Author Archives: Dave

About Dave

A student of the markets and life. Seeking to predict the future and failing often enough.

What Is A ‘Bank’? Amex Is Now.

I just saw this article, and I realized that like many of our ordinary conceptions, the idea of a ‘bank’ has morphed significantly over the last few months:

American Express to Become Bank Holding Company

The Fed’s approval for American Express was similar to the decision it made in September to transform the country’s two biggest investment banks, Goldman Sachs and Morgan Stanley, into bank holding companies.

That move bolstered the two institutions after the collapse of another investment bank, Lehman Brothers, which became the largest bankruptcy filing in history. Goldman Sachs and Morgan Stanley gained the ability to borrow federal money and build a stable base of deposits in hopes of reassuring investors and other banks.

As I have mentioned, I am now unfortunately bearish in the short-term as the dislocations in the credit markets continue to wreak havoc on securities prices, in addition to the fact that the economic slowdown is only just beginning.

One stat that really jumped out at me during my meetings in NYC a little over a week ago was that 65-80% of all corporate borrowing over the last few years came from non-bank entities.

Granted, many of these entities were SIV’s which had the implicit backing of big banks like Citi; however, a good deal of this issuance came from CDO’s, CLO’s and other non-bank entities, which are no longer able to lever-up to buy the assets they have been gobbling over the last few years.

Unlike Amex, Goldman, and Morgan Stanley, these hundreds or thousands of entities will not be saved by the Fed, and as long as they continue to contract to deal with stiffer margin requirements and/or investor liquidations, the selling pressure in the credit markets should continue.

The list of government interventions over the last few months has been too staggering to keep up with, but most smart people I know expect it will continue.

I continue to be a long-term optimist. But don’t be surprised if we have more bad days in the markets between now and then.

Looking back years from now concepts like ‘banks’, ‘hedge funds’, and many others will likely look very different than they did only a few months ago. Thankfully, our language is flexible enough to support these changes, and hopefully our decision-making will keep pace (On Language and Decision Making).

Jim Rogers On The Markets

I’ve been meeting with some very smart investors lately, but few sound as clear-headed and direct as Jim Rogers.

Here is a video on his views on where we are headed:
1) More downside
2) Inflation in the long-term
3) Bullishness on commodities

It is worth a watch:

On Uncertainty And Creativity

Perhaps this will now sound redundant, I will repeat: binary thinking is dangerous and more importantly it is inaccurate.

What I mean by this is not ground-breaking, although lots of wicked-smart dudes like Godel and Sartre have pointed it out in revolutionary sounding ways.

Perhaps best conceptualized in the garb of quantum-mechanics, my point is simply we can’t quite put our finger on the “truth” in any important sense. We can’t know everything about where an atom is if we know its speed, we can’t know what our politics “should be”, and we surely don’t know where our stock market will go tomorrow.

The best we can know is some probable outcome. We can make good guesses and act accordingly.

Where we get in trouble is when we think we are better than that.

It is the overconfidence that statistics gives us about an improbable world that is potentially damaging.

“Knowing” something to a “confidence-level” of 95th percent is surely helpful, but as the statistics-obsessed pollsters showed us in this election, even when the questions are binary and we work really hard at answering them, predicting the “truth” of the matter is hard.

The cool thing is that such uncertainty creates the space not only for mistakes, but it also, importantly, creates the space for innovation, creativity, and improvement.

And it is in this space, in the midst of the abyss, that we should seek to find in ourselves the inspiration to make a change in our worlds for the better.

Just what that picture looks like for each one of us will be different. I am surely still working on mine. But that is part of the fun of creation – it looks different every time.

Hope Is A Long-Term Investment

The Short-term Outlook is Dark.

The unfortunate reality is that we are going to face tough economic times in the short term.

Furthermore, certain “structural” factors in the credit markets have led me to believe that the market prices of assets (including most stocks) have more downside risk than upside potential in the short term.

The key data point here is one of supply and demand. Anywhere from 65-80% of demand in the corporate bond and bank debt markets came from highly-levered entities including CLOs, CDO’s and SIV’s over the last few years. These entities no longer have leverage available, and thus are not buying assets. Until this problem is mitigated, prices will continue to fall in the credit market even if we ignore the weakening underlying fundamentals.

Add to this the facts that: a) the economy has only just started slowing down, b) job losses have been relatively muted to date, and c) the key to this whole puzzle – the underlying housing market – is still facing massive challenges the foremost of which are homeowners underwater in their mortgages, and it is easy to see why things don’t look good in the short term.

However, *if* you are willing to keep a long term focus there is light emerging on the horizon.

Reasons For Hope.

1) Barack Obama is the President-elect.

I want to point out that I am not a Democrat. I am not a Republican. I am an American who finds it equally deplorable to see the disrespect that people show our current President (discussed by the WSJ here: The Treatment of Bush Has Been a Disgrace) as I am optimistic with the election of our new President in Barack Obama.

He stands for something: the kind of optimism and hope in our country that is very important in times like these.

But don’t forget, President-elect Obama called for a sense of service and sacrifice. And he meant it.

2) We have a sense of solidarity again.

This is delicate. We can’t let the short term bad news over the coming months distract us from the momentum this election has achieved.

Voter turnout was the highest it has been in a century. You cared, and your voices were heard.

Last night people were literally dancing in the streets across the country singing God Bless America.

This patriotic spirit is essential for us to collectively overcome the challenges we face.

3) Our long-term economic prospects are strong.

We are the most innovative country in the world.

Trends such as in the success of web services like Twitter; the current adoption of the mobile internet on devices like the I-Phone, the Blackberry Bold and the G1; innovations in clean nanotechnology; and countless other great opportunities show that there are tons of great things happening in our country today.

Our economy is $13T and even if it declines by the greatest amount in history it will still be the largest and strongest economy in the world by a long shot.

Keep A Long-Term Focus.

Emulating great investors like Warren Buffett, we should disentangle the long-term value from the short-term “signal” and technically-driven prices.

The short term is murky, but the long-term truly is hopeful.

The sun has set and we are in the midst of a cool and dark night. The silence is almost deafening, but on the horizon rays show the Hope of a new day. And now we have a leader to take us there.

On Language And Decision Making

Decision Making

After a week of meeting new people in short spurts of mutual analysis (read: interviews), I am starting to realize that we suffer from an intractable problem: our decision making is only as good as our data and our data is necessarily limited.

Whether this be in the context of making decisions about where to work, what to eat, who to befriend, or what stock to invest in, we are very often evaluating our options.

In order to help us come to the “right” conclusion we have shortcuts like information labels, reputational filters, and other mental models that we trust.

For example, when meeting someone new, one often asks where they are “from” and what they “do”. Although perhaps not consciously, as the responses to these questions start coming back, we immediately start to categorize based on our past associations with these places and professions.

A similar phenomenon occurs when evaluating a stock: we look at the company’s performance, compare it to similar companies, try to put these thoughts into a framework we trust, and then make an evaluation.

We Are Like Machines.

This process – data input, association, analysis, action – is central to any form of decision making, even for a computer.

The beauty of computer programming languages is that the decision-making operates within a bounded system. In object-oriented programming, one can create hierarchies of linguistic complexity, but there literally is no data that could be within the system which is incapable of categorization because the inputs are defined. Of course programs are thusly limited in their scope of operation, but everybody knows this.

You can’t use a Blackberry to transmit temperature, but when I press on the letters of this keypad, the machine “knows” exactly how to interpret these actions and how to respond.

Similarly, we humans are limited by our data inputs and representational frameworks. I can’t parse radio waves, and at least my human brain doesn’t have the capacity to digest 6 dimensional objects.

We Are Not like Machines. Our Language Is More Complex.

However, unlike the programs we create, we humans have a much richer set of tools with which to do our analysis.

I believe it is the linguistic element of this toolkit that is the most powerful.

In other words, because we have a common language, we are able to categorize and communicate in rich and powerful ways. When I say ‘Texas’, the person in front of me is able to grasp ‘greatest State’, ‘humble citizens’, and the various different concepts she has grown to associate with this word. Unlike a computer program, her associations can be loose or strong, they can change over time, and here is the key: they are different for all of us.

It is this aspect of our language, and as a result our decision making, that is both powerful and troubling.

Our Language Is Open At The Periphery.

A simple visualization of what I am talking about comes in the form of a venn-diagram:

Venn Language

When we communicate (and also when we process data on companies, food and anything else), there is an overlap of commonality, but there are also areas of disagreement. For example, if the above diagram represents three different people’s understanding of ‘Texas’, person A, B, and C might all agree that the state is ‘great’, but each might independently associate other concepts with the word.

Unlike a venn diagram, our linguistic frameworks are much more hazy, complex and full of not only linguistic connections, but also emotional and physiological connections.

If you don’t believe that language is affiliated with these more complex responses consider words like: ‘rape’, ‘stain’, ‘caress’, ‘love’, etc.

And if that wasn’t complicated enough, these linguistic structures are influenced by our unique personal experiences and our common historical experience.

An example of the latter is how the word ‘hope’ has become hijacked by the recent presidential election and now contains a number of associations it previously didn’t – for better or for worse.

So What? It Matters For Investing…And Life.

The implications of all of this are that we are left with a process that is at the same time both powerful and imperfect.

It is powerful in the sense that we can theoretically accomplish a lot of communication and analysis in a short period of time.

With the addition of representational and processing aids like the machine I am using to write this message, we can tap into the power of language to reach out and interact with our worlds in ways like never before.

We can use this increased power to make more decisions, about more things, more quickly and more “accurately” than ever before.

However, as a brilliant investor once told me: we should never forget that mental models are not reality…they are just models.

In other words, in a world where we bound along from mountaintop to mountaintop aided by the clouds of our linguistic meta-structures and the tarzan-ropes of our communication aides, we often forget that the system is at best one of approximations and at worst one filled with errors. Part of the reason why our “venn diagrams” don’t completely overlap is because the words we use are incomplete and inadequate depictions of the world we experience.

Do: ‘sunset’, ‘heartbreak’, ‘healthy’, or any of our words really represent the things about which we seek to communicate?

The arrogant research analyst in the crowd might try to argue that stocks are different because there we are using ‘numbers’ instead of words. But that is a massive over-simplification.

The numbers on your screen represent a ‘value’ arrived at by people who, using some common language and their own understanding of the world, crafted representational frameworks of entities called ‘companies’ that are really an amalgamation of people, stuff, and mutual understandings.

These representational frameworks are supposed to encapsulate not only the current state of affairs but also the future trajectory of these various different actors.

If you don’t recognize the inherent inaccuracy in such a system then either: a) I am not being clear (which is likely) or b) you are probably smart enough to be dangerous, but not smart enough to know your limitations, which is a really bad combination.

It is this kind of necessary arrogance that leads us through life making decisions with necessarily imperfect and inaccurate information. We don’t have any other choice.

The best we can hope for is that enough of us will have the humility to recognize these limitations that we will collectively band together in support of our failures as they occur. We can also help one another to communicate and learn about the various different aspects of the world that matter.

The sun is rising on the horizon. A new day awaits.

On Humility, Creativity, and The Importance of Others.

Humility.

I just had one of the most profound conversations that I can remember with a guy who has taken an entirely different path through the same twenty-nine years we have been on the planet to arrive at the same place where I arrived tonight at an event with a bunch of “Internet” people down the street from where I live.

The discussion began exploring concepts similar to those underlying my post last week about Emotional Analysis Paralysis, in that we were discussing an idea presented in an existentialism course we both attended today, which basically suggests that:

Unexamined beliefs that are emphatically held onto, and for which reflection is actively denied, can unintentionally become “true” about ourselves in some very powerful and unfortunate sense.

And that accepting such beliefs without opening ourselves up to considering our rationales for them is a form of “bad faith” in life.

Such a dogmatic refusal to examine one’s beliefs can range from situations as simple as interpersonal relationships, to situations a complex as being the central banker of the world economy. Mr. Greenspan today acknowledged a change in one such belief in his world view in this article on Bloomberg: Greenspan Concedes to `Flaw’ in His Market Ideology

`Yes, I found a flaw,” Greenspan said in response to grilling from the House Committee on Oversight and Government Reform. “I was shocked because I’d been going for 40 years or more with very considerable evidence that it was working exceptionally well.” Greenspan added he was “partially” wrong for opposing the regulation of derivatives.

“We have to do our best but not expect infallibility or omniscience,’ he said.

Part of the problem was that the Fed’s ability to forecast the economy’s trajectory is an inexact science, he said.

“If we are right 60 percent of the time in forecasting, we are doing exceptionally well; that means we are wrong 40 percent of the time,” Greenspan said. “Forecasting never gets to the point where it is 100 percent accurate.”

This humble admission by one of the most brilliant market observers in history reflects a basic truth about ourselves: we are fallible, and as a result we should always subject our beliefs to questioning and revision.

Creativity.

One of the challenges I have been wrestling with lately is finding a way to be creative in a world where: 1) chaos and massive uncertainty exists 2) I am limited and flawed and 3) inspiration is presumed to precede innovation.

The conversation not only elucidated a framework for humbly accepting certain of our principles as “true” only after examining their rationales (and in the context of a life-long process of constant re-examination), but it also wrestled with the tension between creativity as “work” versus creativity as “inspiration.”

I have been thinking about this lately in the context of entrepreneurial innovation, but also more generally as I seek to figure out just how I will make my mark.

One takeaway from our talk that I gleaned was that: hard work is almost always necessary for creativity, if for no other reason than to learn the tools of the trade – to play the guitar, to speak the language, to bring resources to bear.

But, I also took away that work is not enough. One must also create the space where inspiration can materialize.

I am still not sure if such a space is created through a destructive/Nietzschean questioning of assumptions, or if it is one that simply emerges from a more Buddhist-minded acceptance of one’s place in the world.

But maybe it is a bit of both – by destroying/challenging one’s stated understanding while at the same time accepting the world as it presents itself, perhaps one is able to create the space for inspiration and creativity to emerge.

The Importance of Others.

However, besides this internal and personal activity, another thing that has hit home in spades over the last few weeks for me is the importance of a supporting cast.

For me that is many of you who read this blog, my other friends and family, and the people I come across in the world like the new friend I met tonight.

But, ultimately, I am convinced this will not be enough for true greatness.

Given our limited nature and the necessary recursive process – self-reflection, destruction, assertion, creation, repeat – that one must go through in life, I think having a partner is absolutely essential…at least for those of us who are not lucky enough to be gifted with the kind of child genius of a Picasso or a Mozart.

In response to the concern that I (and apparently many other people) have about being “too old” to achieve greatness, Malcolm Gladwell recently published a piece in the New Yorker in which he juxtaposed the lives of Picasso (and other “early bloomers”) with Cezanne (and other “late bloomers”) in hopes that showing that we “late bloomers” should not give up hope.

He emphasized just such a notion – the importance of a supporting cast – in this piece: Late Bloomers: Why do we equate genius with precocity?

“On the road to great achievement, the late bloomer will resemble a failure: while the late bloomer is revising and despairing and changing course and slashing canvases to ribbons after months or years, what he or she produces will look like the kind of thing produced by the artist who will never bloom at all.

Prodigies are easy. They advertise their genius from the get-go. Late bloomers are hard. They require forbearance and blind faith. (Let’s just be thankful that Cézanne didn’t have a guidance counsellor in high school who looked at his primitive sketches and told him to try accounting.) Whenever we find a late bloomer, we can’t but wonder how many others like him or her we have thwarted because we prematurely judged their talents. But we also have to accept that there’s nothing we can do about it. “

If you are the type of creative mind that needs to experiment and learn by doing, you need someone to see you through the long and difficult time it might take for your art to reach its true potential.

This is the final lesson of the late bloomer: his or her success is highly contingent on the efforts of others.

In biographies of Cézanne, Louis-Auguste invariably comes across as a kind of grumpy philistine, who didn’t appreciate his son’s genius. But Louis-Auguste didn’t have to support Cézanne all those years. He would have been within his rights to make his son get a real job, just as Sharie [the wife of a “late bloomer” author named Fountain] might well have said no to her husband’s repeated trips to the chaos of Haiti. She could have argued that she had some right to the life style of her profession and status–that she deserved to drive a BMW, which is what power couples in North Dallas drive, instead of a Honda Accord, which is what she settled for.

But she believed in her husband’s art, or perhaps, more simply, she believed in her husband, the same way Zola and Pissarro and Vollard and–in his own, querulous way–Louis-Auguste must have believed in Cézanne.

Late bloomers’ stories are invariably love stories, and this may be why we have such difficulty with them.

We’d like to think that mundane matters like loyalty, steadfastness, and the willingness to keep writing checks to support what looks like failure have nothing to do with something as rarefied as genius. But sometimes genius is anything but rarefied; sometimes it’s just the thing that emerges after twenty years of working at your kitchen table.

“Sharie never once brought up money, not once–never,” Fountain said. She was sitting next to him, and he looked at her in a way that made it plain that he understood how much of the credit for “Brief Encounters” belonged to his wife. His eyes welled up with tears. “I never felt any pressure from her,” he said. “Not even covert, not even implied.”

That we need others, and ultimately the love of *another* in life is becoming more clear as life goes on.

That we are recursively tracing our way along a strand of an infinitely complex set of possible outcomes in one fine-tuned dance that we call life is surely one of the few things we can know with certainty.

But just how we should dance, who we will share this journey with, and whether the tools, preparation and possibility will open up for us in just the right way are mysteries that only the future – or Someone much greater than me – could know.

In the mean time, I don’t think I could stop reflecting on these and other questions if I tried. Thank you for wrestling with them with me.

Consciously Navigating Da Nile

As this article on Naked Capitalism points out, some of the smartest pessimists out there are starting to get significantly more bearish lately.

I have hesitated to to publish some of this content, but I think it is worthwhile to consider positions like the ones discussed here: Roubini Foresees Possible Market Shutdown

After the Fed, ECB,, Bank of England, and other central banks took unprecedented measures over the last month to restore liquidity and recapitalize banks, Nouriel Roubini sounded slightly less gloomy. He had deemed that the authorities has avoided a systemic financial meltdown, but a nasty, protracted recession was in the offing.

It appears that Roubini has reversed himself with his latest remarks He now says systemic risks are increasing due to hedge fund margin calls, redemptions, and liquidations, and the authorities may be forced to close financial market

Similar negativity can be found here:
The Folly Of A Depression Thesis

In short we are setting up for what looks like an even Greater Depression, perhaps something similar to the 1873 panic. While the causes would be very different in practice, in principle they seem to be the same – malinvestment caused by “easy money” that, when business conditions turn, becomes “protected” by government – leading to Depression instead of an ordinary business recession and bankruptcy of those who overextended themselves. Now, as then, we have companies that have spent incredible amounts of money to buy influence – it was recently disclosed that AIG, for example, continues to pay lobbyists in an attempt to loosen regulation even though they are now surviving on money borrowed from The Fed!

Be prepared, get out of debt and position yourself so you can survive without the use of consumer or business credit of any sort.

If you have liquid cash, you will be in a great position to pick off property and other goods that people are forced to abandon as the situation worsens. There are many people who became fabulously wealthy as a consequence of The Depression, and all of them had one thing in common – they had cash when things got really bad, and were able to pick off assets cheaply in forced sales.

The difference between 2 years ago, when I was on the same page of many of these same writers and today, is that much of today’s contagion is being driven by forced selling of assets that are far below their intrinsic value.

I am not talking about the toxicity associated with the still deteriorating real estate market, financial companies, retail-based companies, or consumer credit companies.

Rather, I am talking about the fact that the bank-debt market is trading the $60’s right now for companies that are only 2-4x levered through the bank debt. Basically this implies that many of these healthy companies will go into bankruptcy and liquidate for something like 1-2x EBITDA.

Although I seek to avoid this financial jargon here, the translation is simply this: It is absolutely positively an inaccurate reflection of reality.

I am not one to speak in absolutes, but I can tell you that there is absolutely no rationale for such a valuation for many of the companies that are being “valued” in this way.

The reason for this price-action is completely tied to the forced-selling around asset-liquidations, hedge fund failures, and other “forced” selling action. This is a classic “technical” signal in a market, and although it is important to notice these for trading purposes, it should not be mistaken for a reflection of intrinsic value.

The VIX (a measure of volatility) hit another all-time high today intraday, suggesting that people are panicked, afraid and more importantly they are *uncertain* about the future.

This uncertainty creates a space for someone to fill in the void. They need someone – actually lots of someones – to step up and fill this void of uncertainty with some words of wisdom and common sense to settle their nerves.

Thus, although I think there is a distinct possibility that the uber-bears are right. I am consciously breaking ranks with them because I firmly believe that there is finally a possibility that they might be wrong.

It could be the case that we will find a way to stem the decline in housing prices (my suggestion continues to be to renegotiate mortgages to keep people in their homes), stimulate the economy (likely through more fiscal stimulus), and ultimately find a floor for the various credit markets that are continuing to go through contracting pains.

I am *not* suggesting that you leap into equity markets unhedged, but I am suggesting (perhaps as a broken record by this point), that consciously focusing on the positive will help us determine our future trajectory from here.

The choice of how to fill this void of uncertainty is ours to make. I am choosing to deny the doom – at least for today.

Creating The Future. Not Predicting It.

I have often said that I like to try to predict the future. This materializes most concretely in the area of investing – I think the core being an investor is literally attempting to predict how the world will look in the future. If your view is different from other people, and you are correct, then you win.

However, lately as the markets have played out like a broken record the results of a too-levered too-risk agnostic system, my thoughts have turned from future predicting to future creating…and this brings my thoughts to entrepreneurship.

The world today has many problems:

  • A challenged financial system driven by a falling real estate market and a slowing economy.
  • A massive and growing national debt.
  • Homeowners with too much mortgage debt.
  • Middle class families that are being squeezed by expenses ranging from health care to consumer credit.
  • An educational system that does an inadequate job for many – especially minority urban youth.
  • Environmental challenges.
  • A dependence on foreign oil.
  • Global poverty and illness.
  • A health care system that does not serve the poor.

However, the only way these problems will be solved is if *we* fix them. Thus, the inspiration for entrepreneurship emerges.

Rather than standing by and watching these problems and “predicting” their continuation, instead I think we should try to envision a future where these problems are solved. And further, I think coming up entrepreneurial solutions to these problems is crucial.

And so lately my mind has shifted to this mode of thinking.

I don’t think I could stop the “future predicting” part of me if I tried. But I feel like trying to think about trying to solve these other problems for the next period of time.

Please share any ideas you might have, and I will do the same.

Another $Trillion Lesson

According to Bloomberg, projected losses in the corporate CDO market may approach $1T.

CDO Cuts Show $1 Trillion Corporate-Debt Bets Toxic

Investors are taking losses of up to 90 percent in the $1.2 trillion market for collateralized debt obligations tied to corporate credit as the failures of Lehman Brothers Holdings Inc. and Icelandic banks send shockwaves through the global financial system.

The banks that structured the securities and investors both failed to do “fundamental credit analysis,” said Janet Tavakoli, president of Tavakoli Structured Finance in Chicago. “They were using correlation models, they were using spread models, but they weren’t doing analysis on the underlying corporations.”

As the article highlights, this is yet another example of a situation where people relied on overly complex mathematical models rather than on simple common sense.

The problem with trusting the smartest-guys in the room is that even they are limited by their models and their understanding of the world.

I am not saying that the people who built the models are to blame, nor are the professors who established the theories underlying them.

Rather it is a the establishment of a system of overconfidence in these models, theories and individuals which are to blame.

We must take these failures as a lesson in humility for the future and integrate these lessons into our businesses and personalities so as to avoid repeating these mistakes again.

The clouds remain dark and the shoes are falling like rain, but like all storms, this too shall pass.

On Leadership (Video)

I ordinarily do not like to post simple links here on my blog (I prefer My Twitter page for this).

However, I wanted to share this with those of you who don’t use Twitter, as I think you should really check out this content if you have some time. Or rather, you should try to make the time to watch some of these videos from last week’s HBS Centennial Celebration.

The topics covered range from leadership, to the current crisis, to the future of capitalism and other topics:

The HBS Business Summit Video Content

Some of the featured speakers include:

Bill Gates,
John Doerr,
Jeffrey Immelt,
Meg Whitman,
Larry Summers
…and many more.

If you just watch 1 video, this is probably a good one. It is a discussion of leadership hosted by Charlie Rose, featuring 3 of the 5 above:

Leadership for the 21st Century

As Charlie Rose said in closing:

I wish that this could have been heard by people across the country. Discussions of confidence for the country and self, respect for people and laying out the challenges and what we should do…

And if you have time for two, watch the keynote with Bill Gates.

Bill Gates Keynote Address, A Conversation With Professor Jim Cash