Tag Archives: finance

Old modes of production die with the depression…

A few weeks ago I blogged about how I thought land line phones and cable TV would be among the first items to go as people cut budgets. In contrast Cell phones and internet would be among the last (can you imagine trying to find a job without an internet connection?)

Well I forgot to mention that newspapers would be the other obvious target… why spend to get a newspaper when you can get the content online for less or for free?

So I was probably rash in saying that traditional telephone companies (are there any left?) and cable companies would be among the first to feel the pinch. It is going to be newspaper companies. The end is going to come fast and furious. It won’t be pretty.

For my American friends there is already talk about how much trouble the New York Times is in. Indeed, as one industry observer points out, the NYT may not survive past MAY – although by drawing down on its credit and selling assets (like the Boston Red Sox’s) it can survive until 2010.

Here in Canada the situation is bleaker. CanWest, which owns the National Post as well as newspapers in most of the country’s major markets (such as the Vancouver Sun, here in my home town), has reported Q1 losses and its stock continues to free fall. Having lost 92% of its value in the last year it may no longer be able to meet its debt servicing requirements. It turns out that buying more newspapers is not the solution for newspaper companies. A bigger broken business model doesn’t, at some point, transform into a working business model.

The old modes of production are in trouble. Today it’s print, but TV/video better not assume the same pressures won’t be confronting them in the near future.

CEO compensation – a symptom of institutional decay

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So reading Emergence sprouted another thought regarding the increasingly bankrupt (literally and figuratively) model of the classic bureaucratic organizations. Again I point to Umair Haque’s post on the recent financial crisis:

The first step in building next-generation businesses is to recognize the real problem boardrooms face – that we’ve moved beyond strategy decay. Building next-gen businesses depends on recognizing that they are not about new business models or even new strategies.

The stunningly total meltdown we just witnessed in the investment banking sector – the end of Wall St as we know it – was something far darker and more remarkable. It wasn’t simple business model obsolescence – an old business model being superseded by a more efficient or productive one. The problem the investment banks had wasn’t at the level of business models – it had little to do with revenue streams, customer segmentation, or value propositions.

And neither was it what Gary Hamel has termed “strategy decay” – imitation and commoditization eroding the returns to a once-defensible strategic position, scarce resource, or painstakingly built core competence.

It was something bigger and more vital: institutional decay. Investment banks failed not just as businesses, but as financial institutions that were supposedly built to last. It was ultimately how they were organized and managed as economic institutions – poor incentives, near-total opacity, zero responsibility, absolute myopia – that was the problem. The rot was in their DNA, in their institutional makeup, not in their strategies or business models.

I think Umair is on to something and that CEO salaries may make for a great case in point.

For many years the left has decried growing CEO salaries as a sign of the market’s excesses – or worse, of a broader culture of greed. But excessive senior management salaries are, from an investors perspective, are a symptom of a staggeringly flawed institutional model. If your business depends that much on the one person at the top – if the current and future value of the entire organization rests in the hands of one person… then yikes! Shareholders beware.

The idea that a CEO is worth 1000, or even 100 times more than the “average” workers in an organization isn’t just a problem from a morale or ethical perspective (it may or may not be). If your average worker isn’t contributing that much value in relation to their ultimate superior than you have a massively top heavy – and hierarchical – organization. One where, I suspect, Umair would find there are poor incentives, near-total opacity, zero responsibility, absolute myopia. To be sure, ideas are probably not being floated about, and they are almost certainly not successfully emerging from the bottom up.

In short, it isn’t a happy place to be. And it turns out the markets may not think it is so good either.

The Crash: The beginning of the end…

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The response to the post on complexity theory and the financial crises has been very positive. Been recieving lots of positive feedback, thank you to any who have written or commented.

Several people, including Steven Johnson, the author of Emergence, posted a link to this great piece “The Economy Does not Compute” that I encourage everyone to read.

Dave D. emailed me with this fascinating story from the New York Times that arguably pinpoints the moment the incentives in the market were shifted that started us down the road to the present crises. Entitled Fannie Mae Eases Credit To Aid Mortgage Lending the piece is dated September 30th, 1999. This excerpt below really summarizes the underlying logic and benefits for initiating the change as well as predicts the ultimate catastrophe that it would unleash (remember, written in 1999):

”Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements,” said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. ”Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

The article shows us the challenges around blaming any one individual – except possibly Blll Clinton – as once the incentives for embracing a higher risk group were altered it vastly increased the chance that more and more people would cater to them and expose themselves to that risk.

The other fascinating thing about this piece is how the web is now getting to be old enough that it is becoming a fantastic tool for historians. Think of how much richer our history is going to be when critical documents like this one are both more accessible and easier to locate.