduces the amount of inventory they have to sell. Any feature that provides Facebook more information about what you like or what you are doing provides tremendous value to Facebook’s advertisers regardless of if you find it useful. New features such as timeline, sharing music/movies/books will provide tremendous opportunities for advertisers to target audiences who listen to certain bands, watch certain movies or have children of a certain age/sex/medical condition.
There is nothing wrong with this model, as by signing up for a free service that is paid for by advertising you as a user know that your information will be used for advertising purposes. But as the depth and breadth of what Facebook tracks continues to grow it is reasonable to looks at these new features and ask who they most benefit? You – their user? Or an advertiser, their customer?
Remember – you do not provide the majority of Facebook’s revenue. Facebook is not selling to you, Facebook is selling you.
Parlor Games – Taxes and spending matter less than we think
“In any dispute the intensity of feeling is inversely proportional to the value of the issues at stake.” - Wallace Stanley Sayre
Does increasing or lowering taxes impact the economy? What about government spending? If so, by how much? Listening to either party one would think there was clear evidence that supports their argument, but there isn’t. The only thing that is clear is historically the US economy has both prospered and floundered under every conceivable tax rate and government spending combination. We’ve seen great growth and deep recessions under tax cutting as well as tax raising regimes. Not something that most members of Congress will ever admit to.
As much as Presidents and Congresses like to believe they are able to significantly impact our economy, the bulk of the evidence points to the idea that they too are mostly just along for the roller coaster ride that is the economic cycle. For if governments were able to “stimulate growth” or “avoid recession” shouldn’t there be at least one example of a western country successfully taming the economic cycle in the past 200 years of modern nation states and economies? We’ve seen western governments controlled by capitalists, socialists, communists, dictators and everything in between. We’ve seen governments formed from coalitions that span a wide political spectrum and those directed by a single person. They’ve increased and reduced corporate taxes, individual taxes, tariffs, benefits and investments. None of them, not a single one, has shown any concrete proof of being able to consistently increase a countries immunity from the economic cycle.
Contrary to popular opinion, our political leaders on both sides are not idiots. Most of them are quite intelligent and are likely trying to do what they honestly feel is best for the country. The same inherent desire to come together in the face of dire enemies (9/11, Pearl Harbor, etc), leaves them free to argue so vehemently about domestic fiscal policy. If there was even a shred of concrete evidence that the outcome of the latest taxes vs spending debate would significantly impact job creation or growth, there would be no debate as the way forward would be clear.
Domestic fiscal debate is little more than a modern day parlor game in which the merits of inherently opinion driven policies are incessantly debated with increasing vigor precisely because of how little is at stake.
Investing IS Speculating
Watching this clip of Howard Lindzon from StockTwits and Joshua Brown of The Reformed Broker discussing momentum investing with Herb Greenberg brought an interesting exchange about what the differences are between investing, trading and speculation.
CNBC and the mainstream media continues to preach the folly that “investing” is good while “speculating” is bad. This is especially prevalent with Gold or other commodities which can never be consider a true “investment” since they don’t generate any earnings/yield, so owning them must be “speculation”.
The reality is there is NO difference between investing and speculating. In both cases the only objective is to make money over time. It doesn’t matter what you buy or for how long, if you are not right about your asset increasing in value you will not make money.
This is as true for High Frequency Traders scalping a fraction of a cent on a 500 shares of Citigroup in 300 milliseconds as a pension fund investing billions in the S&P 500 index over two decades. The real blindspot in CNBC and most investors view is that they believe buying something for the “right” reasons and for the “right” timeframe guarantees profits. To those people, I strongly suggest they review this chart prior to making any long term decisions.
How the LinkedIn IPO benefits everyone
It’s only 9:30am and I’ve already seen 10+ articles disparaging the LinkedIn IPO, primarily on the basis of valuation and the huge jump on the open. What these articles miss is that the primary purpose of an IPO is NOT to be beneficial or even fair to the investing public. Instead it is to maximize profits for three distinct groups.
1. Founders/Investors/Employees – This group owns all the shares prior to the IPO and the majority post-IPO. They benefit from both a higher “official” IPO price as well as any increases in the price once trading begins.
2. Underwriters – These are the investment banks that receive fees based on the price of the IPO. The higher the “official” price, the bigger their fee. They also have very strong incentives to make sure the stock doesn’t immediately fall below the IPO price.
3. Institutions – These are the underwriter’s largest clients and in return for all the money they spend with the underwriter, they receive larger allocations of the stock at the “official” IPO price. These institutions benefit from a higher trading price as they can “flip” their stock immediately on open for a nice profit.
Now the real question is where does all this money come from? The answer of course is that the majority is coming straight out of the accounts of the investing public. Every share of LinkedIn traded at the opening price of $83 provided the selling institution with an immediate 80%+ profit over the original price of $45. Over the next few quarters as more insiders are allowed to sell, even larger sums of money will be transferred from the same investing public to LinkedIn’s investors, founders and employees.
Despite the above description sounding somewhat sinister or even underhanded, the net result is incredibly positive. First and foremost, the largest amount of money will end up in the hands of VC’s, founders and employees of LinkedIn, a large % of which will undoubtedly be re-invested into the next round of Silicon Valley startups. Historically, every large tech IPO has led to numerous new companies founded by now independently wealthy employees, this is a very good thing. It also provides additional capital for the VC’s and their Limited Partners to invest in these and other companies. For the other employees it acts like a large bonus (that the company doesn’t have to pay). The spending of these bonuses will benefit numerous other entities – car dealerships, real estate agents, airlines, etc. – all good for economic activity. The profits to the institutions and underwriters are far more concentrated and maintain the machine that makes this entire process possible.
While at first glance it would appear that the losers in this situation are the investing public, it is very debatable if buying a hot IPO is worse than buying leveraged commodity ETFs or trying to daytrade weekly options. What is different in an IPO versus daily trading is not the amount lost by the trading public, but who the winners are. On most stocks the vast majority of retail money is captured by Wall Street and HFTs, on an IPO this money instead manages to find its way out of Wall Street and into the “real” economy where it has the opportunity to provide substantial positive economic benefit. This is a very, very good thing.
Is Facebook the next Yahoo?
Let me preface this post by saying that Yahoo was and is an incredible company. Last year it generated $6b+ in revenue and a billion in profits. However, Yahoo is no longer a growth company and its revenues are now declining. This has led it to have a current market capitilaztion of $22 billion, or less than 1/3rd of what Facebook shares are going for in the secondary markets.
Every day Facebook reminds me more and more of Yahoo, circa the late 90′s. For those who weren’t around, Yahoo was the dominant web brand. As it continued to add users to its ever growing list of popular services (my.yahoo, mail, instant messenger, groups), it’s valuation began to climb exponentially. After all, how could a company that a large percentage of every internet users visited their site every single day not be insanely valuable?
Ten years later, that question has been answered. Fundamentally, nothing with Yahoo has changed. They are still an extremely large site reaching hundreds of millions of users worldwide, every day. They still have a dominant position in the coveted finance arena and are one of the most recognized Internet brands in the world. However what they have never been able to do is convert that name recognition and number of users into vast sums of revenues and profits.
Facebook appears to be following a similar path. Rumors of Facebook’s 2011 projections put 2011 revenue at ~$5 billion and profits at ~$1 billion. Facebook appears to be generating very Yahoo like numbers off what is likely to be a similar or even larger number of users. The concern for investors at current valuation needs to be where does the additional revenue growth per user come from? To justify current valuations, Facebook will likely need to generate ~$15 billion in revenue, a 3x increase from 2011 projection. User growth alone can probably handle a few billion of this, but Facebook still needs to double their revenue per user to get to $15 billion. Something that will likely not be achievable with display advertising alone.
A further concern is that as more of Facebook’s growth shifts to the less developed world, the revenue generated by each incremental user will decline. Now I’m sure that Facebook has many plans for additional revenue per user, and initial ones such as Facebook Credits have already been rolled out. But Yahoo had many plans for incremental revenue as well and by all accounts display advertising still accounts for the vast majority of Facebook’s revenue.
As with Yahoo, even if Facebook follows the exact same path they are an incredibly valuable and successful company likely to generate billions of profits for their investors and many of their employees. It is only the most recent of investors that need to hope that Facebook is able to mimic Google in breaking out of display advertising prison, otherwise they may find themselves with the second incarnation of Yahoo.
Huffington Post Bloggers Want Rewards Without Risk
As someone who occasionally blogged on the Huffington Post, I am completely perplexed about why former bloggers are now suing for $105 million.
On one side is the Huffington Post, a for profit company, that based on their TechCrunch profile had raised at least $37 million in investment. In taking that money, the management of the Huffington Post assumed a fiduciary responsibility to generate as high of a return as possible for those investors. In the case of a media company like the Huffington Post, this meant expanding their platform/coverage to attract as many readers/advertisers as possible and then either sell the company or take it public.
On the other side are the bloggers, individuals who for probably various personal and professional motives, voluntarily elected to write blog posts on topics of their choosing, at their leisure and post them on the Huffington Post. These works were not commissioned and the bloggers could have just as easily posted them on their own personal blogs, facebook or one of the numerous other blog/news aggregation sites. Instead they elected to post at the Huffington Post which to my knowledge never implied either publicly or privately that bloggers would receive any type of compensation for their work nor would they have an equity stake in the company.
If a blogger felt the above deal was unfair they had two obvious options. They could contact the Huffington Post directly and negotiate compensation in return for their work or they could not post to the Huffington Post. While I do not know the details of each blogger in the lawsuit, it appears that the vast majority elected to do neither of these things yet still feel they are owed something.
Jonathan Tasini, the writer spearheading the lawsuit goes further by saying his true goals are larger - “This lawsuit is about establishing justice for the bloggers of the Huffington Post and establishing a standard going forward,” he says. “If we want to have a society that has a diverse, vibrant culture, we have to make sure the people that create the content, whether it be words, images, drawings, photographs – those people have to be compensated fairly.”
While I vehemently disagree that there is a need to establish “justice” for a group of individuals who voluntarily entered into an arrangement that does not appear to have been breached by the Huffington Post, his point about compensating creators has more resonance. What Tasini misses though, is that there is more to creating $278 million in value for investors than just creating content. There was an enormous amount of risk assumed and none of it by the bloggers.
Imagine that instead of being purchased by AOL, the Huffington Post had failed completely. For the bloggers who filed the lawsuit, the only difference between the two scenarios is that they would have no one to sue. Since they did not invest any money, there was nothing to lose. Since they were not employees, they did not forgo other income opportunities, have restrictions on what type of businesses they could engage in or even have a job to lose while posting for the Huffington Post. This is in sharp contrast to the actual investors and employees who did put at risk millions of dollars and have real opportunity costs of taking a job at the Huffington Post.
What is most confusing about Tasini’s position is how easy it currently is for bloggers to be compensated for the overall success of a company. They can either invest in one, become an employee of one or start their own as Arianna Huffington, Michael Arrington and Henry Blodget have done. Any of these three options virtually guarantee that they will get to participate in all possible outcomes, both positive and negative. No lawsuit required. But the bloggers should be warned that trying to create a valuable media property is not a task where you can “Blog as infrequently as you’d like, or as frequently as once or twice a week” to quote the Huffington Post’s Blogging Guidelines, Tips and FAQ.
John’s Postulate #16 – Why everyone argues about stuff that matters least
People’s willingness to share and discuss their opinions on an issue is inversely proportional to the importance of the issue.
Take note of how many times you encounter this in your interactions with other people tomorrow, especially in business environments.
A classic example of this is the weekly status meeting. A few years ago I was in one where we had two new items on the agenda to discuss – a new marketing newsletter and how to handle one of our largest clients who was demanding a refund and threatening legal action.
The first item up was the marketing newsletter. Within minutes, the conversation had grown into a full blown debate of the merits of putting the full content of the newsletter in the email versus with links to the web, whether to include images or not and a million other nuances. The VP of Sales was arguing vehemently for sending out a newsletter once a month while the Director of QA felt strongly that twice a month was ideal.
Next was the client legal issue, the CEO brought up his initial thoughts on the matter and then – nothing. Silence. No one had an opinion, no one disagreed, no one wanted to debate or even pontificate. Despite the fact that there was a substantial amount of revenue at stake, not to mention the potential damage to our reputation, no one wanted to even explore another option.
I believe the vast discrepancy between the level of interest in debating these topics all rests on a single tenant – “if my opinion is accepted, how much damage could it do if i am wrong?”
In the case of the marketing newsletter, assuming the company did not begin emailing daily videos of the CEO in a Nazi uniform talking about his love for Adolf Hitler, the final decision was extremely unlikely to have a material impact on the company’s business or the company’s perception of the individual person whose suggestion was accepted. Even if every two weeks is the ideal timeframe for a newsletter, no one is going to think less of the VP of Sales for settling on once a month, after all – he’s paid to sell not to do marketing.
Contrast this with the touchy client situation where if the VP of Sales takes a hard line and says “they paid us that money, let them try to sue us” and it backfires. It will have a negative impact on both the company and the VP of Sales as he is supposed to know the clients better than anyone. Whereas simply agreeing with the initial suggestion of the CEO, regardless of personal opinion guarantees that no matter what happens, it’s no one but the CEO’s fault so there is no personal risk.
So the next time you find yourself in a room full of arguing coworkers, take a step back and evaluate what they’re actually arguing about because odds are if everyone is interested in debating, the issue at hand is far from critical.
