I have long thought that the gigantic mega-financial institutions of the late 20th/early 21st century significantly overshot the synergies and economies of scale ostensibly underpinning their business model, to find themselves firmly positioned in the realm of diminishing returns and unmanageable complexity. The foundations of this thesis are built on my interpretation of the application of Coase’s Theory of the Firm in the context of massive advances in ICT (Information and Communications Technology) and the business of modern finance. (Indeed, more recently I have articulated this thesis at the Park Paradigm with respect to the specific examples of Citigroup and ABN Amro.)
I’m not suggesting that no economies of scale make sense in banking or financial services more generally, only that they are subsumed by complexity within these ‘integrated’ financial behemoths. I even have some sympathy for the seductive logic underlying integrated business models, however in my view the theoretical benefits of an integrated model - while possibly intellectually robust on paper - are impossible to exploit in reality. It ignores what I describe as corporate entropy: ie in any corporate process there exists an inherent tendency towards the dissipation of useful energy.
Indeed - sticking with the chemical analogy and without writing a book about it - it would be fair to say that giant bank mergers are at best an (intrinsically unstable) intermediate product in the reaction coordinate and to make any sense need to be followed by a subsequent division into multiple new end products (which individually release the benefits of economies of scale and synergy without the instability engendered by excessive complexity.) So Citigroup (or UBS or HSBC or RBS/ABN Amro, etc…) should naturally “decay” to form multiple specialist firms that are more focused and efficient than the multiple firms that had been combined first to form these giants. Until now however, it seemed that my point of view was not shared by many (any?) of the leaders of these mega-institutions, nor more generally by senior executives in the industry.
Still, there are two clear disadvantages of the integrated model:
Increased complexity, which places a greater demand on the competence of the Board and management, as has been amply demonstrated by the proprietary trading losses
Conglomerate and complexity valuation discount and potential contamination of the valuation of the most valuable business, Wealth Management, by the lower rated and more volatile business, Investment Banking.
I’ve never had the pleasure of meeting Mr. Arnold but the little I know about his new venture Olivant (gleaned almost entirely from press coverage and their website) lead me to believe that we share (at least some significant) views of how both to best structure what I would call a modern merchant banking operation - combining operational advice with investments - and the latent problems and opportunities of the current financial services industry paradigm.
Blogged in Ideas, People by Sean Wednesday August 22, 2007
…to James Montier and his long-awaited entry into the blogosphere. James is a former colleague and is an expert in Behavioral Finance. Indeed his research notes were among the only consistent ‘must reads’ in the firehose of analyst notes I used to receive in my previous life. He has recently left Dresdner Kleinwort and while between jobs has decided to start blogging; one can only hope his future employers allow him continue and that he remains motivated to do so once back in the banking salt mines!
I suspect that if more traders and hedge fund managers had read James and taken on board his insights, there would have been far less hubris and perhaps far fewer distressed situations in the markets over the past month or so. Then again, that wouldn’t be nearly as interesting to watch…
(Thanks to Rowan for directing me to James’ new site.)
Last week something special happened in Tanzania. A moment in time. A jumping off point. (Say it softly…) a new future for Africa. The next chapter.
Over the past few years, a growing number of people in the TED community have become passionate about Africa, a continent that appears to be at an important tipping point. Its problems and challenges are well known. Less well known is that across the continent, change is afoot. Instead of relying only on development aid, Africans across the continent are beginning to take matters into their own hands. Ingenious solutions are being applied to tackle some of the toughest health and infrastructure problems. Businesses are being launched that are capable of transforming the lives of millions. New communication technologies are allowing ideas and information to spread, enabling markets — and governments — to be more efficient. And the numbers suggest that incomes are starting to nudge up in some countries and real growth is on the way. A new Africa beckons.
Last week I had the opportunity to attend TED’s second ever ‘Global’ conference. This time the focus was on the future of Africa and the setting was the lush mountains of northern Tanzania near the city of Arusha. The team at TED did what they seem to always do and produced an experience that exceeded the already high expectations (perhaps even their own!) The conference program was put together by Emeka Okafor; his blog - Timbuktu Chronicles - is a must read for anyone interested in African business and entrepreneurs.
One of the nice things about TED conferences, is that there is always a complete, rich and diverse conversation in the blogosphere reporting on, analyzing and extending the many presentations and conversations that happen at the conference, growing over time as the best presentations are released on TED Talks for the whole world to see. It doesn’t capture entirely the amazing energy that permeates the physical conference but nonetheless is a damn good consolation for interested people who didn’t have the opportunity to attend in person. For those of you that are interested, by searching for the tag - tedglobal2007 - on Technorati or other blog search engines, you will find a wealth of information, and in particular Ethan Zuckerman has written an amazingly complete and accurate blow-by-blow account.
Given this wealth of commentary and information out there, I just wanted to add a few thoughts on what I learned or (more precisely) what ideas I took away from Tanzania last week:
There is a new generation of young, intelligent and ambitious Africans that are determined to lead their countries and people to a better future, not through the bankrupt political and government institutions of the past but despite these institutions through enterprise, energy and talent.
There are a tremendous number of new and exciting business opportunities emerging all over the continent. The mobile telephony revolution is just the most visible of these; it is just the tip of the iceberg.
Perhaps the single most important missing element from the development equation is the lack of basic infrastructure: roads (transport), power (generation and distribution) and (internet) bandwidth. It’s not sexy but is nonetheless the foundation upon which a modern economy is built. Without basic infrastructure, efforts to improve health, education and productivity (especially in agriculture) will struggle to have any lasting impact.
There needs to be a greater focus on creating wealth (and I’m not talking about extracting rents from mineral and resource extraction in order to enrich some for some corrupt elite) rather than just reducing poverty. An important semantic distinction.
The debate around aid is complex; a dialog that recognizes this complexity and seeks to improve on the mistakes made in the past is to be welcomed. However, it seems clear that whatever the ‘right’ balance between aid and investment might be, there is currently insufficient private investment on the continent. Perhaps some component of western aid should be aligned to fostering (not subsidizing) more private investment, for example by mitigating the risks arising from the weak legal and institutional frameworks (as opposed to ‘business’ risk which is something that private capital is good at financing.)
To steal a line from JP, this is very much a provisional post - the beginning of a journey, not the certainty of the destination.
And if you want to listen to some of the ‘cheetahs’, here are links to a few of those I had the privilege to meet or hear speak at TED:
Blogged in Ideas, People by Sean Thursday May 17, 2007
I’ve been a fan of Ray’s for the past few years, ever since I was introduced to his papers on the “Law of Accelerating Returns” and then when I first read his book “The Singularity is Near” in late 2005. Indeed his thesis was one of the key pillars upon which I built my “3 Things” presentation. Up until very recently, however well known he was in the world of geeks, TEDsters and academia, insofar as he was known to a wider audience it was generally as the inventor of the ubiquitous and eponymous electronic keyboard, but that is all changing as his ideas (perhaps thanks to the wonderful ability of new networks and publishing tools are enabling the diffusion of good new ideas to the extent they can no longer be ignored by traditional media) - as his speaking fees apparently have jumped from $2000 to $25,000, a forthcoming documentary and a big feature article in Fortune attests…Ray is now officially an icon. Well done.
For those who still haven’t heard Ray’s thoughts on the future, here is a good 20 minute synopsis:
Next thing you know he’ll be dating Lindsay Lohan…I hope it doesn’t all go to his head!
For those of you who have not been following the French election (here is a good synopsis of the first round from Tim King at Prospect), this weekend France will choose between two very different visions of the future. On Wednesday, I watched the televised debate between Sarkozy and Royal. And having led the field throughout, if you believe the betting market, he will be the next President, with over €1mn traded he is currently priced at 1.12 on Betfair (1:8 on, or c. 88% probability):
Given the well known predictive powers of such markets, I have been somewhat dismayed not to see this referred to once during the campaign; obviously I haven’t read or watched every bit of mainstream press coverage of the election but I have been following the campaign closely and have never seen a mention of the Betfair market (or InTrade which although less liquid has a similar price, efficient markets oblige!) not even in the Economist, relying as with the rest of the press on polls alone (these too have Sarkozy ahead with c. 53% of the expected vote.)
Many sense that this election may mark a turning point for France. Volume is high (as they say in the trade) - giving real significance to the result on Sunday (from The Economist):
This weekend’s presidential election has captured the imagination of the French like nothing else for years. On Wednesday May 2nd, a huge 20m-plus people tuned in to a two-and-a-half-hour television debate between the Socialists’ Ségolène Royal and the Gaullists’ Nicolas Sarkozy—nearly as many as watched the 2006 World Cup final. Campaign rallies have drawn tens of thousands. Turnout in the first round of voting was at its highest since 1974. The burden of expectation about the start of a new era, after 12 stagnant years of Jacques Chirac, is almost worryingly high.
If Sarkozy wins, my view is that it will be due to a strong vote from the (usually) silent majority who (as witnessed in the enormous turn-out) have had enough. France is clearly not the only democracy that suffers from capture by motivated and vocal advocates of what ultimately are views held only by a minority, but for many many reasons (enough to fill several books I’m sure) France has had a particular bad time of it in this respect over the past 20 years. But every once in a while, when enough-is-enough, the silent majority makes itself heard. And for its rarity, the sound is reverberates that much louder.
The French are just as capable, intelligent, innovative, industrious as any other nation, possibly more than most, making the politics of defeatism, fear and envy that have monopolized the economic and political scene in France since (at least) 1981 even more frustrating and depressing than they would naturally be. The apogee of this incredibly pessimistic world-view, utterly lacking in self-esteem is embodied by the thinking behind ‘les 35 heures’ - the government legislated work week; a policy that is rooted in the fallacy that there is a fixed amount of work that needs to be ’shared’ and yet another example of the State micro-managing the economy. Indeed the conviction that the State can and should seek to ‘fix’ all the problems of the nation and its citizens is a belief that has historically had significant currency in France. It will be interesting to see if - by voting for Sarkozy - the French have had enough of being treated like children by an over-ambitious State. Indeed one of the great (unintended) tragedies of French government policies - especially policies with respect to taxes (including social security ‘contributions’) and suffocating labour regulation - has been to expatriate hundreds of thousands of some of the brightest, most ambitious of their citizens. One only has to look at London which with several hundred thousand French nationals is probably the wealthiest and most dynamic ‘French’ city. How many great French entrepreneurs have had to leave the country in order to successfully get their business off the ground? Of course these are the very people who are the key catalysts of job creation, only the jobs are not being created in France. What if France took the approach Ireland took a decade ago and created a environment friendly to business and to success? My personal opinion is that you would see a flood of expatriates returning home, creating hundreds of thousands of jobs and significant wealth.
Both candidates have made much noise about how they want to help entrepreneurs and small business owners. Royal wants to give special tax breaks and institute a number of State run programs to encourage small businesses. But what is really needed is for the State to get out of the way. Less not more. Sarkozy is at least acknowledging that there is a need to stop suffocating business and entrepreneurs, although he - perhaps through conviction, perhaps through electoral pragmatism - also advocates a strong role for the State in the workings of industry. It’s is unfortunate that he chooses to highlight the rescue of Alstom not as a sound and (very profitable) ‘trade’ - which it was - but as a chauvinistic protection of French industry. Rather than rail at the evils of hedge funds, he should be striving to bring the same dispassionate performance-driven approach to managing the assets of the State and helping the French to understand that the best - the only - defence against ‘insecurity’: unemployment, low wages, poor prospects, is a flourishing, dynamic and wealth-creating economy. It is also the only true guarantor of the sustainability of generous and high quality public services over time.
Perhaps, just perhaps, the French people are ready to stand up and take their individual destinies back into their own hands. As Mr. Sarkozy is wont to say:
Il n’y a pas de fatalite.
If indeed he is elected though, I hope he will be able to temper his own prediliction for seeing the State as a means to every end and perhaps take another look at the thinking of Bastiat: a great French classical liberal theorist, political economist, and member of the French assembly (quoted at the beginning of this post) who managed to combine sound economic thinking with eloquence and wit. I always wonder why his arguments never seem to be used in the French political arena to defend liberty and markets; I mean after all he’s not some dodgy foreigner like Adam Smith or Milton Friedman! In an article published in July 2001, The Economist does a good job of summarizing Bastiat’s contribution to the economic canon:
Bastiat is best known for an essay in which he petitions parliament on behalf of the candle makers of France. His complaint is against the “ruinous competition of a foreign rival who works under conditions so far superior to our own for production of light that he is flooding the domestic market with it at an incredibly low price.” The rival is the sun. His proposed remedy is the mandatory shuttering of all windows. That, he claims, using all the standard protectionist arguments, will benefit not only the candle industry but also all the industries that supply it. As a compelling statement of the case for free trade, this essay is hard to beat.
During the building of a railway to Paris, it was proposed that there should be a break in the line at Bordeaux because it would help businesses there, such as porters, storage firms and hoteliers. Brilliant, said Bastiat. What better way to boost prosperity in France than to have similar breaks at Angoulême, Poitiers and all intermediate points? “By this means, we shall end by having a railroad composed of a whole series of breaks in the tracks, ie, a negative railroad.”
Noting the popular view that exports are good and imports bad, Bastiat wondered if the best outcome would be for ships carrying goods between countries to sink, thus creating exports without imports. Debunking the “lump of labour fallacy” before it was even given that label, he suggested that to parcel out the limited amount of work available, people should be required to use only one hand, or even to have a hand chopped off. Missing the irony, France recently imposed a maximum working week of 35 hours a person, hoping to share out available work.
France is a remarkable nation, and as my adopted country I have been enormously frustrated by the policies and mindsets that have tied it up in knots. Indeed its success despite these shackles only serves to underline the tremendous potential that could be unleashed. So Sunday I hope that whatever the outcome, this election will have marked the moment when the French decided that the politics of envy and dependence were not worthy of them and they deserved the opportunity to fulfil their vast potential.
And of course anyone wanting to hedge against the possibility of a Royal presidency can get a pretty cheap option at c. 10 to 1 at Betfair, and given the unpredictability of the French electorate, if I were running a small business in France I would probably plonk down a few points of my turnover on such a hedge, at least then if Royal won, I’d have a nice windfall to cover my increased taxes and administrative burden!
I have an enormous pile of clippings, too many dog-eared pages in brilliant books and a gazillion bookmarks tagged ‘to blog about’ … so perhaps after a several month hiatus, loyal readers may find more substantial fare geared to the core theme of this blog which is the future of financial services.
Forerunners are racers that are sent down ahead of the competitors to set a track and to report any problems or anomalies to the race organisers (ie guinea pigs.) It was alot of fun and great training, although I did get off to a bit of a rough start. On the first run of the first day of Downhill (same hill as the Challenge des Entreprises but a longer course and faster) training, I crashed in the finish area. Slight concussion, bruised tailbone and wrenched back. In a daze went back up and opened the second training run as well - although more slowly…was out for a day so missed the second day of downhill training but feeling better (and needing to ‘get back on the horse that threw me’) I was back for the race day. Also opened the SuperG and the GS. I was pretty slow until the last GS run - I’d be lying if I said the crash didn’t knock my confidence - but it was a great experience to ski alongside some really and truly excellent and world class skiers. Yes, the UK has some very very good racers. Chemmy Alcott who swept the board in the women’s events is one of the best in the world and is still improving. Finlay Mickel is a consistent Top 30 performer in World Cup speed events. And lesser known, but exciting young racers like Dougie Crawford and Louise Thomas and others are coming up the rankings.
Like anything, being with people that are better than you (at something) is the best way to learn, be inspired and improve. And so prepared, I had my best results of the season in a couple of GS races in Courchevel last weekend, coming 4th and 5th respectively, and getting a result of 121 points a lifetime best (!) for GS (I think I got them down to c. 140 when I was a kid, although my Downhill points were sub-100.)
All in all a good way to feel 10 or 20 years younger!
Leo Melamed, godfather of the Chicago mercantile exchange, changed investing forever with financial derivatives. Here’s what this market visionary thinks is next.
Way back in 1972, the head of the Chicago Mercantile Exchange had a crazy idea: If you could trade futures on pork bellies, wheat and beef, Leo Melamed wondered, why not on Swiss francs or deutsche marks? Or any other financial instrument for that matter? That notion has radically changed the way market risk is managed.
Way back in 2000, Andrew Black and Ed Wray had a crazy idea: If you could trade derivatives on financial instruments, why not on the outcomes of horse racing or soccer? or any other sport for that matter?
Here in 2007 (and for the past 2-3 years), I’ve been thinking about what I call particle finance, as analagous to particle physics. I firmly believe that advances in information and communication technology will allow us to reduce financial (and more broadly speaking) risk management to its smallest and most fundamental component parts. We are on the verge of discovering and being able to manipulate the quarks of the risk management universe. The ramifications (if my thesis is correct) are enormous and potentially highly disruptive.
In many instances progress will be hampered by powerful incumbents protecting the status quo via regulatory and legislative barriers. But ultimately I don’t think you can keep the genie in the bottle; the US in particular runs the risk of losing it’s pre-eminent position as an innovator in financial services and risk management unless they succeed in reforming their often parochial and restrictive regulatory environment. This in fact was the conclusion of Mayor Bloomberg and Senator Schumer in their recent report on the future prospects of New York as a global financial center:
The joint report stipulated that while many of the causes are due to improved markets abroad and sophisticated technology that has virtually eliminated barriers to the flow of capital, a significant number of the causes for America’s declining competitiveness are self-imposed. For instance, U.S.-based financial services firms are now unable to attract and retain many of the highly-skilled professionals they need because of caps on the number of visas available under U.S. immigration rules. A greater perceived litigation risk has also reduced the appeal of the U.S. market to many foreign firms. Finally, a complex and sometimes unresponsive regulatory framework has not only prompted many foreign firms to stay out of the U.S. markets, but also is forcing more business overseas because of the complexity and cost of doing business in U.S. financial markets regardless of where they are located. The joint report offered several recommendations, derived from detailed analyses of market conditions here and abroad, informed by interviews with more than 50 respected leaders drawn from the financial services industry, consumer groups, and other stakeholders. The recommendations focus on near-term administrative actions that can signal renewed U.S. focus on competitiveness, actions to level the playing field for both domestic and foreign companies doing business in the United States, and longer-term initiatives to address more complex policy, legal, regulatory and other structural issues affecting the U.S. position as the world’s leading financial center.
Their recommendations are straightforward and would indeed have a powerful liberating effect on American financial and risk markets, to the benefit not only of American individuals and corporations but also globally given both the size and depth of US markets and the proven American ability to marshall innovation (when allowed to do so - it is not a coincidence that the US is starting to fall behind in telecoms and financial services as these happen to be two of the most protected and regulated industries…), let’s hope they gain the grass-roots political traction they deserve and don’t get hacked into irrelevance by the dinosaur brigade:
Recommendations to sustain the nation’s and New York’s global financial services leadership:
Provide clearer guidance for implementing the Sarbanes-Oxley Act;
Implement securities litigation reform with particular short-term emphasis on leveraging the SEC’s existing authority;
Develop a common vision and a supporting set of shared regulatory principles;
Ease immigration restrictions facing skilled non-US professional workers;
Recognize IFRS without reconciliation for listing purposes and promote convergence of accounting and auditing standards;
Protect US global competitiveness in implementing the Basel II Capital Accord;
Form an independent, bipartisan National Commission on Financial Market Competitiveness to resolve long-term structural issues;
Modernize financial services charters and holding company structures;
Establish a public/private partnership to promote New York’s local agenda by acting as the high-level liaison between individual industry participants and the city, as well as by driving forward the partnership’s broader strategic plan for New York’s financial services development.
More actively managing attraction and retention for financial services;
Establishing a world-class Center for Applied Global Finance, and
Potentially creating a special international financial services zone.
Anyhow, to come back to the original point - Leo Melamed and the CME should indeed be celebrated for their role in bringing financial derivatives to life and developing and extremely important and robust set of markets that are now part of the very fabric of our global economy. At the risk of sounding presumptuous, I would love to be able to look back in 20 years on a legacy analogous to Mr. Melamed’s; as one of the people who were instrumental in bringing the benefits of particle finance - of ubiquitous and super-efficient risk management and risk transfer - to a global audience. I’ve often been thought crazy (by my managers or colleagues) but apparently I’m in good company here:
(Leo Melamed describing how he came upon the idea of financial futures) And then, finally, I came to the thought that Bretton Woods, the fixed-exchange-rate system, was coming apart. And when it finally comes apart, wouldn’t there be a need for foreign-exchange futures? Our board thought I was crazy, and very frankly I thought it was a little crazy too, because why hadn’t anybody else done this? I went to Milton Friedman, though, and he absolutely embraced the idea.
Well I don’t have Mr. Friedman but I was a syndicate manager and so I guess my challenge over the coming years will be to successfully syndicate my ideas. I’m still thinking about what the right structure might be…but good ideas, like good bonds, tend to sell themselves (but a good story always helps to get the ball rolling!)
DERIVATIVES and foreign-exchange broker ODL Securities has bought Bestconnect, an electronic-dealing service, from investment bank Dresdner Kleinwort for about £5m. ODL, led by Graham Wellesley, a descendant of the Duke of Wellington, aims to use Bestconnect technology to launch into the retail spread-betting market competing with rivals such as CMC and City Index. Last year Wellesley lost out to City Index in the battle to buy IFX, the spread-betting and forex group.
The bestconnect team was previously part of the Digital Markets group I ran at Dresdner. I wish them all the best and a great start in their new home.
Given my new freelance, unregulated, status I thought it was time to try to update the look of the site a little. I’m very grateful to Ranjit Gahir for conceiving and coding the new look.
One of the items on my ‘to do’ list is to learn a bit more on how to create and adapt and run a website. Not that I’m going to become a expert (or even a solid amateur) but I think it is worth knowing a bit more about how it all works. Sort of like knowing how a car works without necessarily having to be a mechanic.
Anyhow, I know JP has been engaged in a revamp of Confused in Calcutta, so in the spirit of ‘keeping up with the Rangaswami’s’ I’ll be trying to improve and tweak the look and usability of the site over the coming weeks. Any views or ideas welcome (but only if you are ok with the idea that they could well be ignored, either by design or lack of competence on my part…)
The most popular and well-loved companies, products, and causes have the strongest opponents.
You’ll know when you get there, because the buzz goes from pleasant to polarized. Moderate, reasoned reviews and comments are replaced with stronger language and more colorful adjectives on both sides. Those who speak out against you will be referred to as “brave” or “having the balls” (see the comments on Scriven’s review) for daring to criticize. They’re hailed as the smart ones who finally call the emporer on his buck-nakedness.
Should you ignore the detractors? Diss them as nothing but evidence of your success? Should you just wave them off with a “just jealous” remark? Absolutely not. Somewhere in their complaints there are probably some good clues for things you can work on. But if you start trying to please them all or even worse, turn them into fans, that could mean death. Death by mediocrity, as you cater to everybody and inspire nobody.
It is physically impossible to have everyone love what you do. And the more people do love it, the more likely it is that you’ll have an equal and opposite negative reaction. X = -Y the physics of passion.
Anyhow good luck JP, I’ve enjoyed working with you and I have no fear that you’ll be able to stay well clear of the zone of mediocrity, even if that means ducking a few bits of flying detritus. Then again, don’t drink too much of your own kool-aid, otherwise you really will end up looking (and acting) like this:
