Why The Bailout Should Not Happen: Time Magazine

Like you, I have been alarmed by what is happening in Washington and on Wall Street.

I have spent many hours over the past few weeks trying to understand the causes of the financial crisis that the world is facing today.

I’ve purchased 4 books on the subject, researched extensively in the Congression Record from 1994 on, studied what Warren Buffett and Charlie Munger his partner have been saying about derivatives for years, and more. I am trying to understand root causes and possible solutions. And I have come to the firm conclusion that the proposed bailout will cause even more problems than it is trying to solve, and that it would be the biggest step towards socialism this country has ever taken (and we have taken lots and lots of little steps.)

Today, Time Magazine published the best piece I have seen so far in the main stream media about why the bailout should not have happened. I recommend that you take time to read it: http://www.time.com/time/business/article/0,8599,1845209,00.html?cnn=yes

Also, if you happen to be interested in some of the tidbits I’ve uncovered about what is wrong with unregulated OTC derivatives, read my comments on Digg.com about the Time Magazine article: http://digg.com/business_finance/Bail_out_people_NOT_banks

Yesterday I read 20 pages from the biography of former secretary of Agriculture Ezra Taft Benson, who was harshly and repeatedly attacked during the Eisenhower years for NOT bailing out this country’s farmers, even when there was serious pressure to do so. But he stood firm on principle, and opposed popular political solutions like price supports and other government programs, because in the end, they never work. They create more problems than good.

When Secretary Benson was assigned by Eisenhower to accompany Soviet leader Nikita Krushchev on his visit to Washington (a visit which Benson opposed), he took him to a USDA experimental station in Maryland and gave some opening remarks: “Our farmers are free, efficient, creative and hard working…. Under our capitalistic free enterprise system they have developed an agriculture unequaled anywhere in the world.”

On the trip, Krushchev reportedly boasted to the Secretary, “Your grandchildren will live under communism.” “On the contrary,” Secretary Benson replied, “my grandchildren will live in freedom as I hope that all people will.” The Soviet leader responded, “Americans are so gullible. They are in the process of being fed small bits of socialism and one day will awaken to find themselves living under a totalitarian order.”

– Ezra Taft Benson, A Biography, pg. 339

It’s hard to find principled government leaders these days, who are true statesmen. I’m finding a few, but they are rare, and not always in leadership positions.

Buffett’s Partner Charlie Munger in 2005: Derivatives Blowup in Next 5-10 Years

Please share this with others…..

Charlie
Munger in Poor Charlie’s Almanack,
Expanded Second Edition, 2005-6, pp. 125-128

Warnings About
Financial Institutions and Derivatives

Risks of Financial Institutions

The
nature of a financial institution is that there are a lot of ways to go to hell
in a bucket. You can push credit too far, do a dumb acquisition, leverage
yourself excessively—it’s not just derivatives [that can bring about your
downfall].

Maybe
it’s unique to us, but we’re quite sensitive to financial risks. Financial institutions make us nervous when they’re trying to do well.

We’re
exceptionally goosey of leveraged financial institutions. If they start talking
about how good risk management is, it makes us nervous.

We
fret way earlier than other people. We’ve left a lot of money on the table
through fretting. It’s the way we are—you’ll just have to live with it.

Derivatives

The
system is almost insanely irresponsible.  And what people think are fixes
aren’t really fixes. It’s so complicated I can’t do it justice here—but
you can’t believe the trillions of dollars involved. You can’t believe the
complexity. You can’t believe how difficult it is to do the accounting. You
can’t believe how big the incentives are to have wishful thinking about values
and wishful thinking about ability to clear.

People
don’t think about the consequences of the consequences. People start by trying
to hedge against interest rate changes, which is very difficult and
complicated. Then, the hedges make the [reported profits] lumpy. So then
they use new derivatives to smooth this. Well, now you’ve morphed into lying. This
turns into a Mad Hatter’s Tea Party  (where normal use of words…begin to
make no sense ). This happens to vast, sophisticated corporations.

Somebody
has to step in and say, “We’re not going to do it—it’s just too hard.”

I
think a good litmus test of the mental and moral quality at any large
institutions [with significant derivatives exposure] would be to ask them, “Do
you really understand your derivatives book?” Anyone who says yes is either
crazy or lying.

It’s
easy to see [the dangers] when you talk about [what happened with] the energy
derivatives—they went kerflooey. When [the companies] reached for the assets
that were on their books, they money wasn’t there.

When
it comes to financial assets, we haven’t had any such denouement, and the
accounting hasn’t changed, so the denouement is ahead of us.

Derivatives
are full of clauses that say if one party’s credit gets downgraded, then it has
to put up collateral. It’s like margin—you can go broke [just putting up more
margin]. In attempting to protect themselves, they’ve introduced instability.

Nobody
seems to recognize what a disaster of a system they’ve created. It’s a demented
system.

In
engineering, people have a big margin of safety. But in the financial world,
people don’t give a damn about safety.

They
let it balloon and balloon and balloon. It’s aided by false accounting. I’m
more pessimistic about this than
Warren.

Accounting for Derivatives

I
hate with a passion GAAP [Generally Accepted Accounting Principles] as applied
to derivatives and swaps. JP Morgan sold
out to this type of accounting to front-end reserves. I think it’s a disgrace.

It’s
bonkers, and the accountants sold out. Everyone caved, adopted loose
[accounting] standards, and created exotic derivatives linked to theoretical
models.

As
a result, all kinds of earnings, blessed by accountants, are not really being
earned. When you reach for the money, it melts away. It was never there.

It
[accounting for derivatives] is just disgusting. It is a sewer, and if I’m
right, there will be hell to pay in due course. All of you will have to prepare
to deal with a blowup of derivative books.

To
say accounting for derivatives in
America is a sewer is an insult to sewage.

Likelihood of a Derivatives Blowup

We
tried to sell Gen Re’s derivatives operation and couldn’t, so we started
liquidating it.  We had to take big markdowns. I would confidently predict
that most of the derivative books of [this country’s] major banks cannot be
liquidated for anything like what they’re carried on the books at. When the
denouement will happen and how severe it will be, I don’t know. But I fear the
consequences could be fearsome. I think there are major problems, worse than in
the energy field, and look at the destruction there.

I’ll
be amazed if we don’t have some kind of significant [derivaties-related] blowup
in the next five to ten years.

I
think we’re the only big corporation in
America to be running off its derivatives book.

It’s
a crazy idea for people who are already rich—like
Berkshire—to be in this business. It’s a crazy business for big banks to be in.

“You would be disgusted
if you had a fair mind and spent a month really delving into a big derivative operation.
You would think it was Lewis Carroll [author of
Alice’s Adventures in Wonderland]. You would think it was
the Mad Hatter’s Tea Party. And the false precision of these people is just
unbelievable. They make the worst economics professors look like gods.
Moreover, there is depravity augmenting the folly. Read the book F.I.A.S.C.O.,
by law professor and former derivatives trader Frank Partnoy, an insider
account of depravity in derivative trading at one of the biggest and
best-regarded Wall Street firms. The book will turn your stomach.”

The Power of LinkedIn and The Speed of Trust

Recently, my team identified 189 high-traffic web sites that we want to approach in the coming months with a very innovative partnership opportunity. We think we can increase their web site traffic and that our proposal makes a lot of sense.

But cold calling 189 these companies would likely be frustrating. Who would we ask for? How many calls would it take to find the right person, or to find a helpful person who could direct us to the right person?

And then, even if we found the right person to talk to, how interested could they possibly be in a startup company from Utah, even if we do have a few million monthly visitors to our web sites? In a phone conversation where we are hunting around for the right person to talk to, trying to catch them at a time when they are interested in hearing our proposal, well, the odds just aren’t good at all.

But then there’s the LinkedIn approach. Since I’ve been investing time regularly over since LinkedIn first launched in building a trusted network of connections, and since I’ve worked in so many companies over the years, and lectured, and taught, and blogged, and networked, and continually refreshed my loose social connections via LinkedIn, I happen to have a mind-boggling LinkedIn network.

My Network Stats show the following:

  • 139,600 Two Degrees Away
  • 986 Trusted Connections
  • 5,715,400 Three Degrees Away

Out of more than 25 million LinkedIn users, I can reach 20% of them through a friend of a friend. The success rate for me of LinkedIn requests has been probably greater than 90%. I never abuse the system. I carefully read profiles before sending requests. I carefully choose who to send the request through. And I always have a legitimate reason for contacting them that I sincerely think they will be interested in.

I’ve used last minute LinkedIn requests to get meetings in London with a top investment bank with less than 24 hours notice. I used it last week to make sure I got an invitation to attend the invitation-only Social Ad Summit in New York City. I’ve used it dozens of times with great results.

So recently I invited one of my (trusted) employees to login to my LinkedIn account, and to search for “marketing” or “business development” employees at the 189 web companies that we want to partner with in the not-too-distant future. Here’s what she found:

  • I have 3 1st Degree Connections
  • I have 31 2nd Degree Connections
  • I have 48 3rd Degree Connections

I actually have LinkedIn connections at almost every one of the 189 companies, but we were only looking for employees who had “marketing” or “business development” roles within the company.

She put all her findings into a spreadsheet, which I shrunk to 6-point font, and printed it out, so I can have it right by my computer and look at it every day. When we are ready to proceed, I’ll budget a bit of time every week to reach out via LinkedIn to some of these partners.

In the past week it has become apparent that FamilyLink.com, with our super popular We’re Related app on Facebook (5 million monthly active users and growing fast), is ready to reach out to brand advertisers and marketers who want to reach some of the families who are using our app.
I just searched for “media buyer” and “internet” on LinkedIn, and found that there are 390 matches that are within my network.

We think we can provide media buyers “the best way to reach families through social media.” Next week we’ll start using LinkedIn to reach the ones that really do seem most likely to be interested in placing relevant ads on social networks.

In the past, when I’ve tried to raise capital or advised others on raising capital, I’ve been amazed at how many thousands of people in the Venture Capital and Private Equity category are using LinkedIn. Since almost all angel and venture deals are done by referral, it makes a ton of sense for an entrepreneur to invest adequate time in building their LinkedIn network, and then when they are ready to find potential investors, to spend serious energy in reading the profiles of all the angel investor or VCs in their network. And then, to choose carefully who to send each request for a meeting through.

Stephen MR Covey wrote a best-selling book in 2006 called The Speed of Trust. I believe wholeheartedly in his premise that when there is trust, business can move at a very fast pace. But without trust, there can be infinite delays or gridlock.

LinkedIn is without a doubt the most powerful “Speed of Trust” tool ever invented in the history of the world, and I think modern entrepreneurs and business people who learn how to fully utilize its capabilities and help others in their network to benefit from it in appropriate ways, will find like I have that it it creates a wrinkle in time where all of a sudden you find yourself through some kind of invisible transference of good-will doing business with people you’ve never met before but that you feel that you have, because you’re friends of the same friend.

Does any of this make sense to you, LinkedIn user or not?

Playing around with Google Forms

The other day I noticed an new feature on Google Docs. When I tried to created a new document, it gave me the option of creating a Form.

I was curious, so I started playing around with it and realized that Google Form is a simple, powerful, and free way to create online surveys which can be emailed to anyone or embedded in a blog or website. All the responses are captured in a Google spreadsheet, and charting features make it easy to see the results.

I’m writing a magazine article about business, social networking, and Twitter, and decided to post a Google Form survey on this page. But it didn’t work. My blog is powered by Drupal now, and I can’t find a way for it accept HTML code right now, so I’ll have to link to the survey instead. So here it is:

Please take this survey using Google Forms. 

I emailed one to all my employees last week and got 32 answers in just a couple of days. It was so easy to do. I am currently looking for a way to ask questions to some of our 300,000 Daily Active Users on our We’re Related Facebook application, and I consider Google Forms the leading candidate right now. It offers free-form text responses (one line or paragraph), multiple choice, checkboxes, choose from a list, scale (1-n) responses. Most importantly, it integrates into my daily work flow, since I live in gmail and google docs, and is super easy to use.

I was going to start use PollDaddy.com before I came across Google Forms.

I’d like to know what tools or sites you use for doing email surveys or embedded online surveys, and if you have tried Google Forms. If so, are you going to switch?