Readers of this blog have confessed concern over my focus on computers that are faster and faster (http://seekingalpha.com/article/223127-the-new-world-order-smaller-and-faster) and the blue-sky idea of quantum computers. I stand by this interest.
I focus on these developments because finance and the future of banking are going to be significantly impacted by faster computers, their greater capacity to store data, and to the ubiquitous presence of these things in our lives.
So we read: “A new photonic chip that works on light rather than electricity has been built by an international research team, paving the way for the production of ultra-fast quantum computers with capabilities far beyond today’s devices.” (See “Computers Set for Quantum Leap” in the Financial Times: http://www.ft.com/cms/s/0/8c0a68b0-c1bc-11df-9d90-00144feab49a.html.) The technical results of this research are being published today in the journal Science.
Many people in the field felt that it might be 25 years before we saw a functional quantum computer.
“We can say with real confidence that using our new technique, a quantum computer could, within five years, be performing calculations that are outside the capabilities of conventional computers,” claims Jeremy O’Brien, director of the England’s Centre for Quantum Photonics, who led the project.
Quantum computers are going to happen. Governments cannot afford to miss out being a part of the quantum revolution in computers. Governments must have quantum computers to keep secrets. Governments must also have quantum computers for defense purposes…a country like the United States cannot afford to be second in this field.
Therefore, “Hundreds of millions of dollars” are being spent “in the field.”
Why is this so important in finance?
Finance is information!
To see that this is so take a look at the book “The Quants” (I reviewed this earlier for Seeking Alpha: http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.) In this book we see how closely the fields of quantitative finance and financial engineering have always been to information science and information theory. For example (I quote from my book review):
“It is interesting to me that the beginning of the story Patterson (the author of ‘The Quants’) tells is how math/physics whiz Ed Thorp, the Godfather of the Quants, started out on the path to ‘Quant-dom.’ Thorp, as a new member of the MIT staff, took some of his early work on how to predict outcomes of roulette wheels to a well-known member of the MIT faculty named Claude Shannon.
Shannon is known as one of the founding fathers of Information Theory, a theory that has to do with the transmittal of information and the ability to receive and discern the message conveyed in the information transmitted.”
Furthermore, “Now let me fast forward to the quant fund group known as Renaissance Technologies and its star fund Medallion. This whole group was created by Jim Simons and it is ‘the most successful hedge fund in history.’
What kind of team did Simons pull together to staff his funds? Cryptographers and people trained in speech recognition; in essence, people trained in Information Theory. They were trained to detect hidden messages in seemingly random strings of code.”
The development of computer technology and data storage in the 1950s resulted in the massive change that took place in the field of finance in the 1960s. Given the availability and greater accessibility of data related to the stock market, researchers on university campuses produced dissertation after dissertation on performance in the stock market.,
The field of finance has never been the same.
The power of quantum computers is hard to imagine. These computers will be able to make calculations that are only dreamed about in “far out” science fiction novels. These computers will be able to access data bases containing information from almost unlimited sources. The possibilities are mind-boggling.
Will these computers be used in finance?
If there is a chance to “make-a-buck” or several billion bucks, they will be used. Finance is always looking for an edge. Faster and more powerful computers are always a potential source for finding an edge.
But, back to one of my fundamental predictions: finance and financial institutions over the next five to ten years will be something substantially different from what we know now. What happened to finance and financial institutions over the past fifty years is only a prelude to what is going to take place.
Showing posts with label financial institutions. Show all posts
Showing posts with label financial institutions. Show all posts
Friday, September 17, 2010
Sunday, March 29, 2009
The Fate of Rick Wagoner
Rick Wagoner, Chairman and Chief Executive Officer of General Motors, will resign as a part of the agreement with the federal government in which the company will receive additional federal aid. General Motors is a turnaround situation; it is not a restructuring exercise. The odds are against a company pulling off a turnaround with the same people that led them into the situation they now face.
Some people argue that the problem is the bad economy, something that the executives are not responsible for and therefore should be allowed to continue in their positions. This, to me, is like saying that executives in financial institutions are not responsible for the collapse in the financial market that exposed to the world the increased risk they imposed upon their companies or the large increases in leverage that accompanied their use of more exotic financial instruments.
When you make bad decisions, a bad economy will exacerbate the results that come from these choices. But, one cannot just place all the blame on the bad economy.
This analysis puts us back into a discussion about our understanding of exactly what it is that we are now facing in the financial markets and the economy. One way to distinguish the two views that seem to be the predominant ones now in vogue concerning our current situation is between those that believe the main problem relating to financial assets is the liquidity of these assets.
In this argument, people insist that banks and other financial institutions are caught in a trap where the markets for many of their assets are so illiquid that these organizations are unable to price the assets and then, possibly sell them. This seems to be the assumption behind the recently presented investment program, the P-PIP, that was announced by the Treasury last week.
The alternative view is that many financial institutions are insolvent and that what is really needed is a recapitalization of those organizations that still have a future while those that are not capable of being salvaged should be closed. Those that take this approach contend that this problem will not go away and will have to be addressed sooner or later. They also argue that dealing with it sooner will speed on a recovery and will also cost the taxpayer less in the longer run. (See my post http://seekingalpha.com/article/127639-public-private-investment-program-liquidity-or-solvency.)
The other area of concern is the status of many of the firms that find themselves in trouble. One group of analysts believes that the problem is one of a bad economy and a bad financial market and that all the companies need to do is restructure their current operations. This can be done, they argue, with the existing management and with just “tweaking” the existing business model.
Yet, here we are with General Motors. Over 20,000 employees were given the option of taking a buyout of their employment contracts. A total of about 7,500 took the buyout, but this was a disappointing result. Several of the product lines are going to be discontinued and/or sold off to bailouts in other nations. Contracts with labor unions regarding working arrangements and conditions must be massively changed. And, a substantial number of the bondholders must convert their bond holdings into equity. This doesn’t even touch the fact that the auto companies are substantially behind the curve in terms of real innovations and preparations for future technologies and products.
Given these factors that need to be addressed and resolved, I believe that one can only call this a turnaround situation, a condition in which new eyes and ears must be applied. To me there is little hope that the executives that got the company into this position are the executives that will bring these companies into the 21st century let alone into the 1980s.
This judgment applies not only to the automobile industry: it also applies to banks and other financial institutions, as well as many manufacturing organizations and other companies that require major changes in their business models. (See my post http://seekingalpha.com/article/127625-let-go-the-experts-who-have-learned-to-fail.)
This country (and the world) is facing a series of serious structural dislocations. The problems are not ones of liquidity or keeping on, keeping on. Lobbying to maintain the status quo will not give us much hope for the future. Inflating our way out of the bad debt or band-aiding inadequate business models will only postpone what needs to be done.
The arrogance that Rick Wagoner exhibited in his first appearance in front of Congress probably doomed him to this result. The behavior of other executives from both the financial and non-financial sectors has not endeared them to either the people of the country or to their representatives in Congress. This will probably not help the executives in the long run. Sometimes a little humility is a good thing!
Bankruptcy is another option for many firms. One could argue that taking this path would probably be an efficient way to get companies into the turnaround mode although it would not include government money as a part of the process. It would keep government officials out of the turnaround process and avoid relationships that are uncomfortable for the new managements that will be leading the companies out of the bankruptcy.
This in not a normal, relatively mild recession that will be ended through the injection of liquidity into the monetary system. The economy is facing a management problem and a debt problem that must be worked through. It is not clear that this is fully understood by those attempting to turn the economy around.
Some people argue that the problem is the bad economy, something that the executives are not responsible for and therefore should be allowed to continue in their positions. This, to me, is like saying that executives in financial institutions are not responsible for the collapse in the financial market that exposed to the world the increased risk they imposed upon their companies or the large increases in leverage that accompanied their use of more exotic financial instruments.
When you make bad decisions, a bad economy will exacerbate the results that come from these choices. But, one cannot just place all the blame on the bad economy.
This analysis puts us back into a discussion about our understanding of exactly what it is that we are now facing in the financial markets and the economy. One way to distinguish the two views that seem to be the predominant ones now in vogue concerning our current situation is between those that believe the main problem relating to financial assets is the liquidity of these assets.
In this argument, people insist that banks and other financial institutions are caught in a trap where the markets for many of their assets are so illiquid that these organizations are unable to price the assets and then, possibly sell them. This seems to be the assumption behind the recently presented investment program, the P-PIP, that was announced by the Treasury last week.
The alternative view is that many financial institutions are insolvent and that what is really needed is a recapitalization of those organizations that still have a future while those that are not capable of being salvaged should be closed. Those that take this approach contend that this problem will not go away and will have to be addressed sooner or later. They also argue that dealing with it sooner will speed on a recovery and will also cost the taxpayer less in the longer run. (See my post http://seekingalpha.com/article/127639-public-private-investment-program-liquidity-or-solvency.)
The other area of concern is the status of many of the firms that find themselves in trouble. One group of analysts believes that the problem is one of a bad economy and a bad financial market and that all the companies need to do is restructure their current operations. This can be done, they argue, with the existing management and with just “tweaking” the existing business model.
Yet, here we are with General Motors. Over 20,000 employees were given the option of taking a buyout of their employment contracts. A total of about 7,500 took the buyout, but this was a disappointing result. Several of the product lines are going to be discontinued and/or sold off to bailouts in other nations. Contracts with labor unions regarding working arrangements and conditions must be massively changed. And, a substantial number of the bondholders must convert their bond holdings into equity. This doesn’t even touch the fact that the auto companies are substantially behind the curve in terms of real innovations and preparations for future technologies and products.
Given these factors that need to be addressed and resolved, I believe that one can only call this a turnaround situation, a condition in which new eyes and ears must be applied. To me there is little hope that the executives that got the company into this position are the executives that will bring these companies into the 21st century let alone into the 1980s.
This judgment applies not only to the automobile industry: it also applies to banks and other financial institutions, as well as many manufacturing organizations and other companies that require major changes in their business models. (See my post http://seekingalpha.com/article/127625-let-go-the-experts-who-have-learned-to-fail.)
This country (and the world) is facing a series of serious structural dislocations. The problems are not ones of liquidity or keeping on, keeping on. Lobbying to maintain the status quo will not give us much hope for the future. Inflating our way out of the bad debt or band-aiding inadequate business models will only postpone what needs to be done.
The arrogance that Rick Wagoner exhibited in his first appearance in front of Congress probably doomed him to this result. The behavior of other executives from both the financial and non-financial sectors has not endeared them to either the people of the country or to their representatives in Congress. This will probably not help the executives in the long run. Sometimes a little humility is a good thing!
Bankruptcy is another option for many firms. One could argue that taking this path would probably be an efficient way to get companies into the turnaround mode although it would not include government money as a part of the process. It would keep government officials out of the turnaround process and avoid relationships that are uncomfortable for the new managements that will be leading the companies out of the bankruptcy.
This in not a normal, relatively mild recession that will be ended through the injection of liquidity into the monetary system. The economy is facing a management problem and a debt problem that must be worked through. It is not clear that this is fully understood by those attempting to turn the economy around.
Wednesday, February 4, 2009
This Issue Is Debt! Too Much of It!
Going forward…the primary issue the world is going to have to face is debt…lots and lots of debt. Debt is clogging the blood vessels of the world financial system!
And the proposal to get us out of this dilemma?
Create even more debt!
If the problem is too much debt then the economy has to go through the pain of working this debt off…and this is called a debt/deflation. As people and companies and government reduce the amount of debt on their balance sheets they withdraw from the spending stream…and save…exactly what people and companies and governments are doing at the present time. But, removing spending from the spending stream reduces the demand for goods and services, causes firms to cut people from their employee rolls…and creates a downward spiral in economic activity. The economy engages in cumulative behavior and gets deeper and deeper into a hole.
This is what the people and the government want to avoid…if possible.
The Obama stimulus proposal is a way to get us out of the current economic crisis.
(There is another way that I will discuss below.) Basically, it is an attempt to inflate our way out of all the debt that exists. The Federal Reserve is doing its part in trying to pump up the amount of cash that exists within the system. But, creating money in this way takes time for the inflation to work its way through the system because it must go through banks and other financial organizations. And, this system, right now, seems to be functioning at a very low level.
Keynes saw this problem in the 1930s and proposed a way of getting around the banking and financial systems…create massive amounts of government expenditures and put this spending directly in the economic system…financing the deficits with government debt. Then, as the economic system starts to turnaround and pick up steam…the banking and financial system will pick up some steam and provide the “kicker” to create the inflationary environment needed to reduce the real value of the debt that had been built up…including the debt the government deficit spending just added to the pile.
Therefore, the first way to reduce the amount of debt that is outstanding in the economy is to create more debt so as to un-clog the banking and financial system…create an inflationary environment…and watch the “real value” of the debt decline.
This is a long term process and has several problems to face along the way. One of these is the question of how much spending should the government undertake? The issue here is about what the “multiplier” of government spending really is. I treated this in a post on January 26, 2009, titled “What will be the impact of Obama’s stimulus plan, http://seekingalpha.com/article/116414-what-will-be-the-impact-of-obama-s-stimulus-plan. Another question has to do with the process of enacting the stimulus plan into law. This I treated in a post on February 2, 2009, titled “the Obama Stimulus plan: Why I’m Concerned”, http://seekingalpha.com/article/117878-the-obama-stimulus-plan-why-i-m-concerned.
However, the ultimate issue relates to the amount of debt that is outstanding…in the United States…and in the world. If the amount of debt HAS to be reduced…and it must be reduced in order to get the economy functioning again…then, following this approach, inflation must take place to reduce the real value of the debt. The danger with this plan is that if inflation is not cut off at some time in the future, the incentives in the economy will be to return to a “go-right-on” and “business-as-usual” approach to living. That is…we will be right back where we were around the middle of this decade, where leverage was good and more leverage was even better, especially within an inflationary environment where things need to be kept “pumped up”! If this happens, we will still be addicted and still have the “monkey on our backs.”
Another way to reduce the amount of debt outstanding in the economy is to basically “write down” or “re-write” the debt and not create any more through an enormous fiscal stimulus plan like that proposed by the Obama administration. This would involve a massive restructuring of existing business balance sheets…both financial institutions as well as non-financial institutions. Insolvent institutions…including the auto companies…need to be recognized as such. In effect, existing shareholders in these companies have lost their investment…so much for good governance and oversight. Bondholders will have to accept an exchange…taking “new” debt at, say, 75% or 50% of the current face value…or preferred shares for the debt they hold…or taking an equity position in the company…maybe even warrants.
These exchanges would have to be negotiated…but the bondholders would have to understand that, as things now stand, the companies are insolvent and they could get nothing if the restructuring does not take place. Plus, the companies or the bondholders…or the public…really does not want the government to take over these institutions. We do not want state-run companies…financial or non-financial…because the fate of the nation would be much worse with a nationalization of industry than it would with an imposed “re-structuring” of the balance sheets of these businesses…financial and non-financial.
In terms of the consumer…a similar thing would have to take place. The major concern has been related to the housing sector and mortgages. But, we are now seeing a massive wave approaching of defaults on credit cards, car loans, and other types of debt that the consumer has taken on. Similar to the re-structuring of the business sector, the balance sheets of consumers must be re-structured. How we do this cannot really be discussed in this short post, but the idea would be that organizations that have extended credit to the consumer sector will have to take a haircut on the amount of debt that is owed by each consumer and the terms of repayment will have to be restructured in order to make the probability of repayment of the debt realistic. Again, this re-structuring would have to be negotiated…but we are talking here about much lower costs than would accumulate if there were more foreclosures and bankruptcies…more lawyers’ fees…and more costs all the way around. And, this could be done in a much shorter period of time than if all these bad assets had to be “worked out”.
I have given two extreme solutions to the problem of the debt overhang. The fundamental crisis is connected with the fact that there is too much debt in the system. For the system to work this dislocation out we would have to go through a period of debt-deflation. The two extremes presented here are, first, the Keynesian approach which is to inflate the economy and reduce the real value of the debt, or, second, to impose a debt-restructuring on the economy which would allow for a negotiated reduction in the debt loads of all economic units in the system.
People will really not be happy with either of these extreme solutions…or, for that matter…any combination of the efforts. But, once one loses their discipline, as the United States and the world did in the 2000s…there are no good solutions available to get out of the hole that has been dug. All people can do is to “take their medicine” and vow not to let such a situation ever occur again. However, looking back at history, one cannot be very confident that we will maintain our discipline once we get over the crisis.
I would like to make just one more suggestion. There is only one real change I would like to see to the regulatory structure…for both financial and non-financial firms…and that is the imposition of almost complete openness and transparency of the business and financial records of companies. Whatever a company does…it should be open to its owners…and to anyone else that might be interested.
And the proposal to get us out of this dilemma?
Create even more debt!
If the problem is too much debt then the economy has to go through the pain of working this debt off…and this is called a debt/deflation. As people and companies and government reduce the amount of debt on their balance sheets they withdraw from the spending stream…and save…exactly what people and companies and governments are doing at the present time. But, removing spending from the spending stream reduces the demand for goods and services, causes firms to cut people from their employee rolls…and creates a downward spiral in economic activity. The economy engages in cumulative behavior and gets deeper and deeper into a hole.
This is what the people and the government want to avoid…if possible.
The Obama stimulus proposal is a way to get us out of the current economic crisis.
(There is another way that I will discuss below.) Basically, it is an attempt to inflate our way out of all the debt that exists. The Federal Reserve is doing its part in trying to pump up the amount of cash that exists within the system. But, creating money in this way takes time for the inflation to work its way through the system because it must go through banks and other financial organizations. And, this system, right now, seems to be functioning at a very low level.
Keynes saw this problem in the 1930s and proposed a way of getting around the banking and financial systems…create massive amounts of government expenditures and put this spending directly in the economic system…financing the deficits with government debt. Then, as the economic system starts to turnaround and pick up steam…the banking and financial system will pick up some steam and provide the “kicker” to create the inflationary environment needed to reduce the real value of the debt that had been built up…including the debt the government deficit spending just added to the pile.
Therefore, the first way to reduce the amount of debt that is outstanding in the economy is to create more debt so as to un-clog the banking and financial system…create an inflationary environment…and watch the “real value” of the debt decline.
This is a long term process and has several problems to face along the way. One of these is the question of how much spending should the government undertake? The issue here is about what the “multiplier” of government spending really is. I treated this in a post on January 26, 2009, titled “What will be the impact of Obama’s stimulus plan, http://seekingalpha.com/article/116414-what-will-be-the-impact-of-obama-s-stimulus-plan. Another question has to do with the process of enacting the stimulus plan into law. This I treated in a post on February 2, 2009, titled “the Obama Stimulus plan: Why I’m Concerned”, http://seekingalpha.com/article/117878-the-obama-stimulus-plan-why-i-m-concerned.
However, the ultimate issue relates to the amount of debt that is outstanding…in the United States…and in the world. If the amount of debt HAS to be reduced…and it must be reduced in order to get the economy functioning again…then, following this approach, inflation must take place to reduce the real value of the debt. The danger with this plan is that if inflation is not cut off at some time in the future, the incentives in the economy will be to return to a “go-right-on” and “business-as-usual” approach to living. That is…we will be right back where we were around the middle of this decade, where leverage was good and more leverage was even better, especially within an inflationary environment where things need to be kept “pumped up”! If this happens, we will still be addicted and still have the “monkey on our backs.”
Another way to reduce the amount of debt outstanding in the economy is to basically “write down” or “re-write” the debt and not create any more through an enormous fiscal stimulus plan like that proposed by the Obama administration. This would involve a massive restructuring of existing business balance sheets…both financial institutions as well as non-financial institutions. Insolvent institutions…including the auto companies…need to be recognized as such. In effect, existing shareholders in these companies have lost their investment…so much for good governance and oversight. Bondholders will have to accept an exchange…taking “new” debt at, say, 75% or 50% of the current face value…or preferred shares for the debt they hold…or taking an equity position in the company…maybe even warrants.
These exchanges would have to be negotiated…but the bondholders would have to understand that, as things now stand, the companies are insolvent and they could get nothing if the restructuring does not take place. Plus, the companies or the bondholders…or the public…really does not want the government to take over these institutions. We do not want state-run companies…financial or non-financial…because the fate of the nation would be much worse with a nationalization of industry than it would with an imposed “re-structuring” of the balance sheets of these businesses…financial and non-financial.
In terms of the consumer…a similar thing would have to take place. The major concern has been related to the housing sector and mortgages. But, we are now seeing a massive wave approaching of defaults on credit cards, car loans, and other types of debt that the consumer has taken on. Similar to the re-structuring of the business sector, the balance sheets of consumers must be re-structured. How we do this cannot really be discussed in this short post, but the idea would be that organizations that have extended credit to the consumer sector will have to take a haircut on the amount of debt that is owed by each consumer and the terms of repayment will have to be restructured in order to make the probability of repayment of the debt realistic. Again, this re-structuring would have to be negotiated…but we are talking here about much lower costs than would accumulate if there were more foreclosures and bankruptcies…more lawyers’ fees…and more costs all the way around. And, this could be done in a much shorter period of time than if all these bad assets had to be “worked out”.
I have given two extreme solutions to the problem of the debt overhang. The fundamental crisis is connected with the fact that there is too much debt in the system. For the system to work this dislocation out we would have to go through a period of debt-deflation. The two extremes presented here are, first, the Keynesian approach which is to inflate the economy and reduce the real value of the debt, or, second, to impose a debt-restructuring on the economy which would allow for a negotiated reduction in the debt loads of all economic units in the system.
People will really not be happy with either of these extreme solutions…or, for that matter…any combination of the efforts. But, once one loses their discipline, as the United States and the world did in the 2000s…there are no good solutions available to get out of the hole that has been dug. All people can do is to “take their medicine” and vow not to let such a situation ever occur again. However, looking back at history, one cannot be very confident that we will maintain our discipline once we get over the crisis.
I would like to make just one more suggestion. There is only one real change I would like to see to the regulatory structure…for both financial and non-financial firms…and that is the imposition of almost complete openness and transparency of the business and financial records of companies. Whatever a company does…it should be open to its owners…and to anyone else that might be interested.
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