New Business Paradigm Needed

10 10 2008

Like many I have been watching the new reports of financial meltdown in global markets – lead in a spectacular way by the US. Although we shouldn’t feel immune -

“At current levels, the ratio of household debt to income (excluding student loans) is similar to those found in Australia, the UK and USA.” from notes on NZ Household Debt graph.

The crisis seems to have moved from being a financial one to a crisis of personal confidence.

It seems that unless you are in an industry sector such as Real Estate then the business fundamentals shouldn’t have changed but the “bad news” reports do cast a shadow over many sectors.

I agree with those who think that the dominance of US media interests means that we get to hear the screams much more than if it was happening in Russia, China and India. The signal to noise ratio in mainstream media – especially TV, is completely unbalanced and devoid of sensible analysis.

It seems like Western style business is based on constant growth regardless of the longer term needs. Longer term merits are being scrapped in favour of what can be ramped this quarter.

In New Zealand we are generally unsure how the macro economics work. ( Some key graphs might help here. ) Add to this the timing of a general election campaign and the usual lolly scramble of promises to sway voters. (NZ – November 08)

We know that when NZ interest rates are high that external investors invest here.
When NZ interest rates go down – the exchange rates go down.
Exchange rates coming down means oil & petrol prices go up

This all creates an extra finance squeeze on all of us.Somewhere in there is a tipping point where in order to attract more capital in the interest rates need to go up again.

An interesting side effect of Australian interest rates coming down by 1% last week might just benefit NZ. This is because all of the big banks are owned by Australian companies who get at least part of their funding from Australian sources. The NZ Reserve Bank is due to make an assessment on Oct 23.

I don’t think it is a popular idea but the core consumerism that drives much of our economy is really the flip-side of the ever demanding corporate growth curves.

At some level we are tempted to think that a bunch of greedy corporates have caused much of the problem when our own over spending and consumerism is also a contributing factor.

In short – most of us don’t have really sustainable lifestyles because when we get a few steps ahead the temptation to trade-up is presented to us.

For those of us who have lived through a few of the earlier economic shocks in 73, 87 and others have hopefully learned to leave some slack in the system. In NZ many of the local corporate cowboys got cleaned out in ‘87. I believe it was a similar situation in Australia.

Earlier this year a number of finance companies have collapsed and while this created some real local pain it does mean that some of the hype went out of the local markets here.

In the US the sheer size of that economy meant that had the luxury of making the same mistakes from earlier times ( Savings & Loans Crisis ring any bells? )

The net effect is that the economies of ANZ are much closer to natural* levels of real business and we are working off a lower baseline. By natural I mean businesses we can understand not hyper trading in derivatives and artificial markets.

Off balance sheet legerdemain was supposed to stop after Enron but as we now know the cards were just shuffled a bit.

Related to this idea – I believe one of the key issues in global financial centres has been a flawed banking system as described by Robin Blackburn in a much longer analysis of the sub-prime crisis much earlier this year.

“The management of risk—especially systemic risk—in the financial world was evidently deeply flawed. An important part of the problem was that core financial institutions had used a shadowy secondary banking system to hide much of their exposure.

Citigroup, Merrill Lynch, hsbc, Barclays Capital and Deutsche Bank had taken on a lot of debt and lent other people’s money against desperately poor collateral.

Prior to the us deregulation and uk privatizations of the 1990s, us investment banks would have been barred by the Glass–Steagall Act of 1933 from dabbling in retail finance, and Northern Rock would have remained a solid, and very boring, building society.”

“….the pursuit of a market in almost everything led to a banker’s nightmare in which key assets could not be valued.”

Robin Blackburn is a historian and sociologist.

Blackburn’s vast knowledge of history is very useful as he mentions a couple of historical success mechanisms that were used in the US and the idea of the HOLC needs to be revisited in a section called Lessons of the 1930’s.

“The HOLC (Home-Owners Loan Corporation) bought mortgages in default from the banks and offered the borrowers lower repayment terms.

Within two years the HOLC had received 1.9 million applications from distressed homeowners and successfully re-negotiated one million mortgages. It closed in 1951 after the last 1936 mortgage was paid off.

While the HOLC was dealing with subprime borrowers, Fannie Mae made it easier and cheaper for prime borrowers to get a mortgage, using its Federal guarantee and tax-free status to organize a secondary mortgage market that underwrote any residential mortgage up to a certain value.”

Of course that Fannie Mae has now come unstuck after it was partially privatised in 1968

“However the semi-privatization can now be seen as a huge mistake, since it allowed the two government-sponsored enterprises to take on inordinate amounts of debt in a bid to promote securitization and boost earnings.”

One of his key ideas is that of financialization (in essence the disconnect between real markets and finance instruments like derivatives.)

“In order to grasp today’s capitalism we need financial analysis, but the phenomenon of financialization sucks oxygen from the atmosphere.

It privatizes information that should be public, just as it commercializes everyday life and promotes a pattern of ‘uncreative destruction’ in which enterprises and work teams are continually broken up and re-assembled to take advantage of transient arbitrage gains.”

And how does a country with a population of 320,000 get such large finance problems (Iceland) after coming top in so many indicators of wealth. Perhaps the fact that it had a

“banking sector (that) has assets nine times the country’s annual gross domestic product of $19 billion.” from Chicago Tribune From some charts I have seen Sequoia Slideshow – the US derivative market alone got to 35 times the US GDP

Not such a good idea. Now for the better news from Robert Peston BBC

“The best time to invest, always, is when everything looks gloomiest. That’s when the bargains are to be had.

But normally those bargains are only available to the super-wealthy. Those on low incomes almost never have the money to invest when asset prices are low.

However, if endowed with a jumbo loan from taxpayers, PADA could invest like Buffett on behalf of the low paid.” Peston

Some other points that should help build confidence levels

Growth rates in India and China are still high (though slowing.)
Baby boomers still need to invest their savings in much larger numbers
Australia has had major growth of Superannuation funds for the past 20 years and this creates a local capital pool for ANZ businesses to a greater extent than before.
New Zealand Banks are safer. Read the list to learn how.
Immigration numbers to NZ - while much lower will continue to grow population demand over time
More background

All markets are not the same and that is an opportunity.

Continue reading New Business Part 2 over here. I made so many extr notes and upadtes that have split the revised post into 2 sections to make it easy to read.

Update: Oct 11 – Dave McClure is based in Silicon Valley where it is always tough – but you need to be positive to get through. Among other thinks he references the litany against fear…

Fear is the Mind Killer of the Silicon Valley Entrepreneur (we must be Muad’Dib, not Clark Kent):- Dave McClure – make a lot of very good points – caution -this post uses very forceful language which might get stopped by your firewall – but its passion and essence is right on.

“while i don’t profess to understand credit or capital markets, i do know that internet startups cost less money than ever to get started. and unless i missed something, there are more people online now than ever, spending more money online than ever.

and i doubt any of these trends will likely reverse in the long-term — lower costs, more people online, more e-commerce. doesn’t that seem like a pretty good environment for building new online businesses?”

And special thanks to Noric for listening to some of these ideas and making better sense of them.

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Date : 10 October 2008
Categories : big ideas

One response to “New Business Paradigm Needed”

11 10 2008: JasonK (11:45:08) :

Been thinking some more about this. Have also just finished reading Dave McClure’s “Fear is the Mind Killer” post and added it above.

Much of the current finance crisis come not paying attention to the business model. The risk management tools and structures used by some banks were so abstracted and the velocity so great that the underlying need for an actual REAL business model was lost sight of.

In dot-com land we have seen all this before and McClure reminds us of the constant pressure and exhilaration of winning against the odds.

So times are tough – but when you already work in a very competitive environment a change in one part of the risk profile – just needs to get in the queue.

Even when that is significant change it needs to be placed in context that not all markets are the same nor are all businesses the same.

They do however need a sound business model.

What do you think about all this – time for some more positive steps or?

thinking: relating- celebrating :-)