A few years ago Congressman Frank Wolf ranted in Congress that if UIGEA was not passed, people would be gambling in … (wait for it…) THEIR BATHROBES!!! Shocking I know. So many lives ruined. If they had only pulled on a t-shirt and a pair of jeans…
Anyhow, he voted for it:
In 2006, the Unlawful Internet Gambling Enforcement Act (UIGEA) was signed into law. This landmark legislation helps to cut off the flow of revenue to unlawful Internet gambling businesses. It outlaws receipt of checks, credit card charges, electronic funds transfers, and the like by such businesses. To do this, it enlists the assistance of banks, credit card issuers and other payment system participants to help stem the flow of gambling dollars.
This is about knowing all of the hard evidence about the byproducts of gambling – crime, corruption, family breakdown, suicide, bankruptcy – and not hearing our country’s leaders speaking out.
Where are the political leaders from both sides of the aisle? Religious leaders? Advocates for children, the poor and the elderly? Their silence is deafening.
It is time for Americans leaders to step forward and address the proliferation of gambling.
(Now replace gambling with banking and maybe we’re talking…UIBEA anyone? LOL)
Anyhow, as widely reported about a month ago, it now seems that the tide is turning, lead by Financial Services Committee Chairman Barney Frank – although I’m not really 100% why other than perhaps that the government needs the money more than it needs to pander to the anti-gambling minority? Or perhaps the gambling oligopolists have decided now they are ready to compete in this market? No idea. Or maybe the message on the absurdity of prohibition coming from the Park Paradigm has worked its magic! (Sure, it could happen…ok probably not.)
I was also pleasantly surprised to learn from (an excellent and newly discovered blog) Zerobeta, that Delaware was thinking about legalizing sports gambling (picking up on an ESPN article):
The newly elected Markell, who has spent the past several weeks listening to proponents of gambling as well its opponents, is much more of a pragmatist than a betting revolutionary. He hasn’t been to Vegas in nearly 15 years and almost never hits the race track/casinos (called racinos) in his home state. But the way he sees it is this: Delaware already allows horse racing and slots. And with the state currently $700M in the hole, offering the Pats minus-six over the Jets when bettors come by to drop a nickel in the slots isn’t amoral. As he told me a couple months ago, “you can’t really be half-pregnant.”
How refreshing. Legalize. Regulate. Tax. The best way to address Mr. Wolf’s concerns, not prohibition. And for those of you who want to trade the probability of this outcome, head over here to InTrade(HT to Chuck for the pointer.)
(Disclaimer: As some of you may know, I am an investor in Betfair and so have an interest in a free and regulated US market (given the current legislation Betfair does not trade in the US in compliance with all federal and state regulations.) However I would hope that those who know me and even regular readers know that my views on the subject are not driven by this investment. Indeed I would say this investment was driven by my views.)
It will come as no shock to most readers that I think one of the key opportunities of the next decade or so is to harness the possibilities unlocked by the advances in ICT – most notably the continuing march towards a ubiquitous, high-speed internet – to vastly lower transaction costs and enable robust, distributed marketplaces to emerge in sectors and activities where heretofore the (informational and transactional) costs of organizing such a market would have been prohibitive. While it is certainly an oversimplification, I think such opportunities can be broadly categorized into two groups:
those that make the transactional mechanisms of existing markets more efficient – either incrementally or by a quantum shift to a new market structure – by reducing informational friction and arbitrage and eliminating parasitic intermediaries while at the same time massively improving the productivity of ‘intelligent’ intermediaries; and
those that enable markets to emerge where previously none existed at all (or only in the broadest economic sense, but where transactions were previously ad hoc and opaque), often (but not always) these are markets for services (rather than goods or financial instruments) where the nature of the service is highly heterogeneous and in data terms is “unstructured” rather than “structured”*
Putting my money where my mouth is, I’ve taken the opportunity to invest in two exciting start-ups that fall into this second group: last year in seedcamp ’07 winner MyBuilder.com and just now in (seedcamp ’07 finalist) School of Everything. Both have passionate, energetic and visionary founders that have been able to translate their ideas into robust and well-executed platforms for organizing and ‘trading’ specialist services. As for any pioneering start-up, neither can be sure of success, however the combination of a fundamentally sound idea, in harmony with the inevitable secular change in how economic activity will be organized in a networked world, married to a strong committed team is as good a place as any to start.
I must admit in the case of SoE, part of my motivation to invest was driven by a more emotional and/or intellectual interest in what they have set out to do:
Our current education system was designed in the industrial revolution to prepare people for factory work. The world has changed a lot since then – and the time has come to rethink education from the bottom to the top.
At School of Everything, we believe that learning is personal, and starts not with what you ‘should’ learn but with what you’re interested in. So we’re building a tool to help anyone in the world learn everything, and teach anything, how and when suits them – by putting people in touch with each other, not with institutions.
Not only is education and learning the lifeblood of our modern economy and an important social good, but by creating a marketplace for people to ‘distribute’ and acquire skills and knowledge, SoE is providing another very useful output for harnessing what Clay Shirky has identified as society’s “cognitive surplus.”
Now, the interesting thing about a surplus like that is that society doesn’t know what to do with it at first–hence the gin, hence the sitcoms. Because if people knew what to do with a surplus with reference to the existing social institutions, then it wouldn’t be a surplus, would it? It’s precisely when no one has any idea how to deploy something that people have to start experimenting with it, in order for the surplus to get integrated, and the course of that integration can transform society.
The early phase for taking advantage of this cognitive surplus, the phase I think we’re still in, is all special cases. The physics of participation is much more like the physics of weather than it is like the physics of gravity. We know all the forces that combine to make these kinds of things work: there’s an interesting community over here, there’s an interesting sharing model over there, those people are collaborating on open source software. But despite knowing the inputs, we can’t predict the outputs yet because there’s so much complexity.
The way you explore complex ecosystems is you just try lots and lots and lots of things, and you hope that everybody who fails fails informatively so that you can at least find a skull on a pikestaff near where you’re going. That’s the phase we’re in now.
So if there is something you’ve always wanted to learn, or something you’d love to teach to others, School of Everything is a pretty good place to start. I wonder if anyone is giving courses on how to run a bank…you’d think demand for that might be pretty high these days… Given these tough economic times I suspect that SoE is even more useful, whether it’s to learn a new skill to keep an existing job (or find a new one) or to earn a bit of money and/or social capital by teaching if you’ve suffered the misfortune of losing your job or are working reduced hours.
In any event, I’m very excited to become a small part of this and congratulate Paul and his team on this follow-on funding and wish them great success in building SoE into a wonderful global marketplace for learning.
Zoopla.co.uk is a unique property website offering users information and tools to help them make better-informed property decisions. Our aim is to provide the most comprehensive source of residential property market information in the UK to help buyers, sellers, owners and estate agents alike and give them an advantage in the property market…
…We have started by providing FREE value estimates, sold prices and local information as well as letting users add content by editing information and uploading photos. We are the UK’s fastest growing property website and by far the largest and most active property community in the UK, with over a million user contributions to our website in 2008 alone…
…Our value estimates are calculated using a proprietary algorithm (a secret formula) that we have developed by analysing millions of data points relating to property sales and home characteristics throughout the UK. The algorithm works by comparing relationships between home prices, economic trends and property characteristics in given geographic areas. Our estimates are constantly refined, using the most recent data available and a variety of statistical methodologies, in order to provide the most current information on any home.
We are still testing and improving our features and tools and recognise that things aren’t perfect yet…
So what’s so interesting about Zoopla!? Or perhaps more specifically, how does Zoopla fit into Nauiokas Park’s investment universe? Two words: rich data.
In Zoopla, Alex and Simon Kain (co-founder and CTO), have leveraged the web to feed intelligent algorithms that allow them to bootstrap basic, publicly available data, into an increasingly more robust, accurate, rich and granular dataset of UK residential property.
They have built the site in a way that naturally compels visitors to improve and enrich the dataset. This user-generated data is not only very valuable but is itself subject to Metcalfe’s Law and so adds tremendously to the sustainable advantage of the site and their database. This is not trivial. When I was running a Credit Trading business, complex-data quality issues were absolutely critical to running the business efficiently and having effective risk management. We, like other banks, were plagued with bad quality (inconsistent, out-of-date, missing, etc. etc.) data. As a part of the ‘web-ification’ of our business (pre Digital Markets stuff), one of the single most effective things we did was to expose our various data structures to broad populations of users within the bank and allow users to correct and enhance the data on an ad hoc basis. Of course the ‘data priests’ were aghast…but it worked. Really I think it’s just applying a variation of Linus’ Law: “given enough eyeballs, all bugs are shallow.”
But how does a unique, rich, ever-improving, granular, transparent, database of UK property prices fit with Nauiokas Park’s focus on disruptive business models and technologies in financial services and markets? Well, we think Zoopla is ideally positioned to drive and benefit from a fundamental shift in the economic structure underlying the property markets. (This is a theme regular readers will recognise,) ie the shift from a market predicated on information scarcity to one build on information abundance. And you don’t even have to be particularly clever to work out how this is likely to play out, as property is the ith market in a series of [N] markets to have this thrust upon them. I don’t want to give too much away, but for the City types out there just think back to the bond markets of 1990. (For Wall Street types you only have to think back to oh about, 2004…) All other things being equal, as this “phase change” occurs in an industry, value moves away from transactions (matching) to data. (Think Merrill Lynch vs. Bloomberg LP over the past few years as a reasonable pair trade in this vein. Or all investment banks vs. Markit Group…)
Post-2008, even the proverbial man-in-the-street knows there was a data… how would you say… “issue”… when it came to the intersection of residential property and finance… Now I’m not suggesting (not quite anyways) that had Zoopla existed and been well-established globally years ago that the sub-crimeprime crisis would not have occurred (stupid is as stupid does)…but having easy access to the kind of readily “digestable” data available from Zoopla would clearly have been a boon to any responsible mortgage underwriter or securitization professional. In fact, I’d go so far as to say that today were I an institutional investor in UK RMBS, I would require that the underwriters/originators of the pools provide me with a FTP feed of the individual Zoopla data of every property in the pool. And if I were running say a big UK mortgage book and/or originator, I would certainly be interested in having an independent automated external mark-to-market run at least monthly, probably weekly…you get the idea.
And finally, whenever you have good, digital, reproduce-able data, well there my friend you have the makings of a myriad of listed and OTC markets in that underlying. Think Case-Shiller only better.
We are truly excited by the myriad of business opportunities available to Zoopla as it continues to grow and improve its core database and builds products and services on top, but perhaps most exciting is being able to participate once again at the early stages of a company that is set to play a key role in transforming an important and large marketplace, reducing friction and creating an entirely new value paradigm. Even reminds me a little of another UK start-up you might have heard of called Betfair… And we can’t wait to see what Alex and the team will achieve in the next few years and look forward to helping them in any way we can.
So, if you live in the UK, what are you waiting for? Go Zoopla! your home, claim it, enhance the data and presto, you now have effectively a pretty good proxy ticker-tape for (probably) the most important asset you own.
A pretty interesting space I’d say. I’d love to be able to attend the Greening of the Internet conference in a couple weeks but unfortunately it would be a bit of a luxury now and logistically impossible as well so I’ll just have to follow remotely. (If anyone spots a good live blog or two on the conference please let me know in the comments…)
Over the past couple years, I’ve become increasingly interested in the potential to combine technology, energy and markets to solve multiple problems concurrently. One of the absolute best people to follow if you are interested in this space is Bill St Arnaud; I highly recommend subscribing to his RSS feed or email list.
One back-of-the-envelope idea I’ve been touting for the past few years is that Iceland should reinvent itself as (one of) the data-centers to the world. Given the complete implosion of the Icelandic economy in 2008, if my idea makes any sense, it should be pursued even more aggressively. In a nutshell…
As the world inexorably moves to computing and storage as a utility, and as energy prices and climate change (price of GHG emissions) loom ever larger in the economics of cloud computing and data-centers, and as information transmission (bandwidth) costs continue to plummet, the relative importance of (carbon-neutral) energy operating costs will continue to increase strongly. (The other main factors being: construction costs, access to bandwidth, legal jurisdiction, security, availability of skilled workforce.) Sooo…. why Iceland? Cold climate and abundant green energy (geothermal now, offshore wave and wind later.) Heck the forward stream of CER’s (depending on what happens in Copenhagen) might even fund the upfront capital cost! Also one would guess that Iceland (as opposed to say Greenland or the Canadian Arctic) would have both reasonable construction costs and access to the skilled workforce needed to both build and then run these operations. I’m not an expert on data-centers but I don’t think they generate massive amount of jobs, but if this vision were to become true, Iceland could build a whole ecosystem around Green ICT and given it’s small population, I’m sure this would have a material impact on both employment and GDP over both the short and the long term. The biggest risk I can see would be natural disaster risk (ie volcanoes blowing up your data-center) and risk of damage to sub-oceanic fibre going in and out of Iceland. Both of which I think should be reasonably easy to mitigate and insure against. Plus, on the face of it, its geographic isolation and NATO membership probably make it a good choice in terms of security.
So…if I were managing a substantial Private Equity Infrastructure fund, I would (do a proper analysis of course but assuming my back of the envelope thinking holds):
Start talking to the Icelanding government, IMF and the World Bank/EIB about co-funding and incentive schemes (especially the required incremental undersea bandwidth
Encourage Iceland to join the EU asap because having data-centers in a EU jurisdiction will be a very important commercial imperative.
Start talking to Amazon (AWS) and Google about partnering / risk sharing as potential ‘anchor tenants’ (they could become to Iceland what Dell was to Ireland 20 years ago…)
Start talking to smart banks, hedge funds, etc. about innovative carbon-based financing and energy hedging structures.
Obviously this is just scratching the surface of the work that would need to be done but equally the myriad of collateral opportunities that would emerge as a part of such an ambitious project.
I’ve decribed this idea with varying degrees of detail to probably 2 or 3 dozen people over the past 2 years and no one has found a serious or obvious flaw in the logic. Then again none of them – myself included – had “done the math” nor was necessarily highly fluent in the mechanics/costs of building data-centers generally. Equally, none of them turned around and offered to raise a few million of seed finance either to do a feasability study, so you could say talk is cheap. So in the spirit of casting the net wider, I thought I’d write about it here and solicit experts to punch as many holes in the idea as it merits.
In any event, I never understood why Iceland put all its chips on banking and retail when it is so clearly at a comparative disadvantage in both domains…if nothing else my scheme at least has the semblance of logic behind it!
Last September I was asked to give a presentation at the DerivaTech conference in London on the merits of derivative markets. My basic premise was that derivatives are (just) tools: they can be incredibly useful and are not intrinsically ‘good’ or ‘bad’ but rather their utility (or danger to society) depends on how they are used. You can use a hammer to build a house. Or you can use it to bash someone’s head in. Getting rid of hammers because of this undesirable use case obviously wouldn’t make too much sense.
Further, I made the case that the industry had done itself an enormous disservice by “using the hammer” in the “wrong” way – by (deliberately) exploiting the ability of derivatives to obfuscate, the industry had not only ended up losing hundreds of billions but had done a great job in destroying perhaps its single most important core value creator. That of course would be trust. And in the bargain all the beneficial uses of derivatives risked being thrown out with the proverbial bath water.
Basically, as their traditional businesses and cash cows – agency trading, underwriting, etc. – had their margins melt and their business models / compensation structures made obsolete by the rise of the networked information economy (destroying information scarcity which lay at the core of the traditional banking business model), the banks turned more and more to principal risk taking – prop trading, derivatives ‘arbitrage’, etc. – to make up the difference. Putting aside the moral hazard (too big to fail, insured deposits etc.) issues this raised and ignoring for a moment whether or not it is an intrinsically good business model for a bank, it got worse as this shift coincided with a long period of low volatility and benign economic growth… This meant that the (real) opportunities disappeared quickly and – still needing to shore up the bottom line, to feed the blue line – what had started out as science slowly but surely slid into alchemy…
Of course this didn’t happen overnight, but slowly and therein lay the heightened danger: like the apocryphal frog boiling in a slowly heating pot, what started out as useful and reasonable ended up dangerous and irresponsible.
My guess is that this is what went down. Even though Madoff Securities was on the leading edge of automated trading, the business itself was becoming less and less lucrative. Everyone had the same computers. Spreads, the difference between the bid price and the ask price that became Wall Street trading profits, began shrinking. And the move to list stocks in penny increments instead of eighths (12.5 cents) whacked trading desks all over Wall Street.
So you make it up in volume. Beyond cocktail parties, Madoff really created the money management business to feed himself trades. But his strategy was garbage. He absolutely bombed as a money manager, but he desperately needed the assets under management to feed his trading operations, so he started to make the numbers up. As is usually the case, most don’t set out to be crooks, but Madoff became one when his talents proved lacking. There is your “why.”
It’s not new. This was the Enron story: They lost tons in water ventures and Indian power plants, so concocted fraudulent entities to cover up their losses. Same for Sam Israel and his Bayou hedge fund. And even (without the fraud) the Citigroup/Wall Street story, too. They tried to be investors to make up the difference of their bread-and-butter business deteriorating and were awful at it, so they levered up in off-balance-sheet vehicles.
So why are smart people seduced into these kind of strategies (ie bloody-mindedly pursuing disappearing returns to the point of destruction)? Obviously any trite answer on a blog post will fail miserably to do justice to this question, but if I had to venture a pithy hypothesis, it would be that – like it or not – most people are wired to prefer risking conventional failure over embracing unconventional success. Just ask the behavioral finance guys…I think it has something to do with continuing to dance.
So I can get my head around a ‘Madoff’ happening. What is harder to understand is what on earth the fund-of-funds who invested so much money with him were thinking? I may be obtuse, but I thought the main (the only?) reason for these businesses to exist was in order to identify, understand and monitor good investment managers. On this I have to say I agree with Martin on this (that financial companies who made money selling Madoff products should return their commissions.) And it is worth pointing out that regulators haven’t exactly covered themselves in glory either (which should be a cautionary tale for those who suggest that regulation is a panacea…)
Perhaps the only good thing to come out of all of this is that the cult of secrecy that for too long permeated finance will disappear. Don’t misunderstand me, there is a time and place for confidentiality. But too often it is indiscriminately invoked like some sort of fantastical talisman – out of all proportion and context – to hide not skill but incompetence.
And to end on a more optimistic note, the problem is with the ‘traditional’ (ie 19th/20th) business models in finance, not finance itself. And here at the dawn of the 21st century there is an abundance of opportunity to discover, invent and build the financial services industry of the future. This hasn’t changed in 2008. It just became a bit more likely to happen sooner rather than later. Remember the wise words of William Gibson:
The future is already here – it is just unevenly distributed.
Kind of a silly thing to do after the year we’ve just finished. If I’m right it’s dumb luck and if I’m wrong, well I’m wrong and don’t look too clever… And for those of you looking for specific numerical targets on liquid tradeable instruments, you don’t need to read further as I’m not sure these are useful at the best of times and I’m quite sure that I’m not going to put my name on what essentially are lottery ticket numbers… Besides any trader worth their salt knows that path-dependency and trading strategy is very often more important than actually predicting where something is going. And if I had forgotten this, 2008 served as a violent reminder as almost all my main macros calls turned out to be big winners and yet on my trading account I ended the year (in November when I essentially gave up pretending I had the time to properly manage any market risk or positions) more or less flat, and my best estimation of my overall net worth was approximately flat to down c. 10% in GBP – not too shabby but much less flattering when considered in EUR or USD… So what were these calls in 2008? In no particular order:
Short (UK/US) Banks, winner but…(too timid, took profits too soon – head faked by mid-year rally)
Short Oil / Long Gold (mid-year), winner but…(put position on too big, too quickly @ ratio of just over 7, stopped out just before giant move to current ratio of c. 21..)
Long Brazil (Bovespa), loser… (looked brilliant for a few months then didn’t react to change in Oil market sentiment and hedge fund deleveraging post-Lehman)
Short GBP, winner but… (too timid, too early, tried to be too clever…couldn’t figure out what to short it against – USD, EUR, CHF all looked like crappy alternatives, kept getting stopped out by ridiculous volatility, and was too busy with work to get much of the big December move)
So what do I think 2009 will bring? Here are a few ideas with a (short) summary of my thinking behind each.
A recovery in institutional credit markets – smart money will start the long and difficult process of separating the wheat from the chaff: ie the bonds that deserve to be priced at 10 cents will decay into default and those that are instrinsically worth par will start moving back in that direction. In fact this has already started to happen (you can see this by looking for instance at the performance of the iBoxx investment grade corporate bond indices(you need to register to drill down into data) which are mostly up 5-10% since hitting lows in mid-October) although to make really interesting returns means sifting through individual securities and names. So for the first time in the last 10 years a corporate fixed income investment manager will actually be able to create “alpha” (as opposed to just leveraged beta masquerading as alpha…)
Equity markets go up from here (for example S&P500 @ 890), and volatility drops… I think the late November low might hold, although we could possibly see one more down trade in 2009 to lower lows, I think this is unlikely and think the market will grind mostly higher through the year. I could bore you for an hour about why I’m thinking this way but boiling it down to three points will probably frame the foundation of this view. (1) Price action: market should have gotten killed on Madoff news. It didn’t. First time we’ve seen positive price action in more than a year… (2) Wall of money: in this world of instant gratification and the constant shrill drone of a CNBC inspired financial media, when the various central bank and government interventions didn’t miraculously fix everything instantly, the downward spiral continued and often accelerated; despite everyone knowing these things take weeks and months (sometimes years) to have an effect. This time will not be different. (3) More buyers than sellers. Cash was king in 2008 because it was a very scarce commodity. It isn’t so much anymore and real returns from holding cash in 2009 will be negative. Besides – even though they will be far fewer in number – many many people will still be paid to invest and holding 50% or more in cash is not what they are paid to do.
Selective Emerging Markets will outperform. Basically the ‘de-coupling’ thesis has some merits and the baby was thrown out with the bath water in the viciousness of the last 6 months bear market. I like Brazil (so I should probably buy more…), (sub-saharan) Africa and (selectively) India. Of these three the only one you can play via public markets is Brazil; for the other two the opportunities I like are venture capital / private equity plays so not easy to access.
Better to be long Oil rather than short. Haven’t had time to check pricing but best way to play this might be to buy long-dated deep OTM calls. Volatility is at record highs so this might look stupid to start, but I think the world is exactly at the marginal supply/demand fulcrum and will be for several years. Economics 101 tells me that the price will therefore be subject to massive, violent swings as demand moves up and down with the cycle. Basically, while 2008 might (we hope!) be an outlier in terms of volatility for many markets, I’m not so sure this will be true of Oil.
GBP will stop going down. Not because the government or the economy has improved, but simply because relative to the other major economies it isn’t actually that much worse off and the shorts will get too smug and the bargain hunters will come out. Only problem is I’m not sure what level it will bounce off of…are we there already or do we go to 1.25 vs USD and 1.10 vs EUR as has been suggested to me by a friend? I’ll admit to this view perhaps being wishful thinking (see above) but have tried to guard against that and after being an extremely vocal GBP bear a year ago, I can’t believe that I’m now finding myself in the bull camp. This discomfort actually makes me feel better about my view.
The next Microsoft/Google/JPMorgan*/General Electric*/Ford* (*the originals) will be founded in the next 1-3 years. The emperor has no clothes. The existing paradigm is not just bankrupt, but has been proven so. The massive barriers of inertia and incumbency have been breached and it is only a matter of time before smart, creative, energetic entrepreneurs and innovators take advantage. Of course I’m talking my book here as we’ve set up our new business to help find, finance and advise these entrepreneurs and Amy and I hope and expect to find one or two future Gates/Edisons/Morgans… Indeed I’m pretty confident this will come true even if (especially if?) all the above views turn out to be wrong.
In any event, I hope I’m right. Obviously it will be a nice boost to my ego and probably help pay the school fees, but mainly I think it will make the world a bit nicer place, especially for the vast majority of people who had no part in the (inevitable) excesses that led to this economic cleansing and yet are suffering its consequences. And if I’m right about the last point – we won’t know for a decade or so – the world will also be a better place. But that’s for another post, another day.
Happy New Year. All the best for a healthy, successful and fulfilling 2009.
(…the President) insisting that the crisis came “solely from our extravagant and vicious system of paper currency and bank credits, exciting the people to wild speculations and gambling in stocks.
The period (of the past 10 years) was one in which it was easy to grow rich. There was a steady increase in the value of property and commodities, and an active market all the time. One had only to buy anything and wait, to sell at a profit; sometimes, as in real estate for instance, at a very large profit in a short time. (- a well-respected leading banker)
As you will have seen, I have not been posting much over the past several weeks. Indeed a few kind readers have gone so far as to contact me directly to ask why and in some cases to compare notes on the unfolding financial drama. There have been two main (entirely unrelated) reasons for my recent silence. The first is simply – I’ve been very very busy: as anyone who has ever started a business will know, there aren’t enough hours in the day or days in the week. I suppose the economic backdrop only contributes further to an already innate sense of urgency. The second is more practical: insofar as I can make an intelligent contribution to understanding current events and more to the point, what actions might be intelligent or appropriate and what opportunities and outcomes may now be possible or probable, it is almost certainly in taking a step (or several) back from the torrent of daily news-flow.
Not that blow-by-blow commentary is not valuable – I’ve been enormously impressed with the breadth and quality of (informed) opinion that the new information ecology has provided me in these incredible markets – just that there are many people who are already doing it, and in many cases exceptionally well – better than I ever could.
There are a number of observations I think are worth making (many though not all, would in fact dredge up ideas that have formed the foundations of the narrative here over the past three years.) And most of these I think would be more or less immune to the vagaries of the swirling markets (and so ‘waiting for it to play out’ / ‘waiting for the dust to settle’ is not really a relevant or accurate excuse.) What I have struggled with is how to articulate these observations – eloquently, concisely but yet accurately, with context – in the short form that is a blog post. At the risk of being delusional, I kept thinking to myself that this or that thesis was the basis for a chapter in a book…
There is one theme in particular – at the heart of the current crisis – that I am very keen to develop, as much as anything to organize my own thinking on the subject as so often is the case. Not the least because in addition to helping to explain the current situation, I think it will be an enormously fertile ground for generating business opportunities in the next financial services industry paradigm. (Can we now all agree that the prevailing paradigm is now well and truly dead or dying and that something new and different will emerge from the ashes of the current wreckage? Hey, if you like we can even call it the sixth paradigm, but I’m open to suggestions.
So watch this space: Part 1 later this week…
PS The first quote above is President James Buchanan in…1857. The second, Thomas Mellon speaking following the panic of 1873. (Both via Ron Chernow’s remarkable biography: Titan – The Life of John D. Rockefeller.) 2008 is bigger. Global. But not unique. It is also worth noting that the roots of some of the great fortunes of the 19th century can be traced back to the opportunities thrown up by these brief periods of extreme turbulence and distress.
It’s like when you are 10 and you get a brand new bike for your birthday and it rains, torentially, for the next month. And all you can do is sit there and stare at it shining in the garage…
So think of this post as a short, sweet sortie into the rain of meetings, deadlines and travel that have stuffed September fuller than a turkey bound for Christmas…
As you know, I believe that markets and financial services in the 21st century are ultimately digital businesses, cornerstones and representations of the “information economy”. As a result, I would suggest that anyone wanting to lead and/or succeed in these businesses needs a lucid and enlightened understanding of this information economy and the internet substrate that underlies it. This probably sounds obvious but, at the risk of sounding patronizing, I would suggest that many (heretofore successful) business people in financial services have at best a superficial or tangential understanding of these powerful currents running under the surface of our emerging information economy.
In the spirit of trying to redress this situation, I would like to bring attention to two people who I would suggest could form the core curricular foundation for an executive course in Information Economy 101. These are not obscure personalities but in their universe, mainstream thought leaders, celebrities even. Indeed for many (most) readers of the Park Paradigm, this will be old hat. However my hope is that some readers will not have been exposed to their thinking previously and that perhaps others (already familiar) would be nudged to push this information into their organizations and to their leaders. Call me crazy, but I think any person tasked with running a large financial services company is unqualified unless they are familiar with the concepts so powerfully articulated by people like Clay Shirky and Cory Doctorow.
Cory’s Cambridge Business lecture is a great place to start:
PS This is the first post I’ve done with tools from (that great seedcamp winning company) Zemanta …can’t believe it took me almost a year!
Information technology, more specifically the development of parallel processing, “gigabit-terabit-petabit” bandwidth and networking logic, is changing the way we conduct our lives today. While jet-setting executives (or policymakers) of this decade can be present in more places in less time than any predecessor, corporate information, corporate processes and corporate controls can now be shared around the world in real time via information superhighways. These advances in information technology are catalyzing the globalization of business and finance in ways far more important to global central banks than something as basic as physical transportation. These advances are driving the age of financial networking, and what has been described by some as leading to the vastly narrowing ecologies of finance.
Basically what I’ve been thinking for coming on a decade and evangelizing for the past 5 years or so, and now a defining part of the thesis underlying my new business.
The first phase of this “age of financial networking” has unsurprisingly driven the creation of a very tightly coupled system, with a relatively small number of very large, very important nodes or hubs (the global financial services mega-fauna*), in effect create a “scale-free network”, which has a number of advantages (played out nicely from 1987-2007 in financial services) but also some key – potentially fatal – vulnerabilities. John Robb (someone everyone involved in senior policy and management decisions should read) describes it better than anyone:
A scale-free network is one that obeys a power law distribution in the number of connections between nodes on the network. Some few nodes exhibit extremely high connectivity (essentially scale-free) while the vast majority are relatively poorly connected. The reason that scale-free networks emerge, as opposed to evenly distributed random networks, is due to these factors:
Rapid growth confers preference to early entrants. The longer a node has been in place the greater the number of links to it. First mover advantage is very important.
In an environment of too much information people link to nodes that are easier to find. This preferential linking reinforces itself by making the easier to find nodes even more easy to find.
The greater the capacity of the hub (bandwidth, work ethic, etc.) the faster its growth.
The Strength and Weaknesses of Scale-Free Networks
The proliferation of scale-free networks and our increasing dependence on them (particularly given their prevalence in energy, transportation, and communications systems) begs the question: how reliable are these networks? Here’s some insight into this:
Scale-free networks are extremely tolerant of random failures. In a random network, a small number of random failures can collapse the network. A scale-free network can absorb random failures up to 80% of its nodes before it collapses. The reason for this is the inhomogeneity of the nodes on the network — failures are much more likely to occur on relatively small nodes.
Scale-free networks are extremely vulnerable to intentional attacks on their hubs. Attacks that simultaneously eliminate as few as 5-15% of a scale-free network’s hubs can collapse the network. Simultaneity of an attack on hubs is important. Scale-free networks can heal themselves rapidly if an insufficient number of hubs necessary for a systemic collapse are removed.
Scale-free networks are extremely vulnerable to epidemics. In random networks, epidemics need to surpass a critical threshold (a number of nodes infected) before it propogates system-wide. Below the threshold, the epidemic dies out. Above the threshold, the epidemic spreads exponentially. Recent evidence indicates that the threshold for epidemics on scale-free networks is zero.
…the networks of our global superinfrastructure are tightly “coupled”—so tightly interconnected, that is, that any change in one has a nearly instantaneous effect on the others. Attacking one network is like knocking over the first domino in a series: it leads to cascades of failure through a variety of connected networks, faster than human managers can respond.
“Recent evidence indicates that the threshold for epidemics on scale-free networks is zero.” “…leads to cascades of failure through a variety of connected networks, faster than human managers can respond.”
And so Bear Stearns (and others) are caught out. But they could not fail. Nor can Fannie and Freddie. Given this understanding of the current global financial system as a tightly-coupled, scale-free network, the effects of stupid and fraudulent mortgage lending in Las Vegas mushrooming into generalized system-wide distress is easier to understand…
Loose coupling describes a resilient relationship between two or more systems or organizations with some kind of exchange relationship. Each end of the transaction makes its requirements explicit and makes few assumptions about the other end.
The risks inherent in this mode of organization are clearly unsustainable. The world’s financial network will need to adapt. (The same is true of many other critical infrastructures: telecoms, utilities, transportation…where progress in this direction is already starting, to emerge.) We need to (and I believe we will inevitably do so) move towards a more robust, loosely coupled financial system: and the beauty is by adopting and adapting lessons computing and networking technology (which ironically underpinned and drove the creation of today’s brittle financial system) we already have a roadmap (and some of the tools) to do so.
Furthermore, these ideas aren’t new. John Hagel (another person anyone running a large corporation needs to have read**) wrote about this in 2002 (!):
A good working definition: loosely coupled is an attribute of systems, referring to an approach to designing interfaces across modules to reduce the interdependencies across modules or components – in particular, reducing the risk that changes within one module will create unanticipated changes within other modules. This approach specifically seeks to increase flexibility in adding modules, replacing modules and changing operations within individual modules. (Note: if any of you have come across a better definition of loosely coupled, please let me know – I’d like to follow up on this in a future blog.)
Three things stand out from this definition. First, it assumes a modular approach to design. Second, it values flexibility. Third, it seeks to increase flexibility by focusing on design of interface.
…The desire for flexibility is a powerful force driving the move towards loosely coupled systems, but there’s an even more powerful reason to adopt loosely coupled systems. It has to do with experimentation, learning and performance improvement. Within well-designed, loosely coupled systems, there’s a lot more room for experimentation…
He goes on to make the point that this move towards loosely coupled systems in business will fundamentally change the way we manage and organize our corporations:
Rather than traditional hierarchies driven by command and control management styles, we are likely to see relatively independent organizational modules brought together to perform one set of processes and then different arrangements of modules to perform other processes. Some of these modules will belong to the same enterprise, but modules from other enterprises may be brought in to perform specific tasks on an as needed basis…Conventional business strategy approaches emphasize the need to develop a detailed strategic blueprint and then tightly couple operational initiatives to execute the blueprint. As uncertainty grows in business environments, these hard-wired approaches to business strategies are becoming less and less viable.
Reading Robb and Hagel, I hope it is as obvious to you as it is to me that: (a) the global financial system clearly not loosely coupled, and (b) would be infinitely more resiliant if it were. I don’t expect these changes to happen overnight. Given the human factor, I suspect it will occur alongside the generational shift over the next 10-20 years. That said, the opportunities for those that ‘get it’ and adapt sooner rather than later are enormous: this sort of discontinuity is one of the only occasions where it is possible to completely alter the competitive landscape, and is particularly perilous for ‘incumbents’ (everything to lose.) Furthermore, given the critical importance of the financial system to our globel economy and societies, and its manifest vulnerability in the current regime, some of this change needs to happen quickly (more quickly than is comfortable) if we are to avoid a potentially very bad outcome. I guess you could say that one of the good things about having swung to the fear side of the fear/greed pendulum is that change – albeit painfully and begrudgingly – is seen as unavoidable.
We are deliberately going to build our new business to align with this new paradigm, so no matter how successful we may be, expect our ‘ecosystem’ to grow exponentially in size and complexity in comparison to our actual firm. For better or worse, we will never be ‘too big to fail’…
* spent 15 minutes searching the web for a list of the world’s largest financial institutions by assets with no joy…a bit surprised, something for freebase?
** I often wonder about the paradox that our most powerful and important corporate and political leaders – the very people who need to be the most widely read and open to new ideas – are by the inevitable constraints and conventions of their position, are probably unable to do so. Think about it, how likely is it that the CEO of a giant corporation will be allowed to block out 4 hours in his diary on Wednesday afternoon to read and think? For the good ones this must be incredibly frustrating. As for the others, well let’s just say I would question the robustness of the process that got them there in the first place…
As we start talking to people about our investment universe and the pillars that underlie our investment thesis – which is centered on identifying and catalyzing disruptive (technology-enabled) innovation in financial services and markets – when we mention that one vector we will look to target is opportunities in ‘frontier’ markets – in particular Africa – we get some puzzled looks. Especially with people who haven’t been long-standing or assiduous readers of The Park Paradigm and haven’t come across my previous posts on the subject.
In a nutshell, it really comes down to the power of looking at the industry from a completely different perspective: understanding how markets and financials services can be made to work in the context of sub-saharan Africa, necessarily forces you to see the industry through a radically different prism: infrastructure, distribution, price points, market structure, etc. So not only do native opportunities exist to vastly grow financial service and markets from very small existing starting points, but also by doing so I am convinced that a number of non-intuitive and powerful learnings applicable to innovating in this sector in developed markets will emerge. And that’s why Africa is actually an obvious element in our strategy and worldview.
The mobile is making low income groups more efficient and productive. Less time waiting and more time working or getting a better price etc. It will also mean they come at other technology products from a mobile technology perspective. Will one of these users ever part with a mobile and want a laptop instead? What if your next choice is a used smart phone or a laptop? What are the trade-offs? Or will you just settle for a TV and make the phone last longer. My bet is on trading up or passing on the computer or TV.
Here we have stopped thinking about bazaar’s and marketplaces. We go to the supermarket. It’s a very very fortunate few that can go to a tailor or have their clothes made. Yet when I walk around India I see vege traders, and sari makers everywhere. They both make efficient use of their inventory and their labor. I see use of missed calls to make “tacit connections” at no cost. I see SMS use and notifiers growing. In fact many of these users are subscribing to SMS notification services for sports and business because they want that greater connection. They are not yet overwhelmed. They are in effect on an accelerated course of “connectivity”. We need to look here to see how mobility and knowledge sharing is changing.
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Given these tough economic times I suspect that SoE is even more useful, whether it’s to learn a new skill to keep an existing job (or find a new one) or to earn a bit of money and/or social capital by teaching if you’ve suffered the misfortune of losing your job or are working reduced hours.![Reblog this post [with Zemanta]](http://img.zemanta.com/reblog_c.png?x-id=d90b4b77-d78a-46ae-b561-09c5c6b83694)
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The biggest risk I can see would be natural disaster risk (ie volcanoes blowing up your data-center) and risk of damage to sub-oceanic fibre going in and out of Iceland. Both of which I think should be reasonably easy to mitigate and insure against. Plus, on the face of it, its geographic isolation and NATO membership probably make it a good choice in terms of security.![Reblog this post [with Zemanta]](http://img.zemanta.com/reblog_c.png?x-id=01f50c75-4841-40dc-98fe-f6812215188b)
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