Which raises the question: Why [no] runs on semis or software companies? The short answer is their business model does not depend upon a belief system — of solvency, liquidity, profitability or risk management.
It wasn’t a crisis of confidence that did the iBanks in, it was a crisis of competence.
That was the element CEOs like Dick Fuld, Hank Paulson, Stan O’Neal and Jimmy Cayne failed to consider: When you are a bank, your existence depends upon the confidence of your clients, investors and counter-parties. Anything you do that puts that at risk is extremely dangerous. If you want to run lots of leverage, push the envelope, well, then, you better hope nothing else goes wrong. At 35X, you do not leave any room for error.
It is inexcusable that the investment CEOs did not seem to realize this. It was unconsionable that the firms had been purposefully put into a risk taking position in extremis. That the CEOs blamed short sellers and rumors, but exonerated themselves, only serves to emphasize their own failures, their lack of comprehension of what they had dome to themselves. It was their own incompetent stewardship that purposefully and unknowingly placed these firms at such grave danger of destruction.
Macro modelers take note: no realistic results without accounting for ape psychology.
Here's a nice video feauring the confidence men (financial CEOs) and their recent payouts:
And this (both via Barry Ritholtz):
Related: Central limit theorem and securitization.
"Why [no] runs on semis or software companies? The short answer is their business model does not depend upon a belief system — of solvency, liquidity, profitability or risk management."
ReplyDeleteWho wrote this? I presume not Steve.
There are runs on banks only. To speak of a run on a non-bank is meaningless. Banks are by definition leveraged. They buy and sell money. They are money brokers. The money they buy is called deposits or long term debt.
The auto companies are so highly leveraged they have negative book value. Why anyone has leant them money over the last eight years I can't explain. It's what happens when you have non-engineers running manufacturing companies. It's disgusting. Rick Wagoner and his ilk of economics BAs and MBAs need hanging.
Software and computer hardware companies in general have very low debt/equity often zero.
Why do you keep insulting the apes?:)
ReplyDeleteFrom Roger Lowenstein a couple of months ago, in an essay in the New York Times:
ReplyDeleteModern finance is an antiseptic discipline; it eschews anecdotes and examples, which are messy and possibly misleading — but nonetheless real. It favors abstraction, which is perfect but theoretical. Rather than evaluate financial assets case by case, financial models rely on the notion of randomness, which has huge implications for diversification. It means two investments are safer than one, three safer than two.
Real confidence is built on attention to particulars and details that matter, and tireless vigilance. Sound abstractions are tested against these things — relentlessly. Accept no substitutes.
The finance CEO's aren't dumb apes. They understood what they were doing. Google Chuck Prince and "we're still dancing". He knew. They all knew.
ReplyDeleteTo paraphase Upton Sinclair, it is difficult to make a man admit to understanding something when he is getting nine figure compensation to pretend otherwise.
I disagree.
ReplyDeleteAny company's value is based on belief. Even when it is traded at par with projected expected cashflows -- how much confidence is in that cashflow?
GOOG was worth $700 because many believed it is gonna rule the world.
I agree that economists and financial economists need to include behavioral elements in their models. Ultimately economic theory is going to look more like sociology and less like physics. Economists are going to have to include the cultural and intellectual aspects of nations if they want to understand why one nation is rich and another is chronically poor.
ReplyDeleteAs for trust, that is important. But to have trust you need transparency. I trust Honda more than GM to make a reliable car for me. My trust is based on direct experience with the product as opposed to knowledge about the management.
High ranking executives have taken the place of the 19th century capitalists in the expropriation of surplus value.
ReplyDelete