Michael Osinski’s Manhattan Project

Monday, March 30th, 2009

Michael Osinski helped build the bomb that blew up Wall Street — software for mortgage securitization:

When I asked Leszek what the busy group did that sat next to us, he told me they created mortgage-backed securities. It was an instrument, he claimed, designed to keep programmers employed. Having started to overcome my aversion to the overpaid life — I had recently bought a suit at Barneys, the old one on Seventh Avenue — I asked him how the bonds worked.

“You put chicken into the grinder” — he laughed with that infectious Wall Street black humor — “and out comes sirloin.”
[...]
At Lehman, I began a thirteen-year effort to streamline the process of securitizing home mortgages, as well as other forms of debt. That was 1988, around the time of the savings-and-loan crisis. Remember that one? Lenders had gone nuts with, what else, real estate, and as they went bust, the government was stepping into the breach. Mortgage securitization was the answer. Retail lenders could make the loan, take a fee, then sell the mortgage to an investment bank. The bank, after bundling thousands of the mortgages together, could, through a little software magic, issue bonds based on that bundle of loans. Now, an investor does not want a single person’s mortgage, much the same as you may not want to underwrite your sibling’s purchase of an overpriced McMansion. But when 1,000 similar loans are combined, and the U.S. government, through Freddie Mac and Fannie Mae, absorbs the default risk, you now have a nifty little AAA-rated piece of paper paying one or two points above Treasury bills. And if the value of the loans is in excess of the limit set by the government agencies, your savvy friends on Wall Street can create a class of subordinated bonds that will absorb all the defaults in the deal. With friends like these…

While I slaved away at the sausage grinder, CMOs took off — $6 billion were issued in 1983, and by 1988, the annual output had jumped to $94 billion. This was the era described in Liar’s Poker. Wall Street guys felt cool and funny; people who were getting ripped off were dumb and ugly and deserved it. I got a $50,000 bonus check, a 50 percent dollop on top of my salary. Peanuts to the traders, but a bloody fortune to me, for the easiest work I’d ever done. I could afford to rent a nicer place in Greenwich Village, go out to jazz clubs, bike in France. But even then, I was wondering why I was making more than anyone in my family, maybe as much as all my siblings combined. Hey, I had higher SAT scores. I could do all the arithmetic in my head. I was very good at programming a computer. And that computer, with my software, touched billions of dollars of the firm’s money. Every week. That justified it. When you’re close to the money, you get the first cut. Oyster farmers eat lots of oysters, don’t they?

I never would have thought, in my most extreme paranoid fantasies, that my software, and the others like it, would have enabled Wall Street to decimate the investments of everyone in my family. Not even the most jaded observer saw that coming. I can’t deny that it allowed a privileged few to exploit the unsuspecting many. But catastrophe, depression, busted banks, forced auctions of entire tracts of houses? The fact that my software, over which I would labor for a decade, facilitated these events is numbing. Is capitalism inherently corrupt? I don’t think the free flow of goods in and of itself is the culprit. No, it’s the complexity masked by thousands of unseen whirring widgets that beguiles people into a sense of power, a feeling of dominion over the future.

Read the whole thing for some crazy stories.

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Tesla Model S

Friday, March 27th, 2009

The Tesla Model S sedan promises a lot:

The production version of the electric sedan, absent a $350 million loan from the Department of Energy and a manufacturing plant, will be tamer in performance but no less striking in its respective segment when it arrives in late 2011. Hours after embargoed studio photos of the concept car, above, were posted to a Flickr account, Tesla revealed the specifications at the official California launch: a 300-mile range, 45-minute charging, and zero to 60 miles per hour in 5.5 seconds.

At $57,400, the Model S is priced in the range of the Mercedes-Benz E-Class, BMW 5 Series, Jaguar XF, and other premium sedans. But Tesla buyers can now claim a $7,500 federal tax credit for electric and plug-in hybrid cars, which President Obama announced last week in addition to $2.4 billion in federal grants for electric car and battery manufacturers.

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Rise of the Machines

Friday, March 27th, 2009

Cringely takes us back to the era of the day trader:

A successful day trader in the late 1990s could gain a following over Internet chat then use that following to make money by becoming an alpha trader. He’d say “I’m selling this” or “I’m buying that” and copycat day traders would do the same. If enough of them acted they could influence the price down or up and — since the leader was leading — he could almost always liquidate his position with a profit. The quickest of his acolytes would make profits, too. Those who didn’t profit weren’t seen as exposing the inherent flaws of this system, they were just viewed as too slow.

To a certain extent, the heirs of day trading have taken the lessons of that earlier era and applied them with devastating effect in the Twitter Age.

If a bunch of wealthy traders get together at Starbucks and agree to short-sell a company or a financial instrument, driving down that price ideally to the point where it never recovers, well that’s against the law. But with trading automation and the Internet as a platform it is possible to accomplish this same end without it being explicitly illegal.

Think about piranhas:

These little guys with their big teeth travel in large schools. They kill and eat their prey, which can be as large as cattle drinking in the river. Piranha, too, take advantage of force times acceleration. The trick is getting a lot of fish — hundreds of fish — to attack at exactly the same time.

How do they do it? How do the piranha know to attack? They don’t wait to bump into a cow leg under water. They don’t sniff for the smell of blood in water. Both of those responses are too slow and would lead to too many victims escaping. Force equals mass times acceleration, remember? And besides, piranhas have tiny little brains to go with their big teeth, so don’t look for any insight there. These are just violent little eating machines.

Piranhas hunt as a school and take all their cues from the fish beside them. Only one fish has to smell blood or bump into some food for the entire school to reflexively attack.

Now we’re back on Wall Street in today’s era of hedge funds and genetic trading algorithms. At any given moment in the market there is more than a $1 trillion in cash that can be brought to bear in seconds by computers that are functioning essentially like piranhas. The cash isn’t held in a few funds or hidden behind some mainframe interface — it is held by hundreds of workstations each operating independently yet as part of a global economic system — conscious or not.

These trading workstations are running in hundreds of offices, all scanning the same data. They have learned over time that certain signals lead to certain outcomes. They may be following an alpha trader but they don’t have to because at some point the market signal, itself, is going to be too strong to ignore.

Here it comes. An alpha trader makes a bold move against a firm or, more likely, against one or more of that firm’s financial products. Say the firm is big stupid AIG, an insurance company, and the instrument is a credit default swap sold by AIG.

Though AIG seems to have forgotten or ignores it, Credit Default Swaps act like insurance and are treated by the market like insurance, but they technically aren’t insurance. They are ultra-hyper-purified demonic risk and nothing else. That’s because CDS’s are not regulated (they are in fact immune to regulation — funny that), they can be shorted without having to ever actually own the underlying security (naked shorts of CDS’s are perfectly legal), because they don’t have to be owned the volume available to be shorted isn’t limited, and — here’s the best one of all — there’s no requirement that the trader have any causal, custodial, or familial relationship with the covered debt. In other words, while most credit default swaps are intended to hedge debt defaults, they don’t have to be. It’s like buying a life insurance policy on the guy down the hall because you hear him coughing at night. His death is meaningless to you so buying the policy is just a gamble, not insurance.

Here’s how it works in practice. The alpha trader senses, guesses, or maybe just wishes for weakness on the part of AIG and its particular CDS issue, so he shorts that mother. The signal from that short (it is big and aggressive, having as much force as possible) is detected by 500 trading workstations running genetic algorithms — workstations that are not regulated in any sense whatsoever. AIG’s CDS begins to glow in front of 500 junior traders. Some programs kick-in automatically and sell, too. The CDS glows even brighter and begins to throb as if its heart was beating. Traders pile-on like piranhas, sensing opportunity, smelling blood, until the CDS is oversold to nothing, until it is dead.

What we’ve accomplished here, through the miracle of synthetic derivatives, is buying a $1 billion insurance policy on a $10 million asset.

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Risk is usually defined as volatility

Thursday, March 26th, 2009

Risk is usually defined as volatility, Less Antman says, but he defines it slightly differently:

I define financial risk as the probability of not being able to pay for something you need. If someone saves 10% of every paycheck over a 40-year working life and keeps it in the bank, they will have seen virtually no volatility, but will only have around 4 years of income in the bank, since bank accounts typically offer a return after inflation and taxes of nothing, or even a little less than nothing. If they put 10% of every paycheck into a US-only diversified equity portfolio, they would have seen wild volatility, and while an average portfolio would be at 15 years of income, the worst case scenario was only 7 years of income.

Now, even assuming the absolute worst result (and notice I’m not even considering the diversification benefits of international stocks, REITs, and commodity futures, which would have raised the worst case considerably), 7 years of income is still better than 4. Who is in more danger of not being able to pay their bills or running out of money? Who is more at risk as a result of their investments?

Here’s the thing. Over periods of time up to around 7 years, the worst performance of stocks has been worse than the worst performance of cash or bonds. Over longer periods, the worst case scenario for stocks has been better than the worst case for cash or bonds. My last newsletter noted that the decade ended 2008 was the worst ever for US stocks, with a 35% real loss, but that T-bills lost 41% in their worst decade. T-bonds lost 43% in theirs.

Over 17 or more years, US stocks have NEVER had a negative real (after-inflation) return, while bonds have earned negative returns after inflation in time periods as long as 56 years. The worst 40 years for bonds lost 60% after inflation (but still before taxes), and it was starting from a low yield comparable to today’s pathetic Treasury yield.

The point is that you need growth in a portfolio unless you are so wealthy that a slightly negative annual return won’t drain all your resources over time. So investments with lower expected returns expose you to the risk of not having adequate growth, which is, in my view, more important to most investors than the risk of a bad year or two.

Antman’s an interesting character with an interesting lifestyle:

I’ve been semi-retired since graduating from college, never working more than 20 hours a week. Except when traveling, my normal wake time is 3 pm in California, after the market has closed, and my afternoons and evenings are spent with Diane, reading, and browsing the Internet. My feeds on Google Reader often lead me to interesting research, and I usually move around the web without plan to confirm or debunk interesting ideas. Sometimes, that’ll get me doing a little spreadsheet work to test out theories or something along those lines. If I’m writing articles, it is usually then.

My actual workday starts close to midnight: I check my email and respond to all correspondents, aiming to zero out my inbox every day (of course, I don’t always succeed). I delegate everything that isn’t advice-related to my wonderful administrative assistant, Jessica, whom my clients adore. Most days I then work on one client, keeping in mind that I’m a comprehensive advisor and may not be working on their investments. My total work day averages 2 hours a day, 7 days a week, but is flexible based on what needs doing that day. When I’m finished, Diane and I practice our ballroom dancing, I take my run, then I read to her while she goes through her nighttime routine. We usually get to bed around 6 am or so.

Needless to say, my clients don’t pay me by the hour, or I’d starve to death. They only care that I make their lives better and let them forget about money.

(Hat tip to David Henderson, who was surprised by Antman’s recommendation of commodity futures.)

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How (and Why) Athletes Go Broke

Wednesday, March 25th, 2009

Pablo Torre looks at how (and why) athletes go broke — and they do go broke:

  • By the time they have been retired for two years, 78% of former NFL players have gone bankrupt or are under financial stress because of joblessness or divorce.

  • Within five years of retirement, an estimated 60% of former NBA players are broke.

  • Numerous retired MLB players have been similarly ruined, and the current economic crisis is taking a toll on some active players as well. Last month 10 current and former big leaguers — including outfielders Johnny Damon of the Yankees and Jacoby Ellsbury of the Red Sox and pitchers Mike Pelfrey of the Mets and Scott Eyre of the Phillies — discovered that at least some of their money is tied up in the $8 billion fraud allegedly perpetrated by Texas financier Robert Allen Stanford. Pelfrey told the New York Post that 99% of his fortune is frozen; Eyre admitted last month that he was broke, and the team quickly agreed to advance a portion of his $2 million salary.

Athletes aren’t rich because of their business acumen. They’re more like lottery winners. The article dances around it, but athletes are often really, really stupid and make really, really stupid decisions:

You might say Ismail had a run of terrible luck, but the odds were never close to being in his favor. Industry experts estimate that only one in 30 of the highest-caliber private investment deals works out as advertised. “Chronic overallocation into real estate and bad private equity is the Number 1 problem [for athletes] in terms of a financial meltdown,” Butowsky says. “And I’ve never seen more people come to me about raising money for those kinds of deals than athletes.”

For the risk-averse investor, an adviser such as Butowsky would suggest allocating 5% to private equity, 7%–12% to real estate, 50%–65% to a mix of public securities (stocks, mutual funds and the like) and the rest to alternatives such as gold and hedge funds. Yet with athletes, who are often uninterested in either conservative spending or the stock market, those percentages are frequently flipped. Securities are invisible, after all, and if you don’t study them, they’re unintelligible. Not to mention boring. Inventions, nightclubs, car dealerships and T-shirt companies have an advantage: the thrill of tangibility.

Many players, consequently, are financial prey. “Disreputable people see athletes’ money as very easy to get to,” says Steven Baker, an agent who represents 20 NFL players. In May 2007 former quarterbacks Drew Bledsoe and Rick Mirer and five other NFL retirees invested at least $100,000 apiece in a now-defunct start-up called Pay By Touch — which touted “biometric authentication” technology that would help replace credit cards with fingerprints — even as the company was wracked by lawsuits and internal dissent. (The players later sued the financial-services firm UBS, which had encouraged its clients to invest in Pay By Touch, for allegedly withholding information about the company founder’s criminal history and drug use.)

About five years ago, Hunter says, he invested almost $70,000 in an invention: an inflatable raft that would sit under furniture. The pitch was that when high-rainfall areas were flooded, consumers could pump up the device, allowing a sofa to float and remain dry. “The guy I invested with came back and wanted me to put in more, about $500,000,” Hunter says. “Then I met [Butowsky], who just said, Hell no! I wound up never seeing that guy — or any of my money — again.”

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Custom Everything

Saturday, March 21st, 2009

The future of shopping is custom everything:

Chris Clark is not a trend-obsessed tween or the kind of guy who lives for designer sneakers. The 37-year-old Dallas attorney is the rare person who actually just wears his running shoes for running.

Yet over the past few years Clark has bought three pairs of kicks from Nike’s NikeID program, carefully customizing everything from the laces to the soles to a label with his middle name — Inslee — emblazoned on it.

“Nike is what I’ve always worn,” Clark explains. “But sometimes you find a shoe that fits great and the colors in the stores are awful. I still care about how they look.”

Nike isn’t the only brand offering custom shoes:

In the sneaker world, there may be no greater brand contrast to Nike, with its high-tech designs and superstar spokespeople, than Keds. While the top-of-the-line shoes that Nike sells are generally priced above $100, Keds’ canvas sneakers retail for around $35.

Except, that is, for the custom versions, which became available through Keds Studio in August. The shoes, on which shoppers can print any color, pattern, or image, run $60. And in the first three months of business, Keds had 80,000 customizations, though not all translated into purchases, however, especially given the economic slowdown.

Keds had wanted to play in the custom space for years, says Charlene Higgins-Crawford, the company’s e-commerce director of merchandising and operations. “It’s taken us a while to figure out how to do it and to find a partner that had the technology.”

Keds Studio was in part made possible by the availability of very high quality digital printers at a price that made the results affordable. Software developments let them give customers a good — and necessary — look at what they were buying. Partnering with Zazzle, a custom printing company that handles the whole process, means the completed shoes can be shipped within just two weeks.

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The Highs and Lows of the Great Zucchini

Friday, March 20th, 2009

Gene Weingarten tells the fascinating tale of the highs and lows of the Great Zucchini, the most popular and successful children’s entertainer in the DC area — who shows up disheveled, with no costume and a few beat-up old props, but who leaves the toddlers literally convulsing with laughter:

The show lasted 35 minutes, and when it was over, an initially skeptical Don Cox forked over a check without complaint. The fee was $300. It was the first of four shows the Great Zucchini would do that Saturday, each at the same price. The following day, there were four more. This was a typical weekend.

Do the math, if you can handle the results. This unmarried, 35-year-old community college dropout makes more than $100,000 a year, with a two-day workweek. Not bad for a complete idiot.

The Great Zucchini has mastered a brand of humor squarely aimed at toddlers:

Even before they respond to a tickle, most babies will laugh at peekaboo. It’s their first “joke.” They are reacting to a sequence of events that begins with the presence of a familiar, comforting face. Then, suddenly, the face disappears, and you can read in the baby’s expression momentary puzzlement and alarm. When the face suddenly reappears, everything is orderly in the baby’s world again. Anxiety is banished, and the baby reacts with her very first laugh.

At its heart, laughter is a tool to triumph over fear. As we grow older, our senses of humor become more demanding and refined, but that basic, hard-wired reflex remains. We need it, because life is scary. Nature is heartless, people can be cruel, and death and suffering are inevitable and arbitrary. We learn to tame our terror by laughing at the absurdity of it all.

This point has been made by experts ranging from Richard Pryor to doctoral candidates writing tedious theses on the ontol-ogical basis of humor. Any joke, any amusing observation, can be deconstructed to fit. The seemingly benign Henny Youngman one-liner, “Take my wife… please!” relies in its heart on an understanding that love can become a straitjacket. By laughing at that recognition, you are rising above it, and blunting its power to disturb.

After the peekaboo age, but before the age of such sophisticated understanding, dwells the preschooler. His sense of humor is more than infantile but less than truly perceptive. He comprehends irony but not sarcasm. He lacks knowledge but not feeling. The central fact of his world — and the central terror to be overcome — is his own powerlessness. This is where the Great Zucchini works his magic.

The Great Zucchini actually does magic tricks, but they are mostly dime-store novelty gags — false thumbs to hide a handkerchief, magic dust that turns water to gel — accompanied by sleight of hand so primitive your average 8-year-old would suss it out in an instant. That’s one reason he has fashioned himself a specialist in ages 2 to 6. He behaves like no adult in these preschoolers’ world, making himself the dimwitted victim of every gag. He thinks a banana is a telephone, and answers it. He can’t find the birthday boy when the birthday boy is standing right behind him. Every kid in the room is smarter than the Great Zucchini; he gives them that power over their anxieties.

Clearly the Great Zucchini has a talent:

“In the beginning, I had almost no clients,” he said, “and I would sit at a table like this in a place like this, and if a mom would be walking by with her 3-year-old, I would pretend to be talking on my cell phone. I’d say, ‘Yeah, I do children’s parties geared for 3-year-olds!’ And a lot of times, the mom would stop, and say… ‘You do children’s parties?’”

When he first started, he found out what other birthday party entertainers were charging — roughly $150 per show — and upped it by $25. That worked; it seemed to give him agency. After a while, his weekends were so crammed with parties — seven or eight, every weekend — he felt overwhelmed. So, applying fundamental principles of economics, he decided to thin his business but not his profits by raising his prices precipitously — from $175 to $300. It turns out that the fundamental principles of economics are no match for the fundamental desperation of suburban parents. He still was doing seven or eight shows a weekend.

Weekdays, he mostly haunts places like this, drinking coffee and tending to his cell phone. It rings a lot. It’s ringing right now.

“Hello. Yes. Okay, sure, what date are you looking at?”

He flips open the tattered appointment book that is always with him. He’s got dates penciled in as far into the future as October.

So, he clears six figures, working two days a week, and his clients come to him from word of mouth; he doesn’t even have to work to sell his services.

On the down side, he turns out to be a compulsive gambler who can’t hold onto any of that easy money. He understands toddlers, because he really is on their level.

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The Real Secret of Thoroughly Excellent Companies

Thursday, March 19th, 2009

Peter Bregman claims that the real secret of “thoroughly excellent” companies is trust — which strikes me as… less than actionable.

More usefully, he explains how Michael Newcombe, general manager of his favorite hotel, the Four Seasons, practices proximity management:

Every month he meets informally with each employee group. No agenda. No speeches. Just conversation. That helps him solve problems: for example, the time guest check-in was being mysteriously delayed.

During his meeting with the front desk staff, he learned they were slower than usual in checking in guests because rooms weren’t available. Then, in his meeting with housekeeping staff, someone asked if the hotel was running low on king size sheets. Most CEOs wouldn’t be interested in that question, but Michael asked why. Well, the maid answered, it’s taking us longer to turn over rooms because we have to wait for the sheets. So he kept asking questions to different employee groups until he discovered that one of the dryers was broken and waiting for a custom part. That reduced the number of available sheets. Which slowed down housekeeping. Which reduced room availability. Which delayed guests from checking in.

He fixed the problem in 24 hours. A problem he never would have known about without open communication with all his employees.

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Bowling for Dollars

Thursday, March 19th, 2009

Climbing up the ladder in a large organization is one kind of bowling for dollars:

One winter back at the College of Wooster, in Wooster, Ohio, I took a bowling course that changed my life. P.E. courses were mandatory, and the only alternative that quarter, as I remember it, was a class in wrestling.

A dozen of us met in the bowling alley three times a week for ten weeks. The class was about evenly divided between men and women, and all we had to do was show up and bowl, handing in our score sheets at the end of each session to prove we’d been there. I remember bowling a 74 in that first game, but my scores quickly improved with practice. By the fourth week, I’d stabilized in the 140-150 range and didn’t improve much after that.

Four of us always bowled together: my roommate, two women of mystery (all women were women of mystery to me then), and me. My roommate, Bob Scranton, was a better bowler than I was, and his average settled in the 160-170 range at midterm. But the two women, who started out bowling scores in the 60s, improved steadily over the whole term, adding a few points each week to their averages, peaking in the tenth week at around 120.

When our grades appeared, the other Bob and I got Bs, and the women of mystery received As.

“Don’t you understand?” one of the women tried to explain. “They grade on improvement, so all we did was make sure that our scores got a little better each week, that’s all.”

No wonder they turned the Stanford University bowling alley into a computer room.

I learned an important lesson that day; success in a large organization, whether it’s a university or IBM, is generally based on appearance, not reality. It is understanding the system and then working within it that really counts, not bowling scores or body bags.

The start-up world is a completely different league:

In the world of high-tech start-ups, there is no system, there are no hard and fast rules, and all that counts is the end product.

The high-tech start-up bowling league would allow genetically-engineered bowlers, superconducting bowling balls, tactical nuclear weapons — anything to help your score or hurt the other guy’s.

Anything goes, and that’s what makes the start-up so much fun.

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Beginning Engineers Checklist

Wednesday, March 18th, 2009

The Beginning Engineers Checklist shares some hard-earned wisdom:

Business will always be part of engineering. Get over it.
  • Lots of people lie. You can’t tell. You can’t get along without them.
  • Salespeople will tell you anything they think will sell their product.
  • Payment for contract work may be difficult to collect.
  • Never underestimate the stupidity of the end user of your product.
  • Make things that people want to buy. Not use, play with, see, understand, etc. — buy.

K.I.S.S.

  • The ideal design has zero parts.
  • “An engineer is someone who can build for a dollar what a fool can build for twenty” — Robert A. Hienlein
  • If it ain’t broke, it doesn’t have enough features yet
  • To the optimist, the glass is half full. To the pessimist, the glass is half empty. To the engineer, the glass is twice as big as it needs to be.

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Free to Freemium

Tuesday, March 10th, 2009

Web entrepreneur Ranjith Kumaran discusses making the shift from free to freemium. This is the point I enjoyed:

People who don’t believe in paying for web-based services will call you a sell-out. Unsurprisingly, these folks aren’t in your target market.

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Free to Freemium

Tuesday, March 10th, 2009

Web entrepreneur Ranjith Kumaran discusses making the shift from free to freemium. This is the point I enjoyed:

People who don’t believe in paying for web-based services will call you a sell-out. Unsurprisingly, these folks aren’t in your target market.

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Be Hapful

Monday, March 9th, 2009

To be a good startup founder, Paul Graham says, you need to be relentlessly resourceful — or, you might say, hapful:

A couple days ago I finally got being a good startup founder down to two words: relentlessly resourceful.

Till then the best I’d managed was to get the opposite quality down to one: hapless. Most dictionaries say hapless means unlucky. But the dictionaries are not doing a very good job. A team that outplays its opponents but loses because of a bad decision by the referee could be called unlucky, but not hapless. Hapless implies passivity. To be hapless is to be battered by circumstances — to let the world have its way with you, instead of having your way with the world.

Unfortunately there’s no antonym of hapless, which makes it difficult to tell founders what to aim for. “Don’t be hapless” is not much of rallying cry.

It’s not hard to express the quality we’re looking for in metaphors. The best is probably a running back. A good running back is not merely determined, but flexible as well. They want to get downfield, but they adapt their plans on the fly.

Unfortunately this is just a metaphor, and not a useful one to most people outside the US. “Be like a running back” is no better than “Don’t be hapless.”

But finally I’ve figured out how to express this quality directly. I was writing a talk for investors, and I had to explain what to look for in founders. What would someone who was the opposite of hapless be like? They’d be relentlessly resourceful. Not merely relentless. That’s not enough to make things go your way except in a few mostly uninteresting domains. In any interesting domain, the difficulties will be novel. Which means you can’t simply plow through them, because you don’t know initially how hard they are; you don’t know whether you’re about to plow through a block of foam or granite. So you have to be resourceful. You have to have keep trying new things.

Be relentlessly resourceful.

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Are big law firms built on implicit leverage?

Monday, March 9th, 2009

Are big law firms built on implicit leverage? Of course they are — but it’s operational leverage:

Over the last few decades – concurrent with the growth of leverage in the financial system – the business model of most large law firms has developed into one built on leverage as well. It is just a leverage which utilizes people rather than borrowed money. Specifically, since law firms generally bill by the hour (a system whose demise has been predicted for the near future and, in my opinion, always will be), firms increase their profitability by increasing the amount billed in respect of each equity partner. Since there is only so much time in the day, firms have tended to increase the ratio of attorneys per equity partner. Without irony, this ratio is known as…”leverage,”

…Now, in times where there is an easy supply of credit work, this system of leverage works very well for all involved. But when the flow dries up, the firms are left with high fixed costs to be serviced – and the more leveraged the firm is, the harder it is to service those costs with reduced revenue. Sound familiar? It should be no surprise that large law firms have been laying off attorneys in far greater numbers than in previous downturns, with some doomsayers (whom I hope are less accurate than their counterparts with respect to the economy generally) predicting additional firm collapses and permanent changes to the firms’ business models. (The one saving grace to the law firm model of leverage is that they can “deleverage” far more easily than banks, as banks can’t merely fire their “troubled assets.”)

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Iceland’s other main natural resource

Saturday, March 7th, 2009

Michael Lewis discusses Iceland’s other main natural resource — not fish, but energy — and I get the feeling that the locals must have been pulling some foreigners’ legs:

The waterfalls and boiling lava generate vast amounts of cheap power, but, unlike oil, it cannot be profitably exported. Iceland’s power is trapped in Iceland, and if there is something poetic about the idea of trapped power, there is also something prosaic in how the Icelanders have come to terms with the problem. They asked themselves: What can we do that other people will pay money for that requires huge amounts of power? The answer was: smelt aluminum.

Notice that no one asked, What might Icelanders want to do? Or even: What might Icelanders be especially suited to do? No one thought that Icelanders might have some natural gift for smelting aluminum, and, if anything, the opposite proved true. Alcoa, the biggest aluminum company in the country, encountered two problems peculiar to Iceland when, in 2004, it set about erecting its giant smelting plant. The first was the so-called “hidden people” — or, to put it more plainly, elves — in whom some large number of Icelanders, steeped long and thoroughly in their rich folkloric culture, sincerely believe. Before Alcoa could build its smelter it had to defer to a government expert to scour the enclosed plant site and certify that no elves were on or under it. It was a delicate corporate situation, an Alcoa spokesman told me, because they had to pay hard cash to declare the site elf-free but, as he put it, “we couldn’t as a company be in a position of acknowledging the existence of hidden people.”

They had a more serious problem, too:

The other, more serious problem was the Icelandic male: he took more safety risks than aluminum workers in other nations did. “In manufacturing,” says the spokesman, “you want people who follow the rules and fall in line. You don’t want them to be heroes. You don’t want them to try to fix something it’s not their job to fix, because they might blow up the place.” The Icelandic male had a propensity to try to fix something it wasn’t his job to fix.

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