Who's creating these days?

7:35 am, express train to Grand Central Terminal. Leading luminaries of Wall Street and the New York City bar populate most every seat as far as one can see. All monthly commuters. All headed in to their high-flying, high-paying positions in the world's leading financial center. The financial center that has spread its ways and wares to all corners of the globe, in the form of debt and equity securities, syndicated bank loans, project finance and other structured financings, commodity and currency derivatives, and complex credit and equity derivatives, to name just a few high-lights. These structures have worked pretty well in the US market and legal system, but they have fared quite poorly in some other parts of the world.

With all the power and influence riding the train right next to me, what strikes me most is what these folks are reading. Almost to a person, they are all reading the Wall Street Journal, and a few are reading the New York Times business section. That's it - I can see scores of the papers, often open to the same page and read at roughly the same pace. Like lemmings. These people are all informing themselves, but only with the same data as their colleagues and competitors.

I have to imagine that such market behavior helps put a kind of frame around what these people create. All the time spent catching up on what your competitors are reading cannot be spent preparing to enter markets and build ideas and products that the competitors are not. Although my evidence is purely anecdotal, my clear sense is that most of these folks do not read other news sources that would inform them better about developments in other fields and from other countries' perspectives. OK, they all have Bloomberg terminals, so they can follow throughout the day whatever Bloomberg thinks is important - but that seems to be much of the same stuff as appears in their morning papers, only more hastily written.

Is it any wonder that this closed information loop leads to Wall Street products that so often merely replicate - culturally - what has been done in the past, even when those products have badly failed investors in parts of the world far away from New York. I have been there when many fixed income products failed investors in the wake of currency and political crises, so I am awed that the international finance products Wall Street and their lawyers still trot out today are complete replicas of the failed deals.

I am sure that institutional compensation structures drive this dynamic as much as anything - it is expensive and risky to adapt deal structures to other cultures, especially when the existing deals continue to sell so well - to a buy-side with complementary compensation structures, and informed by the same news sources. I expect there is opportunity out there for creative people to build new, more culturally-sensitive approaches to investments, approaches that will be more lucrative, even to the deal designers, in the longer term. But somebody will have break out of the "Wall Street Journal on Metro North" model of self-education first.

Sovereign Resurgence?

This post is only to re-direct you to a piece in last week's Economist (sorry for my delay) on the subject of my favorite "bone" - global liquidity. In this piece, Buttonwood helpfully introduces what has been going on in the credit markets of late. The author's final words are resonant in my mind.

Perhaps my bone is tastier than I knew. All gnawers are welcome.

Join me in Hell

In most human activity, hidden opportunities are plentiful. The world's most capable and effective people know how to seek out and capitalize on those chances. So it must also go in the game of international relations, US politics, and the war on terror. On the basis of that premise, leap with me into the abyss. Osama bin Laden is the most widely-recognized terrorist, and perhaps the most inhumanely savage murderer, in recent memory. There is no case for supporting anything that he does or supports, he must be stopped, and there can be no credible argument against that view. At the same time, however, responsible and thinking warriors on terror MUST consider carefully what Osama has to say. His chosen subjects and his choice of words almost certainly loom large in the minds of the terrorist enemy. So, if we are to prevail in the war on terror, we must understand his means and his meaning. We must learn from his tireless efforts to corrupt Islam and to coopt the world's Muslims, and we must deploy what we learn as an important weapon in the war. It cannot be that the war on terror is the sole form of human activity in which there are no hidden opportunities.

If you are still with me down here (is it hot enough yet?), let's have a quick look at important parts of Osama's latest. First, I think noteworthy the broad span of world and religious history that he recites in his speech. The fellow speaks to the world once every couple years, and he chooses to describe the details of centuries of relations among Islam, Judaism, and Christianity. He must know that the US population has little understanding of the subject, and perhaps even less patience for it, so he cannot seriously believe his words will persuade. Instead, he must know that these words will be described as "strange", if not outright offensive, and they will be perceived that way. In the western coverage I have seen, the point that is most frequently identified is his invitation for the US to convert to Islam. How odd, and what hubris!

Second, Osama goes to great lengths to inform the US population that their ways and means have led them astray from monotheism - the belief in one god. According to Osama, corporate wealth, consumerism, and democratic power have each risen to the level of a god in the western mind and in western pursuit. So today's Jews and Christians (those in power at the least) cannot rightfully claim to be monotheists. Instead, they have reverted to pre-Abraham paganism and idol worshiping (the idols being the latest country invaded, the latest pool of oil reserves controlled, the latest collection of corporate profits expanded). That such barbarians so completely rule the world today is seemingly Osama's greatest complaint.

Finally, Osama explains important similarities among Islam, Judaism, and Christianity. As many people know, all of these religions emanated from the same Abrahamic tradition in the middle east. Judaism was the first religion/tradition to form, based on what was revealed to Moses at Sinai. Christianity was a branch of Judaism whose rabbis were persuaded that Jesus Christ was the messiah who had been promised in Judaism's Torah. Islam came along five centuries or so after the birth of Christianity, and it came in the form of the Koran as revealed to the Jew Mohamed. Osama well understands this common history, and, it seems to me, he seeks a sympathetic ear by referring to it. Though his call is clearly for US conversion to Islam (the purest form of monotheism in his opinion), one could read his speech as stating that he would be satisfied were the world made up of pure and true monotheists (in his judgment) of any stripe. He even states that submission to the one and only god is the most important truth in human activity, even if the laws people use in that pursuit differ among themselves.

Hmmmmmm. So what do we make of all this? (Bear with me as I seek out the hidden opportunities and, for the moment, I ignore the truly offensive parts of his speech - particularly where he refers to his responsibility for 9/11 and where he reveals obvious antisemitism and disdain for Christians, etc., etc., etc., etc.) How do we think the Islamic world perceives his words (I imagine they are fairly well-received)? What opportunities exist for the warriors on terror to design countervailing messages that would be credible in the minds of those Muslims who are disposed to be sympathetic to Osama's words? I am no expert, though I certainly hope that the US Government is carefully wrestling with these questions and any related opportunities, from the White House on down.

Were I in the White House, I would consult my best Islam (and Islamic) experts to learn just how powerful Osama's words are among Muslims in various places and various traditions. I would ask if there are important sections of Islam that are receptive to a co-existence of Islamic tenets and human culture (business, society, democracy), and if so, what could be done to speak to the people in those traditions. I would ask if there are concrete investments that the US could make to become credible in that universe - whether re-constructing destroyed mosques in Iraq, promoting Islamic awareness within the US, strengthening the position of peaceful Islamic leadership in critical locations, etc. I would ask those and other experts whether an education campaign in the US about the deep commonalities among monotheistic traditions would be useful, whether a substantial education and re-direction of the western media on these subjects would be helpful in focusing the US on the opportunities for peace, and also the specific hot-spots where military engagement is completely unavoidable.

I contend that using Osama's speech against him, educating the warriors on terror so they can be smarter and more appealing and effective in the world's hot spots, must be the right thing to do. I am constrained by my limited knowledge of Islam and the details of the war on terror. But the way the western media presents the whole subject, I am left with the impression that the US Government is falling short and missing opportunities that may be in the best interests of the United States and international security.

Bush's China/Iraq framework, according to the AP

In what one can only hope was a rather hastily assembled (18 minutes ago!) AP headline story on Yahoo! yesterday, there was a discussion of the Bush administration’s current position on China and Iraq. It seems Bush would be concerned about the Chinese military, if China ever “turned hostile”, as he was explaining to the Australian Government. Bush said that his administration spends “a lot of time on China”. Would it be fair to wonder what the Bush administration is actually considering doing about China? What specific actions do you think the folks in the White House have in mind?

Remaining in a hopeful mood, one hopes that we glean nothing on this question from the AP reporter who did the story. Without transition, Bush is stated to have urged all countries considering pulling out their troops “to base their decision on restoring the country’s security”. Oh, that is a reference to Iraq. No need to worry that the Bush administration is promoting military options to address his concern about China turning hostile. Whew.

I imagine President Bush actually addressed China and Iraq in close succession at his press conference in Sydney. And perhaps Bush did so in a way that was somewhat confusing. But come on, the Associated Press ought to be able to find reporters and editors who can sift through the word salad and report something lucid about what the United States President has had to say at a meeting with another head of state. Right? The fact that this AP story is still on the web, largely uncorrected, is bad news indeed for the US media consumer. But do you think anybody cares, or will even notice?

Temasek's investment leadership

I have been thinking of late about the recently-published annual report of Temasek Holdings, one of Singapore's sovereign wealth funds. Temasek is boasting that it now has more than US$100 billion under management, making it a sizable investor by almost anybody's scale. My recent ramblings on this page have been based on the idea that sovereign wealth funds may, together, make-up the next massive wave of investment around the world. I have also long seen Singapore as a leader in investment-related matters. So I wonder what this report may tell us about Singapore's role in the future of global investment.

Moving things around - "intermediation" may be the more technical term - is among Singapore's core skills. Singapore's deep history is rooted in its being the mid-point - by sea - between major ports in India and China. As a port, Singapore has long made a living getting things in and out of the place. This trans-shipment tradition continues today, as Singapore remains the busiest container port in the world. Singapore intermediates other things as well. Perhaps most importantly these days, oil and money. The amount of money that makes it into Singapore's financial institutions (and tax coffers) is just enormous. In many senses, Singapore is the Switzerland of Asia for Southeast Asia's Overseas Chinese. In its own way, which is quite different from the loud and machismo ways of Wall Street, Singapore serves a very important function in keeping funds flowing throughout Asia from investors to businesses in need.

Temasek is undoubtedly a core part of that activity. US$100 billion, and look at where its annual report tells us Temasek is busiest - China, India, and Vietnam. These are places where intelligent capital is very much in demand. Temasek says it plans to play an expanding role in these places. I also think it is fascinating to note in what industries Singapore invests. Unsurprisingly, 74% of Temasek's investments are in financial services, telecom/media, and transport/logistics - classic intermediation industries. Talk about money that knows what it's doing!

Large sums. Managed quietly. Deployed in businesses the fund's management well understands. These are fundamentals that are becoming more attractive again these days, as we watch Wall Street's labyrinthine financial structures come apart at a few seams. No wonder Temasek sees the Barclays/ABN deal as an opportunity. Expect to see much more of that, if you are alert.

Second Hand Litter

What is it about smoking? Full disclosure: I am not a smoker, but I am not maniacally opposed to others smoking. I do wonder though, about one aspect of the behavior of many smokers I observe: littering. For most folks I observe, littering is taboo. When the seventies passed by, so did the tacit consent society gave to the litterer. Aside from the occasional apple core or peach pit hurled out a car window, how often do you see somebody just throw their trash on the street these days? Wouldn't it jar the senses to see that?

Now think about smokers. How often do you see them toss their butts to the ground? I see it probably every day, certainly every week. I just saw it again this morning as I was entering my town's train station. A perfectly lovely lady, chatting about her children's affairs, took her last drag, and flicked the rest of her cigarette to the street. She gave no thought to it at all. Perfectly natural. For some reason it jarred me today. So I started looking around. Before I could board the train, which was only about 90 seconds later, I counted four other cigarette butts and an empty package of Marlboro lights flung around the place. No other litter, just this cigarette waste.

What gives? Why should this behavior be OK? There has to be an answer that a non-smoker cannot immediately appreciate. At least for the lit cigarette butts, it could be that disposing them in the normal trash is a fire hazard? So the process of disposing of the butt would include throwing it down, stepping on it, and then (indignity!) bending over to pick it up again before placing it in the trash. Sounds like a lot of work, I have to admit. And perhaps the avoidance of all this work leads folks to be more liberal about disposing anything to do with cigarettes, such as empty boxes.

I wonder if there is any upside in inventing a portable cigarette extinguisher? Ha ha ha ha ha ha ha ha ha ha ha ha ha ha ha ha ha!

Dog with a Bone

Like the Captain of the Titanic, I cannot bring myself to the life boats just yet. Yes, I am back to my old favorite: global liquidity. Now, Nouriel Roubini is adding his booming voice to the likes of Edward Altman. We are apparently experiencing a true crisis in the credit markets these days. Not just a liquidity issue, but a fundamental insolvency problem. Reciting the melting subprime mortgage industry, the hurting US consumer/homeowner, and contracting credit availability emanating from there, Nouriel is persuaded we are at the beginning of something big and terrible.

I still wonder. Not because I disagree about the loony levels of corporate (and sovereign) debt that have been slapped on the books in recent years. I am not under under the impression that these unprecedented debt levels are magically sustainable by business or government operations when they have never been sustainable before in human history. I agree that credit issuances are badly matched against the fundamental businesses of the issuers. And so I also agree that a crunch must be coming, and that the longer it takes to get here, the worse it will be.

Where I disagree - or more likely, fail to understand - is in the timing. Nobody that I have read makes a well-crafted connection between the weaknesses that Nouriel describes on the one hand and the huge sums of capital that remain in the global system on the other hand. It seems clear to me that the recent build-up of over-indebtedness is a direct result of massive global liquidity. (Does it perhaps matter whether such liquidity is due to central banks' addition of money to the system, whether the liquidity is merely credit, or credit derivatives-related, or something else, or some combination?) Every problem that an issuer could encounter of late has been resolvable by the introduction of more liquidity - more money at cheaper prices, and with fewer restrictions.

Assuming that is a fair way to see things, what the heck has changed? From what I can tell, massive amounts of money are still on the side-lines, much of it sitting in sovereign wealth funds, whose aggregate size dwarfs the size the global hedge fund industry. Not so, I am told, when one considers the leverage that hedge funds bring to bear - with that leverage, hedge funds are a much heavier influence on the globe. But, I wonder, what happens when the sovereigns begin to deploy such leverage on a similar scale? And where are the fleeing investors going anyway - are not sovereign obligations, like T-Bills, more appealing to investors these days? Does that begin to sound like sovereigns expanding their ability to lever their investments?

OK, I'll slow down. But is it not the case that there is at least the strong possibility of further rescue financing or further opportunistic asset purchasing by these sovereigns? And if not, where will all that money go? Has anybody worked this stuff through? Because I am lost. But I cannot see the logical path to concluding that today is the beginning of the insolvency crisis.

John, You're Killing Me

It was a very warm feeling, at least at first. I was watching John Stewart on the Daily Show the other day, and he was doing the entire pre-guest show by himself. No bit from any of the other usuals. And the subjects he chose to examine (ridicule) were two subjects that I had just noticed and pondered a great deal as well, in the previous days.

He first focused on the piece in The Economist last week reporting on Dick Cheney's initial observation of the small silver box that had sworn to secrecy, on pain of death, the interpreter who was aiding Dick's exchange with Morocco's King Hassan. According to The Economist and John Stewart, Dick's thought was "damn, I need one of those". John's message here was, as is often the case, "You don't know Dick".

John second focused on the recent exchange between Barak Obama and Hillary Clinton in which Obama, somewhat refreshingly, pointed out that the US's not speaking to foreign leaders was not much by way of punishment for them. Accordingly, Obama would undertake, in the first year of his presidency, to speak with folks like Castro, Kim Jung Il, and Ahmadinejad. Hillary, based on the depth of her alleged foreign policy experience, said she would not commit to meet these folks in the first year of her presidency. The ever sharp US media has blown this difference into a huge and fundamental policy divide between the two candidates, which seems odd when one considers what each candidate apparently said. Both would seriously consider talking; one thought the first year was the right time and the other was not so sure. John's message here was, as is often the case, in what orifice is the US media's head?

Although many of you may also have seen and thought about these stories as well, I felt as if I had written the script for John that evening (OK, not the humorous approach that only John can deliver). But is that a good or a bad feeling? At first, I felt like I was "in touch" in some sense; close to things that this thinking media powerhouse also finds important. On longer reflection, I felt somewhat redundant. Who needs a poorly followed blog when John is broadcasting well enough to young folks? Even this post, how redundant can you get?

In search of a new train.....

Contrarian Optimism

Mostly because it's fun, I am going to stick by my liquidity guns for a while longer. This has been a scary week for those who follow the credit markets. Many of my friends who run fixed-income portfolios are not even returning phone calls, they are so busy managing their affairs, presumably looking for exit ramps and downside protection. We have seen stories cascading out of the US sub-prime mortgage lending debacle: LBO financing arrangements are stalling en masse, credit default protection for large investment bank debt is getting much more expensive, US Treasury bill prices are sky-rocketing, emerging market spreads are widening drastically. Everybody is fleeing to quality, we are told.

Other developments are making the media and investors even breathier. Stock markets are plunging. US housing sales are way off. Government officials and market gurus are telling us that these developments may be the beginning of a serious market correction. People reading about these developments are getting even more scared, which must be causing even more selling and even more price declines.

I cannot deny that these developments are large and important. I doubt that my limited window into the credit markets makes me smarter than the experts and the investing herd. Still, being a contrarian type, and seeing nothing that has changed my earlier-posted liquidity analysis, I am going to remain of the view that these developments are not (yet) the beginning of a major correction. I am not sure where all the sovereign wealth funds are going to deploy their vast sums in the next months and years. But I have to imagine that the relatively recent trend of these sovereigns pursuing greater investment diversification will continue. I imagine that diversification may slow somewhat, as sovereigns may find that greater sums need to be invested - say in US treasuries, even at the newly inflated prices - in order to pursue policy goals, such as currency pegs.

But all that money, not to mention the amount of private capital that is also on the side-lines at the moment, has to go somewhere. And the recent market dips must have some appeal as buying opportunities. If not, I have a large mattress at home that I might be able to roadshow successfully in Beijing, Singapore, and Dubai.

Sovereignty's Dirty Laundry

Have you seen the excerpt from J.M. Coetzee's new novel, Diary of a Bad Year, which is forthcoming in January 2008? Pretty interesting stuff. I have to confess as somebody who does not read a lot of novels that the format is a bit confusing to me. Large swaths of non-fictional observations are interspersed with short bursts from a fictional exchange in a laundry room. I could not connect all the dots, although the novelty was captivating.

Mostly, what strikes me about the excerpt is the collection of observations about what the state is, how it is established, and how it evolves. At bottom, Mr. Coetzee observes that most of us are born into a territory where a state has long asserted sovereignty, so the state's structure is hard-wired into our psyche and our behavior. The concept of removing the state (or, I imagine he would agree, drastically altering it) is not something that occurs to most folks or that we would be capable of achieving in any event. "It is what it is", and we are generally content with the marginal tools available to us for effecting marginal change.

These tools include the (false) choices presented in elections - candidate A v. candidate B. We have very little say in which candidates are presented to us, we have even less ability to provide a fair shake in the elections to a candidate C, and we have almost zero ability to drive toward something completely different (e.g., a new form of government, or no government at all).

Even more insightful I think are Coetzee's comments about how a state is born. He cites to the Kurosawan movie "The Seven Samurai", in which a population accepts the samurai's services in ousting a harmful group of bandits who were demanding excessive tribute. Once the samurai succeed, they then offer to serve as the new "protectors" of the population for a price. The population declines their offer, and the samurai leave. I am not sure what happens after that - I have not seen the movie. But the text Coetzee uses at this point in the excerpt is very insightful:

"The Kurosawan story of the origin of the state is still played out in our times in Africa, where gangs of armed men grab power—that is to say, annex the national treasury and the mechanisms of taxing the population—do away with their rivals, and proclaim Year One. Though these African military gangs are often no larger or more powerful than the organized criminal gangs of Asia or Eastern Europe, their activities are respectfully covered in the media—even the Western media —under the heading of politics (world affairs) rather than crime."

I like to consider this subject globally as something of a spectrum that includes both politics and crime. Certainly, there are similarities between (legitimate) governments and armed gangs. Both are groups that provide protection to a population in exchange for a fee, and both maintain power through a combination of superior weapons and mythology (i.e., nationalism, loyalty, fear of outside evil forces). It is a spectrum I have long wrestled with, and I am gratified by Coetzee's text. I look forward to reading the full book next year.

How Liquid Is That?

This post is just to note another piece of evidence in support of my earlier post on the likelihood that the global liquidity glut may last a while longer yet. Usual caveat: nobody can predict cataclysmic change, and I have to confess that the huge and growing notional amount of the credit derivatives market has been troubling me a good deal of late. Check out this post on the Seeking Alpha page for a chilling report on that subject.

But I could not suppress a smile when I read this story on Bloomberg yesterday. It seems that the same week as the ratings companies are finally realizing the US sub-prime mortgage market disruption means related mortgage-backed paper should be down-graded, US HUD Secretary Jackson is in Beijing urging the Chinese Government to invest more heavily in US mortgage-backed securities.

I am sure I am wrong, but it sounds like somebody is asking the Chinese to provide liquidity to help revive a deflating market in the US. The story didn't say what the Chinese reaction was, although I imagine if Secretary Jackson had been laughed out of the room, Bloomberg would have mentioned it.

Being Hugo Chavez

You're Hugo Chavez, what do you do now? The world is on edge, quite uncertain of which direction you may go. You seem hell-bent on a vague socialist agenda, nationalizing major industries in Venezuela and ousting foreign investors. You espouse anti-"northern" values, in an effort to consolidate power around you in the "south". You close down domestic media which disagree with your agenda, leading to frequent accusations of your impairing freedom of the media. You accuse foreign governments of meddling in your internal affairs. You proudly hold summits with other national leaders who are at least at verbal war with the United States (e.g., Cuba and Iran, perhaps North Korea will be next?). You co-issue bonds with the Government of Argentina on the heels of that Republic's messy and forced 70%+ haircut on their previous external debt. You threaten to pull out of the IMF.

But you don't pull out of the IMF, after it seems that you realize such a step would cause a default on your outstanding external debt. You don't stiff those external creditors, but instead, you keep paying them, likely from the deepened revenue base the higher oil prices provide you. You don't seek to sever ties with the "imperialist" United States, but instead you invite a new ambassador who is serious about your country. You continue to use the global media, wherever possible, to advance your domestic, regional, and global agenda. You cautiously navigate the claims of the investors whose assets you expropriate. You declare that entrepreneurs have a critical role in the development of the socialist economy.

Although I am certain that you have a clear set of goals and a rational game plan, you have confused much of the world. On the one hand, we could readily believe that you are about to slip into Argentina's behavior pattern in the wake of its currency crisis, limiting foreign exchange flows and defaulting on or effectively repudiating external debt, with an added dose of 20th century-style, poorly compensated expropriations. Especially if oil prices trend downwards significantly, or if you locate another, non-US export target for your crude, we could probably already write the speeches for you - as you have been doing for Morales in Bolivia and Correa in Ecuador - about how the interests of your citizens must come before the interests of anonymous foreign investors.

On the other hand, we could readily believe that you consider an unblemished relationship with investors, even imperialist investors, to be the best Bolivarian example of how to build and transition to a responsible, 21st century socialism, and we could see you honoring contractual obligations and negotiating expropriation compensation in good faith. Especially if oil prices remain steady or rise, and if you continue to need the US as a primary export target for your crude, we could see your speeches describing the establishment of socialism without any reliance on the financial resources of the imperialists. Distinguishing yourself from the violent tactics of Argentina and yet also from the pandering tactics of Brazil.

Of course, there are many other possible outcomes as well. But if we cannot predict which of these two extreme paths is more likely, you have accomplished a great deal of deception. The resulting uncertainty could give you a meaningful edge. So again, what do you do now?