Conclusions drawn from rational, logical analysis of an issue are valid. I lose my mind when decisions or comments are based on faulty logic. Some recent examples:
The Path to an Honest to Goodness Depression
Mark Twain said that history doesn’t repeat itself, it rhymes. Excluding a decent size chunk of the lunatic fringe of the Limbaugh Republican Party, most policy makers know that balancing the budget and putting up trade barriers is a sure way to oblivion. Thankfully, we seem to be avoiding those pitfalls.
However, when you have nitwits like Charles Grassley telling AIG executives that they should resign or kill themselves, the United States has begun to flirt with anarchy. The fine legislative branch that spent millions to impeach Bill Clinton for marital misconduct passed a 90% tax on bonuses for any firm that “took American taxpayers’ money” in TARP funds. Lost in the fine press coverage of this event, was the fact that the vast majority of TARP recipients didn’t even want the money. They were told they had to take it.
Now Congress has decided to ignore that pesky, out of date Constitution by voting to retroactively tax a specific group of people in an effort to punish them. As my wonderful Congressman Barney Frank has reminded us, “The American public owns these companies” and as owners, we obviously should get a big piece of those ill-gotten bonuses.
A major contributor to the October/November economic collapse was a disappearance of credit. I have spoken to several banker friends who told me that they: are 1) going to pay back any TARP money before they do anything else, and 2) they will refuse to take anything more. These executives have no interest in letting Congress destroy their firms for the sake of populist grandstanding.
So, we will be able to punish these evil doers and the result will be a sharp contraction of any desire to put money into the economy for lending (because paying back TARP has become Mission number 1). In case you didn’t bother to read it, the stimulus package is far more back end loaded than most observers wanted or expected. There is now a very real possibility that credit will begin to contract again, and with real fiscal stimulus months away, the apparent stability of the U.S. economy is just a branch that we’ve hit halfway down a fall off of a 1,000 foot cliff.
The first Great Depression didn’t really wipe people out in the first 50% down move. Instead, it was when the economy collapsed when Hoover decided to balance the budget which in turn sent the market down more than 80% from its high (that would put us at 2,500 on the Dow). We are not making the “balanced budget” mistake this time, but if Congress gets back into its demonization mode, we could be headed for far worse times.
Case-Shiller: Misleading… at Best
The Case-Shiller index has become this era’s Irrefutable Truth on which politicians pounce and with which the mass media begins all reports. The previous methodology of totaling gross house value sales and dividing by the number of homes sold was a blunt instrument at best. This old school calculation would move around randomly based on whether expensive or cheap homes were selling during the period. To be fair, this methodology was developed before computing power became sufficiently inexpensive to do more than blunt analysis.
The Case-Shiller folks applied computer power to their methodology:
The Path to an Honest to Goodness Depression
Mark Twain said that history doesn’t repeat itself, it rhymes. Excluding a decent size chunk of the lunatic fringe of the Limbaugh Republican Party, most policy makers know that balancing the budget and putting up trade barriers is a sure way to oblivion. Thankfully, we seem to be avoiding those pitfalls.
However, when you have nitwits like Charles Grassley telling AIG executives that they should resign or kill themselves, the United States has begun to flirt with anarchy. The fine legislative branch that spent millions to impeach Bill Clinton for marital misconduct passed a 90% tax on bonuses for any firm that “took American taxpayers’ money” in TARP funds. Lost in the fine press coverage of this event, was the fact that the vast majority of TARP recipients didn’t even want the money. They were told they had to take it.
Now Congress has decided to ignore that pesky, out of date Constitution by voting to retroactively tax a specific group of people in an effort to punish them. As my wonderful Congressman Barney Frank has reminded us, “The American public owns these companies” and as owners, we obviously should get a big piece of those ill-gotten bonuses.
A major contributor to the October/November economic collapse was a disappearance of credit. I have spoken to several banker friends who told me that they: are 1) going to pay back any TARP money before they do anything else, and 2) they will refuse to take anything more. These executives have no interest in letting Congress destroy their firms for the sake of populist grandstanding.
So, we will be able to punish these evil doers and the result will be a sharp contraction of any desire to put money into the economy for lending (because paying back TARP has become Mission number 1). In case you didn’t bother to read it, the stimulus package is far more back end loaded than most observers wanted or expected. There is now a very real possibility that credit will begin to contract again, and with real fiscal stimulus months away, the apparent stability of the U.S. economy is just a branch that we’ve hit halfway down a fall off of a 1,000 foot cliff.
The first Great Depression didn’t really wipe people out in the first 50% down move. Instead, it was when the economy collapsed when Hoover decided to balance the budget which in turn sent the market down more than 80% from its high (that would put us at 2,500 on the Dow). We are not making the “balanced budget” mistake this time, but if Congress gets back into its demonization mode, we could be headed for far worse times.
Case-Shiller: Misleading… at Best
The Case-Shiller index has become this era’s Irrefutable Truth on which politicians pounce and with which the mass media begins all reports. The previous methodology of totaling gross house value sales and dividing by the number of homes sold was a blunt instrument at best. This old school calculation would move around randomly based on whether expensive or cheap homes were selling during the period. To be fair, this methodology was developed before computing power became sufficiently inexpensive to do more than blunt analysis.
The Case-Shiller folks applied computer power to their methodology:
“The S&P/Case-Shiller Metro Area Home Price Indices use the “repeat sales method” of index calculation – an approach that is widely recognized as the premier methodology for indexing housing prices – which uses data on properties that have sold at least twice, in order to capture the true appreciated value of each specific sales unit.”
(http://www2.standardandpoors.com/spf/pdf/index/SPCS_MetroArea_HomePrices_Methodology.pdf)
Thus, C-S calculates an appreciation/depreciation index value for each market based on houses that have sold. This is certainly better than previous methods, but it is farther from perfection than everyone, including Case-Shiller, is willing to admit. And this is where I take issue with C-S and all of its followers.
C-S overestimates the swings in pricing; perhaps dramatically. Try this thought experiment. Which homes in your neighborhood tend to turn over most often? Answer, homes often owned by people who have to move a lot. When these people have to move again, they typically have to sell quickly so the seller can buy a new house elsewhere. In a robust market, the price of a home that needs to be sold quickly clears the market at the offering price.
In a difficult market, someone who tries to sell a house quickly is certain to take a price discount. In this instance, C-S is technically correct about the valuation of the specific house that is sold at a lower price. After all, the price is the price. However, this methodology suffers from the same problem as the “Marked to Market” accounting edict that has effectively bankrupted 80% of the nation’s largest financial institutions. The price you get today for a house sale reflects a distressed price – because the people who are selling homes today are almost certainly doing so out of financial distress. This means that subdivisions in cities that were obviously overbuilt such as Las Vegas and most of Florida are getting hammered as defaults and foreclosures hit the market.
If I told you that we needed to calculate your net worth and that the valuation methodology would be based on what you could get for your house if I forced you to sell your home immediately, what kind of price haircut would you have to take? I’d suspect a lot. If every resident had to sell their house today, what would the price be? A lot lower.
My gripe is with the presentation of the C-S data as an accurate assessment of the housing market. Not only does the index overstate the current malaise, but by blaring the “fact” that housing prices are down 20-40% it simply accelerates the present economic collapse. Apparently, it is too much of a burden to expect the mass media to explain the nuances of the index to a public with an attention span of a fruit fly.
Entrepreneurial “Failures”
This past Sunday’s New York Times included an article that reported the results of a definitive study showing that entrepreneurs who fail do not learn from their mistakes and therefore are just as likely to fail again.
Venture investors basically have to be good at two things: optimizing business models, and assessing managers’ ability to execute on those business models. I use the phrase “business model” to include not only the way in which a firm organizes itself to go to market, but also understanding the timing of technology adoption. The NYT article focused on the second attribute, management quality. It was a worthy effort, but I just about fell out of my breakfast table chair when I read the basis that the academics used to define success:
“Professor Gompers and his co-authors Anna Kovner, Josh Lerner and David S. Scharfstein found that first-time entrepreneurs who received venture capital funding had a 22 percent chance of success. Success was defined as going public or filing to go public; Professor Gompers says the results were similar when using other measures, like acquisition or merger.”
(http://www.nytimes.com/2009/03/22/business/22proto.html?ref=business)
I could not find the actual study, but I find it nearly impossible to believe that “other measures, like acquisition or merger” produced similar results. I was actually shocked that 22% of venture funded companies ever got to the IPO or S-1 drafting stage. In software, my experience is that less than 10% of venture funded firms ever get close to an IPO. The vast majority are acquired before that stage.
If you asked venture partners if a merger was a “failure”, you’ll get a rightfully confused response of “Huh?” In fact, selling a company is more of a win, at least on a risk adjusted basis, than an IPO. If a company goes public, VC investors have to wait at least a year to get liquid during which they have far less control over the company’s direction, and zero control over whatever mania or depression will afflict the stock market. Oh yes, there’s that little thing called Sarbanes-Oxley that will force your firm to send $2 million per year to worthy charities also known as auditors, Directors’ insurance companies, and attorneys. In fact, I know several CEOs who are expressly talented at building well functioning companies that are then sold. If that is the description of a “loser”, I’d take a bus load of those kinds of CEOs.
The reality is that unless you expect a roughly 50%+ advance in stock market valuations from current levels, it is very unlikely that there will be a huge flood of IPO’s. The reason is simple. A software company poised to go public at a 4x EV/Revenue valuation at best will get 2x forward revenues. Public company investors are reeling, and the appetite for sub-$200 million market cap companies is approaching absolute zero. Therefore, all of those $50 million revenue companies certainly can’t get public now, and even with a mythical 50% appreciation in the stock market, you will need about $70 million in profitable revenues to have a prayer to get out. This recession/depression has put the kibosh on just about everyone’s growth rate, so most firms will not grow much in 2009. This means that unless your firm was already approaching $70 million in revenues, your IPO window probably won’t open until very late 2010, if not 2011.
Thus, we expect some private placements to tide firms over until then and a lot more mergers. Whether academics call the latter path a “failure” or not, venture investors will be happy.
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