by Mike Masnick
Mon, Nov 24th 2008 2:47am
by Mike Masnick
Thu, Oct 30th 2008 7:53pm
from the will-some-VC-play-its-Ben-Bernanke dept
by Mike Masnick
Mon, Oct 20th 2008 2:39pm
from the too-small-to-care dept
However, apparently, there are still some folks using Second Life, and the company wants to let you know that as the financial crisis spreads around the world, the fundamentals of the economy in Second Life remain strong. Over the past few weeks, I've seen press announcements from plenty of tech companies trying to spin the financial crisis as a reason to write about their company, but this one might be the most ridiculous. It's not as if people are going to start moving money into Lindens any time soon as an investment vehicle.
by Mike Masnick
Fri, Oct 3rd 2008 6:22pm
from the and-there-you-go dept
by Mike Masnick
Thu, Oct 2nd 2008 12:00pm
from the connecting-the-dots dept
Getting beyond Wall Street
I discussed some of that in the original post, but many people are still having trouble seeing how this crisis spreads beyond Wall Street financial firms (or, in some cases, their own stock portfolios). There are still plenty of people screaming out that these financial firms need to be punished or done away with completely, without any recognition of how that might flow through the rest of the economy. The New York Times has an excellent writeup, noting that people said the same thing as the Great Depression was happening, as well -- again, not realizing that destruction on Wall Street can flow through the rest of the economy.
The basic problem is the fear that the credit markets will simply dry up. If no one will lend money (or it simply becomes ridiculously expensive to borrow money), then some very basic economic functions cease to work. This may start out at a high level with bank to bank loans and bank to business loans, but it can also filter down to things like your mortgage (if you thought things were bad before, wait until adjustable rate mortgages reset with even higher interest rates, contributing to this spiral), car loans and even credit card payments. At the top of the chain, banks are increasingly afraid to lend to each other fearing that whoever they lend to (even for very short term loans) may default before the money can be paid back.
Already, some companies are seeing the direct impact. For example, Caterpillar, the maker of construction equipment is a company you would think would be separate from the financial mess on Wall Street. It has great credit and a long history of being good for paying up any debt. Yet, in a matter of days, the interest that Caterpillar has to pay to borrow has shot up.
Debt isn't a bad thing
Now, there are those who will say that any "borrowing" or "debt" is somehow bad (we had a few such comments on the first post), but that shows a fundamental (and, somewhat dangerous) misunderstanding of basic economics. Borrowing money and taking on debt is not, by itself, a bad thing. In fact, it's a very, very good thing. If you can borrow money at one rate, and invest it more profitably, you can contribute to economic growth and provide important goods and services. It's at the very core of a functioning economy. Money moves around so that it can be invested in more profitable endeavors, and that benefits all of society, by making sure that the money is more efficiently put to work.
Of course, with any amount of debt, there's always a "risk" involved in whether or not the money (and interest) will get paid back. The amount of interest generally represents the cost of that risk. Higher risk requires more interest. Thus, there are a variety of different ways that you can invest your money with different risk/reward profiles. Lower risk gets a lower return and higher risk, with its higher chance of default, should net you a larger return in the long haul.
However, the fear of various banks defaulting at the top of the pyramid is increasing the risk down the entire chain, even to the point that relatively "safe" investments are suddenly being seen as risky. Part of that is due to uncertainty about how the crisis will impact others (sort of a self-fulfilling fear) and part of it is due to a still murky understanding of the risk involved in the assets at the heart of all of this mess: the various mortgage backed securities you keep hearing about.
So what happens if things get worse?
Well, it won't be pretty. Credit is such an important part of the entire economy that it's almost impossible to figure out all of the ramifications of a near total credit crunch. Plenty of companies rely on commercial paper and short-term, low risk loans to finance certain operations, while others use it to get a small, but safe, return themselves. If that were to completely collapse, money would have a lot of trouble moving from where it is to where it would be most efficiently put to work for the economy. Effectively, important projects would get starved of necessary cash and die.
That may happen to some projects all the time -- and it's a natural part of the market -- but if it happens across the board, a lot of companies could go bankrupt. A lot of useful investments would go to waste, and (more importantly) the next set of important projects that require investment wouldn't be able to get the necessary money. It would shrink the economy and harm pretty much everyone.
But won't that be an opportunity for someone else to lend?
Yes, indeed. And that's what many free market supporters are betting on. There is still money out there, and it can be put to work. The trillion dollar (plus) question at this point is how much of that money really is out there and how quickly can it flow through the economy (and at what price). Some argue that since so many companies rely on lending out money to make money, that the idea that it would cease is almost impossible to imagine. And that's true to a certain extent. There will always be some money out there to lend, but the question is how much and at what price. With too little at too high a price, you end up with significant portions of the economy screeching to a halt.
While the markets are normally quite efficient, you do get periods of... irrationality. Mostly, we think about it from the "irrational exuberance" side, which leads to bubbles. But it happens at the other end as well, though usually to a lesser extreme. If almost no one's lending, the result is a bit of a herd mentality, where very few people want to be the first to step out on that ledge, as they're afraid that the ledge will get quickly chopped off. Some daring souls may step out, but will it be enough to really keep the economy chugging along?
That sort of "crowdthink" risks severely thinning the amount of capital moving around the economy. Even if certain companies know that they should be lending the money they have sitting idle, they'll be too afraid to step out on the ledge since no one else is doing it. Those in charge of making lending decisions start thinking: "what do they know that we don't know?" -- and that mentality paralyzes the lending market.
So, what does it all mean for a small business operator?
Well, that really depends on what sort of business you're in. If you're a venture-backed startup, it's probably not as big a problem, immediately. As we originally noted, top tier VCs are pretty secure with the funds they have, and as we saw after the dot com bubble, the big institutional investors still can't resist allocating a segment of their cash to VC funds. That money is pretty safe. A good venture capitalist should help its portfolio weather the storm. By the way, that doesn't mean showering them with too much cash. Companies that have raised a ton of cash aren't necessarily better off, contrary to popular opinion. A lot depends on what business they're in, how focused they are on an actual business model and how much they're actually burning. As we saw after the last dot com bubble burst, it was some of the most heavily funded companies that went belly up first -- because they had focused too much on raising money and not on building a business.
But, of course, venture backed high growth companies are a tiny, tiny segment of the small business arena. Most small businesses will face a different set of challenges. While they may not rely so heavily on regularly tapping into borrowed money, that doesn't mean they're not exposed in many ways. Any sort of expansion capital will be much harder and much more expensive to get. That will make it more difficult for some of those small businesses to make the investments necessary to become big businesses.
More importantly, their own customers may be exposed as well. Many small businesses effectively provide "loans" to their customers, in giving terms of payment, such as net 30 or net 60 (allowing the customer to pay within 30 or 60 days, rather than upfront). Unlike constantly fluctuating interest rates, small businesses generally don't change those sorts of terms with any regularity. So, many small businesses actually become a lot more exposed: they're "lending" money at the same rates as before, while the rest of the money flowing around the economy has become more expensive.
With that happening, more customers can be expected to default, putting more pressure on the cash flow of the business. And hiccups in the cash flow will be harder to overcome in the usual way: it will be more difficult and expensive to get a small business loan or a line of credit. Thus, it becomes more difficult to meet payroll and could result in layoffs. Companies may also try to tighten up their payment terms, but that effective "raising" of the interest rate can scare off customers, as well. Already, we're seeing small businesses being advised to push for early payment and change the terms of payment they offer customers.
Most of this won't happen immediately for most businesses. It certainly will impact some in the very near future (and a few companies are already experiencing problems). The real worry is the cascade effect of this happening to more and more small businesses, putting even more pressure on the overall economy. More companies having cash flow problems means fewer customers for other companies, as well, accelerating the whole cycle.
So what do you do?
If you're a small business: focusing on cash becomes king (it should always be, but even more so at this point). Companies won't be able to rely on lines of credit as much as they have in the past, and should see what can be done to lock in any kind of line of credit or opportunity for a decent loan if they can get it. Basically, companies need to prepare themselves for the possibility of money not flowing, customers not paying and additional economic hardship.
But, beyond that, as with any such situation, new opportunities open up. It really depends on what business you're in, but if you provide a product that is better/cheaper/more efficient than what others are using, this becomes a sales opportunity. Focus on letting customers know that they can conserve cash by using your product instead. Plus, look for new areas that you can invest in safely and cheaply, recognizing that these sorts of financial messes do pass, and there will be tons of opportunity on the other side if you can grab it.
by Mike Masnick
Mon, Sep 29th 2008 10:06am
from the bailouts,-moral-hazard-and-adverse-selection,-oh-my! dept
So, what happened?
Well, there are tons of good resources that can give you bits and pieces of it. A good place to start, however, may be The Giant Pool of Money podcast that was on This American Life a few months back (which we mentioned recently). The NY Times just had an article about what led to that podcast being created. It's also worth noting (oddly not mentioned in the NYT piece) that the two reporters who put that together -- Adam Davidson and Alex Blumberg -- are collaborating on a new daily podcast and blog for NPR called Planet Money, which is fantastic. They're also working on a new episode of This American Life for next week about the current crisis. That will be a must-listen as well, I'm sure.
But, the basic summary is that a chain of events all resulted in more and more money being put into riskier and riskier mortgages, where much of the risk was hidden away by computer models and the repackaging of those risky mortgages in bulk. Normally speaking, the idea of bundling up a bunch of risky projects into one actually does make some sense -- because you're figuring that while some will fail, the successes will greatly outweigh the failures. And, in many cases, that's true (it's basic diversification). But the problem was that very few, if any, of the models seemed to take into account the fact that these weren't independently risky items, but that many were very dependent on each other. Thus, rather than a small group of risky deals going south, outweighed by the success stories, people started to realize that you could have a domino effect, where a large portion of the risky stuff going bad could actually lead to even more of it going bad. That's just what you get for creating bad models that don't take dependencies into account.
What made this even worse, however, is that a bunch of the risk was eventually pawned off to the least knowledgeable investor: the public markets. In a world where you're always looking for the last sucker to invest, the public markets are always going to be your best bet -- and many investment banks took advantage of that. While, historically, many investment banks were partnerships, where the partners understood the risk of what they were doing, once these banks were public, the risk was shifted from the folks who at least understood some of the more complex details to those who didn't. Whether that rises to the level of fraud, in falsely portraying the real risk at hand, is something that we'll leave to federal investigators to sort out. Either way, we had a long chain of players, who effectively kept "laundering" the risk through various ways until it ended up being held by people who simply had no clue how risky the products were that they owned.
Then, once stuff started to go bad, the dependencies started to snowball and make everything worse -- and the confusion over how bad and how risky things were made those who actually had money on hand reasonably afraid to keep lending it to those who couldn't accurately express the risk. That resulted in a lack of liquidity -- effectively the oil in the economy's engine. Without liquidity, a lot of stuff freezes up pretty quickly and dangerously. That's what caused Treasury boss Paulson and Fed chair Bernanke to ask for the "bailout" plan.
Why are we "bailing out" those who created this mess?
Actually, while almost everyone is calling it a "bailout," it's not quite a true bailout, and it's not clear that it really "rewards" those who created the mess. Like everything else, it's quite complicated. Personally, I like Fred Wilson's use of the phrase "The Splurge" to describe it, because in many ways it's more accurate than a bailout. Basically, the government is asking for $700 billion to try to buy up distressed assets. The details suggest that it's starting out with $350 billion, with another $350 billion to be handed out later, if necessary. There are plenty who believe that $700 billion is just the tip of the iceberg, and eventually that number will grow to be much higher.
So, why isn't this a full "bailout"? Well, because the government would be getting equity back as well, and there are plenty of smart folks who believe that this could lead to the government making a profit. Indeed, buying up distressed assets historically isn't a bad way to make a profit -- if you know what you're doing. Lots of folks tend to shy away from distressed assets, and a good fund manager can buy up distressed assets for pennies on the dollar and figure out ways to sell them down the road for nickels or dimes on the dollar. It's a perfectly reasonable business proposition, and historically, there are plenty of stories of folks who made out like bandits buying distressed assets following bursting bubbles. So, if the government can drive a hard bargain and buy up these assets at a reasonable price, it could work.
So, the good news is that there's a chance that the "splurge" could result in a best case scenario: it pumps liquidity into the market, stabilizes things, gets the economy moving again and lets the government profit.
But that's the best case scenario. Others are a lot less sure, noting that the upside pales compared to the downside risk, and even if an upside scenario may seem a lot more likely, the cost of the downside is much, much bigger (at least $700 billion at this point, and perhaps more). In fact, there are those who suggest that a poorly done splurge will almost certainly make things even worse. And, plenty are pointing out that the smart money seems to be betting that the government is entering the game as the "last sucker" we were discussing earlier. Given that there's still confusion over how the gov't will value these assets, it seems reasonable to worry. Plus, there's the thought that if the hard bargain is really a good bargain, then others will come in and do the deal -- such as JP Morgan Chase buying up WaMu or Barclays with Lehman or BofA with Country Wide or Merrill Lynch. But, there's a question of how much those companies can handle, and if it's enough to keep the economy from stalling.
So, really, a lot of it comes down to how well such a government fund is managed -- and right now that's a huge open question. If it's managed well, by folks who actually have the ability to get a pretty good read on the likely real value of these distressed assets -- then the splurge plan could work wonders. But how often do you see the government do anything right -- especially when it comes to managing money? So, while, in theory, I don't have a problem with the government entering the market as a buyer, you have to worry significantly about the fact that it's the government, and they're prone to screwing things up badly -- especially once politicians get involved. Once you have people trying to get elected on a regular basis messing around with the decision making, you know things are going to get bad fast. That's why, if such a plan does need to move forward, I'm actually all for limited oversight from Congress if (and this is a big if) there's real transparency into what the fund is doing. I might be more convinced if there were oversight from a group of economists instead.
Also, you've probably heard a bunch of folks warning about "moral hazard" lately, which is an economics term basically meaning that if you protect someone via insurance of some sort, it makes them more likely to do risky behavior. That is, if you tell someone you'll protect their downside loss on something, they're more likely to do it. Or, more specifically, if you tell someone that if they jump out of a tree, you'll catch them, they're more likely to jump out of that tree. In this case, the idea is that "rescuing" the banks makes them more likely to do risky things again, knowing that the government will rescue them. In this case, however, the risk of moral hazard seems overblown. This is hardly a pleasant time to be working in the financial sector, and I don't think this is exactly an enjoyable experience. Plus, if the Splurge works by buying stuff at pennies on the dollar, that's not going to be particularly pleasant either. It may be more like saying you'll have insurance to fix your broken legs from jumping out of a tree. Yeah, you've got insurance, but the broken legs are pretty good incentive not to do this again.
Oddly, there's almost no talk of the risk of adverse selection, which is moral hazard's sibling in looking at any sort of "insurance" market. I would think that the risk of adverse selection is much greater here than the risk of moral hazard. With adverse selection, the problem is that when you have asymmetric information (one party has a lot more info than the insuring party), the riskier deals end up gravitating towards the insurer. Thus, the insurer thinks its covering a uniform population, but only the riskiest bets take up the insurer. That seems a hell of a lot more likely in this scenario. The government does not know how to value these distressed assets, but the banks selling them probably have a much better idea, and are more likely to try to pawn off the worst of the worst on the government -- meaning that the gov't may get stuck with assets that are more distressed than they expect.
Perhaps the most worrisome aspect of this is the rush to get this done. Deals done in a panic are rarely good deals. And while I can understand and agree with the idea that perfect is the enemy of good, rushing through isn't a good idea either. Will it mean that some firms go into bankruptcy in the meantime? Yes, almost certainly. But is the whole economy going to collapse? Unlikely to happen right away, and it should be preventable with minor tweaks while the larger details are worked out.
But isn't this just about Wall Street?
There's a common refrain among many, many people, that this is just the result of greedy Wall Street bankers, and the proper thing to do here is to just let them all fail. It's not that easy. The ripple effects here would be pretty serious -- and while I don't think the economy would fully seize up, it would be really painful across the board. The lack of liquidity in the commercial paper world (short term lending, mostly) would impact a lot of businesses that you might not think have such exposure to Wall Street. And that, in turn, could create an ongoing spiral.
It would stop somewhere, but where is anybody's guess at this point, and it may be pretty far down a hole, with a pretty massive destruction of wealth in the meantime. Some may believe this is the best way to get through things (the rip the band-aid off quickly belief), but the overall damage could be significant, and not so easy to come back from. Ripping the band-aid off quickly doesn't always yield the best result if it rips the scab with it, causing more damage. So, simply letting everything fail, while an option, could have serious long term consequences.
And what about Silicon Valley/Tech?
Well, for those of us in tech, the good news is that we're more insulated than others. The tech industry is less reliant on investment banks for cash (with some exceptions) and, on the whole, doesn't have huge exposure to the commercial paper markets either. There is some fear of a loss in customers, especially for those who service Wall Street -- but there should be lots of integration work in the meantime. On the startup front, VCs still have plenty of cash for investing, and while they only put out cash calls on committed money when it's needed, it's unlikely that most limited partners (i.e., investors) in VC funds will be unable to meet those calls. The big investors, like university endowments, aren't likely to be impacted too badly. You'll likely see some slowdown in startup investing, as VCs get nervous about the overall environment and the potential decrease in exit opportunities.
But, for the most part, that should just mean better and stronger startups get funded, as the investors end up asking better questions, and only the best survive. Downturns are the times when the best startups get created.
I'd expect there also to be some fallout in the online ad market, for a few reasons. The mortgage/real estate industry has always been a big spender in the space, and that's going to drop off (if it hasn't already). Some of the other businesses impacted by the whole mess will also cut back on advertising. However, the market may start to consolidate around advertising models that actually show strong ROI, but will move away from "advertise and pray" models. Once again, the long run result may be better advertising models, rather than a lot of the crap we see today -- and that's a good thing.
To sum it all up
It is a huge mess, no doubt. The splurge is quite risky -- and while I can appreciate the upside potential, if done right, that "if" scares me a lot. I'd be much more comfortable with it if it wasn't being pushed through in its entirely in such a quick manner, with partisan players on both sides going on the news yelling at the other side each night. Instead, focus on a smaller initial package and spend a bit more time working out the bigger deal later, with a lot more input. In the short term, there's still going to be a fair amount of bloodshed, and the downside will impact companies outside of the financial sector, but for those in tech, the good news is that we're probably more isolated than other industries, though certainly not completely isolated. And, since everything is changing so rapidly, you never know what shoe might drop next.
However, in the long run, there is still money out there, and there are still opportunities. People will need to put that money to work one way or another, and rather than freaking out, now is a time to be looking for the opportunities created by this mess, and the tech industry is likely to have a lot of those opportunities. Remember that for every bubble bursting, something ends up getting devalued below its real value. The trick is just figuring out what it is before anyone else notices.
by Mike Masnick
Wed, Jun 25th 2008 9:26am
from the not-quite... dept
As the article notes, the figure is clearly exaggerated. However, many of the other criticisms of what McCain says seems misguided. It seems like a stretch for anyone to think that McCain is suggesting that people will find jobs selling on eBay. Rather, he's using the example of eBay to note that innovation leads to new ways for people to make money -- using the rise of the ecosystem around eBay as an example -- not as the definitive method for creating jobs. And, on that, he's correct. Continued innovation does tend to lead to job growth.
The second part of the criticism that seems incredibly unfounded, is the assertion by a few economists that eBay is just a business model for moving junk around, and that it doesn't add anything to the GDP. This is simply incorrect, and it's really strange that prominent economists would make such an assertion. eBay is about making an efficient market. Plenty of people use it to sell new products, rather than just "junk." And, many of the people who use eBay to "make a living" do so by adding value to products which they then resell. That does add to GDP. eBay is about a lot more than just moving around junk. In fact, a rather large percentage of our GDP is based on taking already built goods, adding value to them and reselling them. To pretend this doesn't happen on eBay is simply incorrect.
Now, before anyone thinks that this means I support McCain's economic positions, I don't. I think his continued disdain for basic economics, and his seeming assumption that economics can be handled by someone else is problematic. And, of course, his proposed gas tax holiday is just downright nutty.
by Mike Masnick
Tue, Jun 10th 2008 3:53am
from the holding-off dept
by Mike Masnick
Thu, Sep 13th 2007 7:01am
from the take-that,-RIAA dept
The report is put out by the Computer and Communications Industry Association, of which Google, Yahoo and Microsoft are members. There's little doubt that the report is just as biased as the reports on piracy numbers -- but really what this report highlights is how bogus the numbers are in the piracy reports. You can put out a report that'll show just about any "loss" or "gain" if you get to set the assumptions and conveniently ignore certain things and double count other things. In this case, the CCIA was fairly rigid in using WTO approved methodology for how countries are supposed to count the value added for the copyright issue -- they just applied it to industries that are based on fair use in some way or another. You can certainly quibble with how they pick which industries are enabled by fair use, but at no worse a level than how the copyright lobby defines the importance of copyright-based industries. Either way, though, if the copyright industry is going to keep publishing its bogus reports, it's hard to fault the CCIA for using the same methodology to show how much more important fair use is. The next time anyone cites the bogus piracy numbers, they should at least be forced to acknowledge these numbers on the value of fair use as well as a counterweight. They may be bogus, but they're equally bogus to the piracy numbers. In the meantime, it's probably also worth noting that Microsoft is on both sides of this debate -- as an active member of the BSA which is famous for its bogus numbers, as well as a member of the CCIA. Apparently, the company is a little confused on its position on copyright.