March 4, 2013
Cover via Amazon
I usually get really worked up when I am speaking with some employees in a bank about Startups and Entrepreneurship, they immediately say that it is Risky. I always ask them could they please tell me why they believe Startups are risky? Their usual answer is well 90% of all startups fail, which is anecdotal evidence because there is no way anyone has documented all the startups in the world and calculated the failure rates. I have written a lot about how we as humans are wired to be fooled by statistics and we just underestimate the risks associated with many things. What is even fascinating is that those same people from the bank were still working in the bank when the entire financial system in Iceland collapsed. I think banks are bigger risks than startups, atleast with Startups you know the risk of failure will only wipe out what you invested, whereas with Banks it can wipe out the entire equity base of Iceland. No wonder, Warren Buffett called Banks sit of Weapons of Mass Destruction. The risk on banks are exasperated by leverage, were as Startups run on equity which means what you put in is what you loose if the company goes under. Typically Startups that I have been pounding the table on require very little capital to validate, build a Minimum Viable Product and get market traction.
I have written about the books that really changed my perspective on Risks and I have Nasim Nicholas Taleb to thank for. I listen to audio books all the time and I think this is the 100th time that I am listening to his classic book “Fooled By Randomness“. There are so many pearls of wisdom in that book that I discover something new every time I listen to it. The only positive aspect of risk taking is in the Startup world because a black swan event ie. the chance of finding a Google or Facebook or Twitter or Amazon is very low but when it does happen it usually results in such a positive impact I don’t know why not everyone invest a small portion of their investment egg in this asset class. The monstrous returns that are possible can only be achieved if one takes enough bets but the size of the bets are usually very small and thats the point of doing this.
November 15, 2012
The expansion of $100 through fractional-reserve banking with varying reserve requirements. Each curve approaches a limit. This limit is the value that the money multiplier calculates. (Photo credit: Wikipedia)
I think I know enough about banking to say that debt creates very little wealth or value. I have often wondered what makes banks better at accessing risk than anyone else. It is even scary to think that people who work for banks take risk with someone else’s money with the illusion that they understand the risk. Time and time again we trust the banks to do the right thing and it leads to bigger and bigger financial calamities, I have written about why I think this problem exists. The whole banking system is built around a ponzy scheme and it continues to give the privilege of creating money to private banks and hope they will spur the economic progress of the city, or state or country. It is romantic thought process but it is flawed from the outset. I believe the way out of this financial mess the world is in is through equity, i.e let Entrepreneurs lead! We had the dot com bubble and it left fantastic value after its collapse like the Internet, Google, Amazon, Ebay, Apple etc but I am not saying that is the only business we need to create all I am saying is give Entrepreneurship a chance. Let us cut the fractional reserve system that disproportionately allocates capital to “Risk-Free” assets which is an oxymoron because you cannot have Return without Risk associated with it. If someone is selling you “Risk-Free” drug, please ask why they are doing that. I believe Iceland has the opportunity to redefine how the Banking System can be restructured. Here is a link to a Paper by Jaromir Benes and Michael Kumhof from the IMF, with the title “The Chicago Plan Revisited“. The abstract of the paper is given below:
At the height of the Great Depression a number of leading U.S. economists advanced a
proposal for monetary reform that became known as the Chicago Plan. It envisaged the
separation of the monetary and credit functions of the banking system, by requiring 100%
reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this
plan: (1) Much better control of a major source of business cycle fluctuations, sudden
increases and contractions of bank credit and of the supply of bank-created money.
(2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt.
(4) Dramatic reduction of private debt, as money creation no longer requires simultaneous
debt creation. We study these claims by embedding a comprehensive and carefully calibrated
model of the banking system in a DSGE model of the U.S. economy. We find support for all
four of Fisher’s claims. Furthermore, output gains approach 10 percent, and steady state
inflation can drop to zero without posing problems for the conduct of monetary policy.
One of my favorite authors, Nicholas Nassim Taleb has written a lot about it and we don’t need complicated models to explain the fallacy of Debt or Leverage on Securities (which includes Mortgages, Government Bonds etc). I blogged about it in my personal blog and I think it is about time we looked for a better way. I think the above plan can be implemented in Iceland. It could pave the way for defining the right way for financial systems to work in an economy. I am sure it is not simple but necessary to debate and review otherwise we will be stuck in this Ground Hogs Day of Leverage if we don’t change something about this system. I wanted to leave you with a couple of documentaries about Debt and leverage.
Overdose: The Next Financial Crisis
June 4, 2012
I have been on a plane and airports the whole day yesterday, but caught up on my sleep. I probably slept for 3 hours on the plane from London to Abu Dhabi and in the Shangri-La Hotel got another 3 hours. While I was catching up on my reading came across this @newsycombinator post of a blog about how Software was eating into the Fortune 500 companies. I think we are embarking on a new wave, the President of Iceland called it the 3rd wave of transformation. The world is changing dramatically our old tools don’t seem to work i.e Monetary Policy, Fiscal Policy, the age old job creation story, monetary union blah blah blah I really wish the policy makers would just look at the grassroot level and understand the demographic and economic shift that is happening there. Mary Meeker from KPCB outlines the build up for the change in her presentation in All Things Digital Conference. I like the two bullet points in that particular slide:
Image via CrunchBase
- Fearless (& Connected) Entrepreneurs
- Fearless (& Connected) Consumers
In my view these two points are game changers, no longer are the young people want to fit the norm and conform, they want to chart their own path. Consumers are pushing the envelop as well, they are asking for better service, for lower cost and ubiquitous always on products and services. Those companies that serve this need will win and those who do not will die. It is as simple as that, some companies that have industry monopoly and resource power will delay the inevitable but it is going to happen it is just a matter of time. So which sectors are ready for disruption, IMHO, Financial Services, I think the Bankers have lost it. They have lost the credibility, their talent to manipulate market making and resourcefulness. Check out the slide again from Mary Meekers
almost 20% of the market capitalization is hogged by Financials, why is that? well it was concentrated because Banks had the “regulatory” right to be lenders and that gave them the right to create wealth with leveraged capital and guess what? they kept most of it to themselves. I think this market is ripe of disruption. I bet small startups will start chipping away at the juggernaut of money making i.e financial services. It is already starting to happen, with network efficiencies and availability of mobile devices, the traditional banking model is changing. With the advent of peer to peer transaction mechanism like Square, Dowalla etc and Internet based capital raise methods using Crowd Funding it is going to be interesting to see the transformation. I think we will see the incumbent fight the entrant with new regulations and rules to stop innovation but it is inevitable. The consumers are fearless and they will vote with their feet.
April 28, 2012
TechCruch has the post about the Winklevoss Twins of the Social Network movie fame jumping into the VC bandwagon. I think the VC bubble story is now complete, well maybe in the US but it has not started in Iceland. I was informed that all the banks in Iceland are thinking about doing VC funds (it is a nice rumor and I wish all of them luck).
I wanted to ponder on the acronym VC, as I have written before for me VC stands for VALUE CREATOR. What should a value creator do to earn a living? well, that is obvious one has to create value. Do banks create value? I am not so sure and I used to work for a bank! The 3+ years I worked for a bank I was always thinking how do I create value, actually I remember a funny incident when I suggested to an Investment Banker that it makes no sense to me that we don’t try to help the companies that we lend into or raise money for. Like Management Consulting Services, my logic was we analyze their business, industry and everything else under the sun to make a credit decision or convince an investor to put money in the company, we know a lot more about the business because we spend considerable amount of time creating the material that is used to make the capital decision, why don’t we follow through and ensure all the promises we make during the fund raising process actually get done. The investment banking professional almost fell out of the chair laughing, I was not sure why this was so funny so I asked him. He only had one question to me “Who is going to pay for the time and effort we put in helping our customers!” I could not believe that he asked me that question. My understanding was we DID get paid a fat 2% to 5% of the capital raised, is that not sufficient to pay for helping our customers? apparently he was thinking of the disproportionate bonus he was hoping to get at the end of the year and did not believe helping our customers after the capital is raised creates value for him. He really did not want to work hard to make that money! I should have quit banking then! I could not understand this logic, this short term thinking… no sense of purpose, no goal higher than whats in it for me. Well, maybe the “professional” that I was talking to was an exception to the rule and I am sure there are many professionals who work in the banking industry that work very hard to create value. But the fundamental problem is always, leadership and incentives drive behavior. The professionals within the banking industry have a very poor incentive mechanism, it is not the professionals, it is the weird income and bonus structures that create perverse incentives.
Thats why a strong leadership is needed to ensure that there is a grander vision for the organization. I believe there needs to be balance in an organizations vision, it needs to balance 4 things, Body, Mind, Heart and Spirit. I will write about leadership in another post. I believe if one wants to understand what drives someone to do something one just has to look at the incentives. I fundamentally believe the Investment banking business model is dead! yes, you heard it here for the first time. Not totally dead but it is like watching a train wreck in slow motion.