Hierarchy of Ideas
May 27, 2008, 11:25
Filed under: Web Trends | Tags: ,

I recently heard that one of my high school friends quit his job up north to move back home and launch a start-up. I won’t even bother adding the site link here, because I have nothing good to say about the startup, and I don’t want to be mean:

  • Its success hinges upon the favor of a very small niche. A dorky niche.
  • The site does not provide a necessary service
  • The site does not provide access to necessary products

The very best ideas in the world of technology are those that fulfill a need people were previously unaware of. Just to list a few examples: Google (research anything in seconds), Orbitz (plan trips fast, cut out the middle man), Ebay (online auction), Amazon (online store), Skype (talk on the phone, for free, anywhere o earth),  Facebook (a platform with dozens of options used to connect with friends—pictures or chat or messages or pokes or just stalk people without becoming their friends).

People lived without any of these services or products in the 1980s, but probably cannot imagine life without them now that they’ve had a taste of them.

Good Ideas leverage the very best ideas out there, offering a service or product that enhances an already something that already has a high number of users. Take Kayak, for example, which is a search engine of search engines for all travel related sites. Picasa, a free and more simple version of kodak gallery. Take any of the facebook applications. I would even bucket into this category, because the site leverages great ideas (youtube videos, song clips, etc) into one easy to access bundle. Good ideas. Not the best ideas because they did not revolutionize anything or create a giant market to make mounds of money off of, but decent ideas that generate profit and are useful to those souls that choose to use that site.

Blah Ideas, like the one my friend is launching, do nothing. They add no value. They attract only a sliver of the population and do little to change their lives.  The money being invested into this startup could probably earn a higher return in a 9 month CD at a bank. In other words, there is no economic or social reason why anyone should develop Blah Ideas, yet people do…..


Hope for the Environment?
May 27, 2008, 11:25
Filed under: Uncategorized

Maybe there is hope…seems like a high-school junior discovered a way to decompose plastic bags at low costs thanks to the help of some bacteria. He is the first person to make such a discovery. Just wait until hot shot scientists get their hands on this—maybe they will come up with a large scale method for applying this decomposition technique.

Credit Crisis For Dummies

Most people hear about the so-called Credit Crisis but probably don’t really understand how it works. I never studied finance and usually avoid thinking about topics in overly complicated ways. Luckily, I learned about the topic first hand via my last two jobs. Here goes:

The Regular Joe: Consumers usually don’t have a lot of cash on hand to make big purchases. In fact, the United States savings rate has declined over the last two decades. Luckily, banks put their excess cash to good use by lending money to individuals. Mr. Joe gets to buy his $100k house and the bank gets monthly interest and principal payments. (Note: $100k house? For real? No house is that cheap but $100 is a round number and simplifies the math behind my explanations).

How Banks Should Work: A bank typically checks potential borrowers out before lending them any money. The borrower provides credit history, employment history and income statements to prove that he/she makes enough money each year to cover the debt payments for the new home. If the borrower meets these standards (underwriting standards) then he/she will get the $100k.

The bank is happy to get a steady interest payment but it’s out $100k in cash. Lets say that this bank made 1000 loans in one year—it’s out $100 million dollars. Luckily, the bank did a great job verifying that financial security of each borrower and is confident that they will all make timely payments every month until the loans are paid off. Imagine, 10% interest off of $100 million every month…that’s a lot of money. The payments are predictable, so it is possible to bundle all of these loans up, figure out what the monthly payments will be, and find an investor that is willing to buy this package of loans in return for steady payments.

MBS/Securities/Secondary Mortgage Market: In the past, Fannie Mae and Freddie Mac were the biggest investors buying these packages of loan, building up portfolios worth trillions of dollars. Sometimes they buy these bundles of loans for cash, other times they charge the bank a fee and then “guarantee” to make the monthly payments if the borrowers fail to do so. Fannie and Freddie can make this “guarantee” because the world financial market assumes that the government of the United States will back Fannie and Freddie up if anything bad happens. Financial markets make this assumption because the US Government created Fannie and Freddie at the beginning of the Great Depression to help stabilize the mortgage market—they used Fannie and Freddie to inject cash into the system.

So you know, this action of “bundling loans” is what the markets call securitization. The bundle is officially a “Mortgage Backed Security.”

Where do Fannie and Freddie get the cash to buy this $100 million bundle of loans? Again, since the financial markets assume that the government will back these companies up if anything bad happens, their corporate debt is practically as good as US Treasuries. For example, Fannie Mae will go on a road show in Asia and investors will give the company tons of money in return for an interest payment that is slightly higher than the interest on a US Treasury. Let us say that Fannie Mae will pay these investors 5% interest for the $100 million it will borrow to buy the bundle of loans we keep talking about. This interest payment will almost always be lower than the interest payment that the bundle of loans are pulling in, which is 10% in my example. 10% interest in – 5% interest paid out to investors in Asia = 5% interest on $100 million that Fannie Mae expects to get every single month until the debt is paid off. That is A LOT of money, especially when you figure that Fannie Mae really does trillions of dollars worth of business.

Wall Street: Banks in Wall Street saw that Fannie and Freddie were making a killing, and they wanted to get in on the fun too. Some banks take the cash in their clients’ deposit and savings account and use that to buy/securitize mortgages. Usually the interest rate they pay their customers on a particular savings account (the bank’s cost of funds) is lower than the aggregate interest rate their mortgages bring in (revenue). The difference is called the spread, and a positive spread = a lot of profit.

The Perfect Storm: Risky Products + Falling Housing Prices + Over Extended Banks = Writedowns

Factor A: In the good old days (1), borrowers would plunk 20% of the payment down and borrow only $80k. This was a good risk mitigant because it shows that the borrower is responsible (hell, he/she wanted to buy a house, set a goal, and saved $20k to meet that goal). In the good old days (2), borrowers would look for 30-Year Fixed Rate Loans. The payments on this loan are identical every single month for 30 years, so there is no confusion as to how much money the borrower should set aside to meet his/her debt obligations. In the good old days (3), borrowers would have to prove they made enough income to cover the loan payments for their house. All of these factors would help ensure that the money was being lent to a responsible borrower that would likely make timely payments on the loan until every cent was paid back.

Well, the good old days are no more. The “traditional” market got tapped out and banks started offering more aggressive products in order to attract new, less traditional borrowers into the housing market. To do this, they stopped requiring down payments, they stopped asking for proof of income, and they created new products that make it difficult to predict what the borrower should pay back from month to month. Banks knew these moves were risky, and that is why they charge borrowers higher interest each time they chose to build a mortgage that deviated from the template seen in the good old days.
To use the terms out in the news: Borrowers in the good old days were charged interest rates equal to the prime rate. Borrowers with risky mortgages (no down payment, no proof of income, and/or risky mortgage product, etc) would have to pay a higher interest rate making them subprime borrowers because they are less credit worthy than the borrowers that pay the prime rate.

Now, banks thought that they would avoid any serious risks because a) they were charging higher interest rates and b) housing prices in the last five years have gone up. In a worst case scenario, banks and securitization agencies figured that a borrower that stopped making his/her payments would simply be foreclosed upon, the bank would take ownership of the house, and sell it for a profit since housing prices were going up, up, up. By selling the house for a profit the banks would be able to pay back investors that bought the securities (or bundles of loans). Yes, the investors would lose out on steady interest payments but at least they got their original investment amount back in full.

Factor B: Guess what, housing prices fell. I’ll leave the reasons behind this phenomena for another post. All you need to know right now is that banks no longer had an easy out in case borrowers started to default on their loans.

Factor C: Lets say a bank takes $100 million in deposits, buys mortgages, securitizes them and then sells them to investors for a profit. They get $100 million back in cash and repeat the process all over again maybe ten times so that the original $100 million is holding up $1 billion in investments. Then, something bad happens. Borrowers stop making payments. The investors that bought the securities demand payments. Who is going to pay? Who loses? How much is lost?

Update 9/18/08: Lets go back to this concept of $100 million dollars holding $1 billion worth of mortgages up. The original $100 million is the actual amont of capital (aka cash) that the bank has at hand. Using it to dole out mortgages, selling these mortgages to Fannie Mae for cash, then re-using that cash to dole out more mortgages is what we call “levering up.” This hypothetical bank has levered itself 1:10 because it owes $10 for every actual $1 that it has on hand. Remember this point because I’ll explain how leverage brought down Bear Stearns, Lehman, Fannie Mae, Freddie Mac, and Merrill Lynch.

Writedowns: The perfect storm happened and many borrowers started to default on their mortgages at the same time. Banks are usually prepared for a certain amount of losses, breaking risk down to two factors: 1) Probability of default and 2) Loss given of default. People placed in mortgages that were inappropriate for their income level raised risk #1 and the fact that housing prices fell raised risk #2. That’s why banks are facing unprecedented losses right now.

Unfortunately, the end of the money train still expects their payments. Remember that banks give mortgages out, bundle the mortgages together only to securitize them later on. The investors that bought bits and pieces of these securities demand their payment (interest and principal payments). This brings us to the global market.

The Global Credit Crisis: The mortgage securities market is global. Investors around the world buy securities that are backed by properties in the United States because, in the past, these securities produced a nice and predictable interest payment. These securities were once considered uber safe investments and were being snatched up left and right. Rating agencies concurred; they analyzed the mortgages behind the securities to make sure that everything was in line (i.e. safe borrower, good property investment, reasonable interest rate, etc). The best securities got AAA ratings.

Many securities backed by subprime loans received AAA ratings, and then they blew up. Investors started questioning the AAA grade much the same way you would question the value of an A+ in calculus if even the worst student in the class received an A on every test. Investors world wide started losing money on their supposedly safe subprime investments, so they wondered what other AAA investments were going to blow up? And what about BBB investments, because if the A’s were failing then wouldn’t the Bs be even worse off? Extend that line of reasoning and you will see why subprime loans in Arkansas affected global investment behavior. Finance is global, everything is interconnected, and a problem in one sector has the ability of spreading to others….like a contagious virus. Investors became wary of putting their money in anything—stocks (the Dow fell), corporate debt (it became more difficult for companies to raise cash for things like research, acquisitions, etc), and pretty much anything else that you can think of.

This is what happened next: Investors with cash were still willing to invest, but only if the price was right. An investor may have been happy with a 5% interest payment on a AAA security 2 years ago but now demands 15% in order to compensate for all of the risk (more defaults, losses, etc). Remember that banks and companies like Fannie Mae/Freddie Mac are in this business because they borrow money from one place (savings accounts or corporate debt investors) at one rate, purchase a bunch of mortgages that pay a higher rate of interest and keep the difference as profit. Can you see how they would lose money now?

Before: Borrow $100 million and pay 5% interest. Buy $100 million in mortgages that pay 10% interest. Keep 5% of $100 million = profit profit profit.

Now: Borrow $100 million and pay 15% interest. Buy $100 million in mortgages that pay 10% interest. Lose 5% of $100 million = A) losses losses losses B) The market dried up—-Why do the deal in the first place? Why invest in mortgages in the first place? Why invest in anything if you’ll lose money?

The cost of “borrowing” money became extremely expensive for financial institutions. Borrowing is another word for credit, companies couldn’t buy things (securities, other companies, money to build a new facility, etc) on credit; hence, the credit crunch. This had the unwanted but expected effect of slowing down the economy around the world.

Update 9/18/08: Back to the concept of leverage. Virtually every financial institution in the world levers itself. In our example, the hypothetical levered each $1 of cash on hand with $10 dollars worth of obligations. Leverage is great when times are good and absolutely horrible when times are bad. During the good times that $1 of capital on hand generates 10x the profit. When times are tough, that $1 generates 10x the losses.

The mortgage fiasco spread like a virus. Every package of loan that was securitized is tainted by the higher than expected losses. There are barely any investors on the planet earth that will touch these securities, which lowers their value even further. In other words, our hypothetical bank has $1 billion worth of stinky crap. Investors still demand their timely interest payment, but the original homeowners are no longer paying their mortgages. Somehow, our hypothetical bank has to use it’s $100 million cash on hand to pay $1 billion in interest obligations.

$1 billion – $100 million = $900 million that the bank still owes. The bank can try to raise more cash by selling its stock, but what if or the Wall Street Journal already heard that the bank is in trouble and does not have enough cash to meet its obligations (liabilities)? Will rational investors buy this bank’s stock? Would you invest in a sinking ship? No. Of course not. The bank fails to raise enough capital, and has to declare bankruptcy because it cannot pay back the $900 it owes.

Lehman has declared bankrupcy for this reason. Fannie Mae, Freddie Mac, and AIG would have declared bankrupty but their failure would have produced a tidal wave of problems for the world, so the US Government “leant” them money so that they can meet their obligations. Washington Mutual and Wachovia are close to declaring bankrupty, but it is possible that a healthier (and larger) bank will purchase them and effectively “loan” them the money they need to meet their obligations.

Please check this site out for another very easy to understand explanation written by an Economist.

What is happening is bad. It is a once in a century ocurrence. It is unfathomable that some of the smartest people on earth got themselves in this mess. Why did it happen? Didn’t these bankers (like me) know that lowering underwriting standards would lead to more defaults? Didn’t these bankers (like me) think that over-levering was a bad idea? Was any of this accidental? Bad luck?

Yes and no. I explore these questions in other posts and will continue to explore them in the future.

And that is the Credit Crisis in a nutshell.

Corporate Karma
May 12, 2008, 11:25
Filed under: Un-Wordy, Uncategorized | Tags:

Here is a little free advice—-when someone you know asks you for business advice, help them out. Always help them out. The person asking may seem like a novice, a baby in the industry who doesn’t know pencils from pens…but, that person will grow professionally and they will (hopefully) always remember that you helped them out when they were starting off their career.

Help the kid that randomly contacted you after finding your name your college contact database.

Help the girl, that friend of a friend, that is starting her career in the same obscure field you already maneuvered a decade ago.

Help your friend’s kids who are thinking about college and want to know more about UF or NYU or UT or whatever school it is that you graduated from.

Memories are long. Networks are small and weirdly inter-connected. TRUST ME that at some point it will come out that you did or did not help xyz out when he/she facebooked you with a job-related question or two. I speak from experience.

I put my sister in touch with a friend of a friend that has been in the marketing industry for awhile. She asked him a pretty simple question (any advice on how to source new clients?). She definitely didn’t ask him for a job or anything like that, she just wanted advice on how to fully leverage the job she already has. Well guess what, he never wrote back.

That’s fine. See, he is in the process of building a start-up that happens to be smack in the middle of a field in which my best friend plays a key role.  My best friend heard the story and no matter what happens going forward, he will know that this start-up is managed by the douche bag that chose to not help my sister out. Maybe that first impression will make a difference one day, maybe it wont…but what I do know is that the first impression has been set.

HELP PEOPLE OUT. ALWAYS. It pays off, even if the payoff is nothing but the simple thanks of a grateful person.

The Man in the Arena
May 9, 2008, 11:25
Filed under: Un-Wordy, Uncategorized | Tags:

My favorite quote.

It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.

-Theodore Roosevelt, 1910.

UPS—Terrible Service

Remember the opening scene of Ace Ventura Pet Detective? The part where Ace plays a delivery man and kicks the cardboard box with fragile contents up and down Lincoln Drive? Well, given my experience with UPS this past week it seems to me like Ace was a UPS Delivery Man. Lets compare:

This is the video of Ace Ventura kicking the box around—

Now take a look of some pictures I took after the UPS delivery man left my boxes at the door:

Box of Linens The Banged Up Side

Another Box The only mug and cup that made it in \

Here is the story:

1) UPS said I should be at my apartment between the hours of 9am and 7pm to receive the UPS man that would pick my shipment up (I was moving from NY back home and needed to send a few boxes down). He arrived at 7:30pm. That’s just annoying

2) My jaw literally dropped to the floor when I saw my box of china (clearly marked FRAGILE) tattered to pieces. I was even more shocked when I realized that 99% of the contents had been shattered. UPS pro-actively addressed the issue by sending me a letter stating the following:

The contents contained in the package described abov were damaged. We regret any inconvenience this may have caused you. The damaged portion has been discarded and the remaining contents were forwarded for delivery.

We have determined that insufficient packaging was used for this shipment. UPS is not liable or responsible for loss or damage to any package resulting from inadequate packaging.

To quote Ace Ventura—RE-he-he-heaaaally???

Take a look at my pictures, UPS. I shipped pristine looking boxes and look at how banged up they were delivered to their final destination. Clearly, my packages were not taken care of. They were mishandled and that is why the contents in my box of china were broken.

I purchased $2 of insurance which translates to $200 in coverage. I WANT MY MONEY. I am going to call UPS tomorrow and make a big fucking stink about this one because I think it is ridiculous of them to wash their hands of the situation when they smashed my box to little pieces!!!!

All 100% of my wrath will concentrate against this company tomorrow.

SNAP—Hillary Clinton Pulls the Race Card

She must be getting desperate or else she would have avoided pulling the race card during her interview with USA Today.

Say whaaaat!?!?!?!?!!!!!!!!!!!!! Let us not forget that Obama has WON more delegates than Clinton. He has more popular support than Clinton.  Mathematically speaking, there is absolutely no way that he could have achieved either of these two feats unless he had wide spread support because there are not enough minorities in this country to out vote the majority. Duh.

Talk about flawed logic Ms. Hillary Clinton. Didn’t you go to Yale Law School? The best law school in the United States? Law = Logic = WTF is going on with Clinton.

I’m feeling insulted right now. Race card…come on. As the first female candidate you have got to be better than that or else someone might pull the gender card which is equally bogus.