Archive for the ‘Finance’ Category

Who Said You Can’t “Bite” City Hall

In Business, Finance, New York, Politics on December 16, 2009 at 9:58 am


I would like to thank the Chairman on the Finance Committee and the members of the Council for this opportunity to speak with you this morning.  My name is Hermann Mazard, I currently teach a graduate course on innovation at Polytechnic Institute of New York University and I am the CEO of a technology startup, HomeShop Technologies, Inc.

My company, HomeShop, has developed the framework for a digital grocery list. Our goal is to create a tool that allows consumers to save time in the grocery store, reduce impulse shopping and eliminate unnecessary trips. We are staunch advocates of the home-cooked meal and given the high concentration of foodies in the metropolitan region, New York would be an ideal location in which to deploy our technology. I am here today because I question the City’s commitment to technology entrepreneurs.  And I am not alone.

Over the last six months, there has been a mass exodus of entrepreneurs who  have found it increasingly difficult to grow a technology business in New York City.  Lack of capital is often cited as the primary reason but the real problem in New York is a lack of structure for attracting and retaining investment capital at the stages needed most. Specifically, at the seed stage.

Historically, federal government has been able to create liquidity for technology investments by lowering the capital gains tax. This tool was instrumental in fueling the flight of capital from the bond market to the stock market; it was also a factor for attracting venture capital and IPO investments during the late 1990s. But times are different now.  Manipulating the capital gains tax rate alleviated a bottleneck at the growth & expansion stage of technology development. Today, that bottleneck exists at the seed stage and early stage of development. Because investing at this stage involves more risk, there needs to be greater proximity between investors and entrepreneurs. In other words, there is no federal program that can address this issue, it has to be done at the state and local level.

Silicon Valley is often referred to as the model for innovation but there are successful technology communities in many other cities including Boston, Austin (TX), Denver & Philadelphia.  What these cities have in common is (a) a partnership between the private sector, the university system and government and (b) a robust investment community.  New York City has the former, not the latter. The City is home to only seven venture capital firms, of which only two are nationally recognized and actively investing. The City also has only three angel investment funds, of which only one is actively investing. The concentration of capital in the hands of so few investors creates a death-trap for any entrepreneur looking to raise capital, especially at the seed and early stage of development. This is why we are leaving. More competition is needed to create a robust investment community. If the goal of members gathered today is to turn the Big Apple into an orchard of innovation, I urge the City Council to address the barriers to attracting and retaining investment capital at the seed and early stage of development.

New York City is the financial capital of the world and the resources to build a robust investment community already exist within the city limits. That capital, however, exists on the sidelines earning a low rate of interest as it waits for the next “bubble” to emerge.  For many years, New York investment houses have made a name for themselves by trend-surfing and riding investment waves. There is one more wave left to be surfed in the form of energy-investing and sustainability-investing as a result of federal stimulus programs.  But that does little to create opportunities for the 95%+ of entrepreneurs who have neither experience nor training in solar energy, sustainable farming or wind-turbines.

What is needed is an investor literacy program that empowers high net worth individuals with an appetite for risk to effectively evaluate the merits of a business plan. The shutting down of the IPO markets coupled with the private sales of social media companies has reduced the public disclosures about new revenue sources and business models.  The net result has been a widening of the education gap between investors in-the-know and those out-of-the-loop. An investor literacy program can change that; a curriculum has already been developed by the Kaufmann Foundation, which promotes the development of angel investment funds.  Such a program could easily be administered in partnership with NYU, SUNY Levin or the CUNY system. It would be an essential first step in broadening the base of investors in New York City startups.

What is also needed is a tax incentive to attract investors, such as the seed stage tax credit implemented in over 20 states nationally. NYC’s QETC tax credit attracts investors to companies that are post revenue but this not where the bottleneck exists. In fact, there is adequate investment capital available at the Series A & Series B stage for companies that generate revenue.  Where the incentive is needed is at the seed or angel stage where entrepreneurs are proving the viability of new business models.  This program, sometimes called a High Tech Investment Tax Credit or Angel Investment Tax Credit creates liquidity at the earliest stage of investing. Implementing such a program in New York City would go a long way in creating jobs and re-energizing the local economy.

I spent time speaking about what the City Council should consider; if time permits, I would like to spend a minute talking about what doesn’t work. As much as we need the money, entrepreneurs could not in good conscience accept a direct investment from the City. State-sponsored investment programs don’t work because the interests and risk appetite of the municipality may not be aligned with that of the entrepreneur or his/her investors.  Too much oversight and the investment vehicle becomes vulnerable to patronage and corruption; too little oversight and it becomes vulnerable to krony-ism with the private sector. A so-called “public option” in technology investing may have seemed like a romantic idea. But the interests of the City are better served by building a robust base of private investors rather than trying to beat the venture capital community at their own game.

That having been said, there are gaps in the funding universe where a public option would continue to prove helpful. This gap exists for immigrant entrepreneurs, women, blacks and Hispanics. Refocusing the City’s direct investment programs (micro-lending, seed fund, pension investing) to groups that have historically had limited access to capital  would level the playing field and create a technology sector that is more reflective of New York’s diversity.

I would like to conclude by saying that New York City is the greatest city in the world.  One source of our greatness, that is rarely talked about, is the high concentration of churches, synagogues, mosques and temples within the five boroughs.  What it tells me is that faith lives in Gotham City.  Well, innovation is as much about faith as it is about technology; given the City’s religious leadership, there is no reason why we should rank behind Boston, Denver or San Francisco in any category much less believing in its people and our believing in ourselves.

Thank you again for the opportunity to speak frankly today. I strongly believe that the key to solving the capital issue is to address the structure of the investment landscape. I am available to answer any questions and look forward to working in partnership with you as we turn the Big Apple into an orchard of innovation.


The Inefficient Grocery Shopper

In Business, Finance, Grocery, Lifestyle, Marketing, Politics on August 21, 2009 at 1:14 am

Last week I walked into the grocery store expecting to spend $20 – $30. After all was said and done, I found myself debiting almost $130 from my Chase account. I would love to tell you that I was surprised, but I cannot. This happens to me all the time; upon further inquiry, I found out that this happens to many people with an alarming frequency. Why is that? and why isn’t anyone doing anything about it?

In economic terms, we call this phenomena a disconnect between realized behavior and prior intent.  For most Americans, purchase intent and purchase behavior aren’t even remotely correlated.  To better understand this problem, we collected anecdotal frustruations to identify the key sources of shopping inefficiency. Some of the mistakes were made in the grocery aisle, while others were made in the home.  The combined list included thirty-seven (37) unique actions, however near universal consensus was found amongst the following eight (8) behaviors.

  • Forgotten Purchases – suffering a memory block about a needed item but remembering it after you’ve left the store. | Tweet: I’m guilty!
  • Impulse Buys – purchasing items only because they were on sale, accessible and/or prominently featured.| Tweet: I’m guilty!
  • Binge Buying – buying items in extremely large quantities to avoid the possibility of it ever running out.| Tweet: I’m guilty!
  • Duplicate Purchases – making a purchase on a “just in case” basis only to find out that you already have more than is needed.| Tweet: I’m guilty!
  • Subjective Consumption – focusing deeply and purchasing items you use while mis-prioritizing items needed by others in the household.| Tweet: I’m guilty!
  • Recipe Roulette – risking the taste of a meal by substituting an available ingredient in lieu of making a special trip to the store| Tweet: I’m guilty!
  • Unplanned Trips – making an unplanned trip to the store for one or two essential items.| Tweet: I’m guilty!
  • Plan B Dining – ordering take-out or fast food because you don’t have the ingredients to prepare a decent home-cooked meal| Tweet: I’m guilty!

Using only three of the mistakes (impulse shopping, unplanned trips & plan B dining), we did some analysis to quantify the impact of the problem. We concluded that consumer inefficiency in the store was a $2800 a year problem.

  1. Impulse Purchases: The average household with children spends $119.30 per week on food and other grocery items. Of this amount, approximately 20% represent spontaneous and unnecessary buys that reflect the wants of the consumer, not an immediate need.  On an annual basis, impulse buys create $1240 of economic waste.
  2. Unplanned Trips: The average household makes 2 trips to the grocery store per week. Assuming one of those trips is unnecessary, a 10 mile distance between the home and grocery store, gas prices of $3.00 per gallon and fuel efficiency of 12 mpg, unplanned trips.  On an annual basis, unplanned trips create $260 of economic waste.
  3. Plan B Dining – One of the biggest sources of economic waste is switching the venue of food consumption from the home to a restaurant or take-out counter. In general, the cost of a meal prepared outside of the home (approximately $15 per person) costs between 3x and 6x the cost of preparing that same meal at home.  Assuming a family can eat one more meal at home and a markup multiple 3x, on an annual basis, Plan B Dining creates $1300 of economic waste.

In 2008, the median household income in the US was $50,233 and grocery waste represents 5.5% of that figure.  To put it in other terms, solving the shopping inefficiency issue has the same effect as President Barack Obama putting forward a $392 billion stimulus package that reaches every American family without increasing the federal deficit.

Surely, there will be opposition to such an endeavor. But no goal worth achieving was ever met without challenge or adversity. Solving the inefficiency problem has been a constant obsession and is the goal of my company, HomeShop Technologies, Inc. We surely hope you will join and support us as we embark upon this journey.


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Happily Every After

In Business, Cooking, Finance, Grocery, Marketing on July 17, 2009 at 8:11 pm

Can you tell a little bit about yourself? and most importantly about your passion in healthy and delicious foods?

When I was growing up, my mother cooked every night; the family ate dinner together and life was a lot of fun. As I grew older, it became harder and harder to orchestrate a family meal. With both parents working, we kids had to fend for ourselves. Sometimes I would eat at a friends house and I don’t remember what my sisters did. When we stopped eating together, we started to drift apart. I think this happens to a lot of families. In America, most people can count on one hand the number of days per year when they share a meal at home with more than one other person. I think this is bad. My generation works longer and harder than did our parents, we earn more money than our parents did but we enjoy life less.

I am now an adult and I don’t believe that success and isolation are inextricably linked. My primary focus in starting a company was not so much good food but rather the impact good food could have on making us feel more connected, more alive. I love bringing people together and have always viewed food as the ultimate lubricant for social interactions. I think that if we can get more people to break bread together, we can solve a lot of problems in terms of how we relate to one another, how we feel about ourselves and our place in this world. With this as my goal, I sought to figure out a way of getting people to cook more.

What is HomeShopr? What’s the goal? How did it start?

I conducted a brief survey to understand why people don’t cook. The #1 reason was because they didn’t think they had the time to cook. The #2 reason was because they rarely had the proper ingredients in the cupboard. The #3 & #4 reasons were not knowing what to cook and not knowing how to cook, respectively. Of the four problems, I thought the second was the most important. When I started HomeShop, I was looking for a solution that would address the empty pantry problem. The first thing that came to mind was a grocery list so I examined the reasons why people don’t shop with a list.

The problems I found were two-fold. First, lists are hard to generate and second, people usually leave the lists at home. Any solution I came up with would have to address both those problems with tools to which everyday people would have immediate access. When Apple announced that they would allow third-parties to develop applications on the iPhone, I immediately saw mobile phones as the platform for delivering a digital grocery list. What I liked about the iPhone was the large screen and high quality graphics. The Treo and Palm Pilots called for small fonts that were very hard to read; but the iPhone offered design flexibility given its large face. The other thing I liked about mobile phones was that, like an American Express card, people never left home without it. I often tell a joke about how Brittany Spears doesn’t always wear her underwear but she’ll never go out without her phone. America, and the rest of the world, is very much the same way. The mobile phone is a constant and its ubiquity solved the problem of access to the grocery list. My only problem now was devising an easy way to get entries onto the list.

Can you tell me the story behind ReciClick? What were your goals in the first place? and how its going so far?

When I originally launched the company, I thought a hardware solution would be the most optimal. I purchased a laser scanner, wrote a serial driver for the device, hooked it up to a Mac-mini and built a barcode database for the 300 most commonly purchased items in my home. I positioned the scanner near a garbage can; whenever I ran out of an item, I would scan the barcode then throw the item out. It seemed like a perfect solution because we (me and my original partner Eric) had developed a solution for capturing product needs at the “point-of-depletion.” This solution was superior to the pen & paper because it was effortless. We also developed a wireless solution that would connect multiple scanners to a Mac-mini. By positioning one scanner in the kitchen, another in a bathroom, another in another bathroom and maybe one in the home office or other room where there was a garbage can, we offered significant flexibility for creating an accurate grocery list. And because the scanners were fixed in their positioning, they wouldn’t get lost.

It sounded like a great idea so we costed out the materials. We figured that we could build a stand-alone single-purpose computer that bridges to wi-fi, connect it to two wireless satellite scanners and sell it for $120. At that price point, we would suffer a slight up front loss but profitability would be achieved by charging a subscription fee for using our service. We also came up with alternative ways of monetizing the scanner information to further recover costs and meet profit and growth expectations. It seemed like a great idea until the economy turned and we came to the conclusion that people aren’t going to have an extra $120 to spend for what, to many, would seem like a “nice to have” product. When times get tough, people cut back on extras and the general feeling was that our model would not be feasible. Confident we had a killer solution, we looked for another way to monetize our product. At first we took the idea to an online grocer to see if they would give the product away in exchange our directing their grocery list information to their fulfillment centers; they said no. We went to an appliance manufacturer to see if they would incorporate our scanner in their refrigerators; they too said no. Innovation for innovation’s sake did not make sense. As 90% of the refrigeration market is controlled by 3 companies, we could not make the case that it was in anyone’s best interest to incur the cost and technological risk of our new gadget. After only nine months on the path to entrepreneurship in pursuit of Life, Liberty & Happiness, we gave up and started looking for jobs.

Later that year on Thanksgiving morning, I was sent to the store to buy ingredients for the meal my then wife was going to cook. When I got to the store I was greeted by an army of cell phone’d boyfriends and husbands taking orders from their significant others as they shopped in the aisle. One man’s wife was reading off the ingredient list from the web page of a celebrity chef while he navigated the supermarket aisles. A mental light bulb was immediately lit; instead of linking my digital grocery list to a scanner, maybe it would make sense to link it to online recipes. This was the genesis of ReciClick.

I put a few thoughts on paper and went to a pitch event to get feedback. It was there that I met our third founder, Maria, who worked at a marketing company that delivers contextual coupons alongside the receipt of a supermarket purchase. She was there to get feedback on her pitch for a real estate idea but heard my idea and sort of liked it. I thought her marketing expertise would prove useful so we kept in touch. Within a month, I invited her to join Eric and me on our journey, more like a bridge to nowhere, and Maria agreed. We clicked and started working together. After doing a little research, we found that most people shop at the grocery store based on habits. At dinner time, they look inside their cupboards to see what ingredients they have and, based on that, decide what to cook. When the ingredients run out (as they most often do), people then resort to plan B, ordering take-out. With ReciClick we can change all that. Instead of shopping first and selecting meal ideas based on the ingredients you have, we allow you to select from the web the meals you want to cook and we’ll then tell you the items for which to shop. Our ReciClick solves the empty pantry issue, thereby eliminating a key barrier to cooking. We changed our business model from purchase and subscription (razor and blade) to an advertising model. By converting to a software-based entry solution, we made the service free to the consumer thereby eliminating an adoption hurdle. We built a prototype of this functionality and are currently raising a seed-stage investment in order to launch into a public beta.

Can you share tips for new start ups around the world? How should they follow their passion? Is it easy?

I attended top schools and received the best education money could buy. Nevertheless, nothing I ever studied could have prepared me for the life of an entrepreneur. Unlike in most professions, intelligence is not a factor in determining ones entrepreneurial success. The driving factor has been a passion for solving problems and the perseverance to see things through. I am not yet successful but I strongly feel that we are on the path to success; for this I am eternally grateful. There are times when I have wanted to quit or when I think my life shouldn’t be so hard. But then I step back and ask two fundamental questions: #1 Do people need help in cooking at home? #2 Would my digital shopping list be useful to them? For as long as the answer to those two question is yes, I summon the will to keep going.

In a more general sense, entrepreneurs have to be problem-focused, not solution-focused. When I started, I identified a problem and developed a solution to that problem. When my solution didn’t work out, I gave up because I was married to a solution, one of many possible solutions but I was not singularly focused on the problem itself. It took a few weeks for me to realize that the problem still needed fixing and I probably wasted a lot of time by not sticking with it. Thank goodness someone sent me shopping on Thanksgiving morning. A goal is only worth pursuing if a great deal of effort is required to achieve it. In other words, entrepreneurship, problem solving, innovation is supposed to be hard. If it were easy, everybody would do it and there would be no great rewards at the end of the journey.

Life is not a fairy tale but if everybody does their job, dreams can indeed come true.  Having been through all this, I am certain I will never take any bit of future success for granted. I have seen very high highs, I am experiencing very low lows and I feel that I am back on the path to even higher highs than ever before. No matter what happens, I can say with definitiveness that I was not cheated out of life. I feel more alive now than perhaps ever before; if I had it all to do over, I would not change a thing.

When all is said and done, I sincerely hope history determines mine to have been a life worth living.

Andrew Cuomo is a Rat!

In Finance, New York, Politics on March 22, 2009 at 8:18 pm

You Dirty Rat

Does the timing of AIG bonus debate make sense to you?  It doesn’t make sense to me. The bonus issue first came up last November and the government dealt with it as a condition of funding for the original bailout.  In case you forgot, here is a summary of the compromises made last fall:

  • the incoming CEO, Edward Liddy, agreed to a $1 salary.
  • the outgoing 5 month CEO, Robert Willumstad, was forced to reject an unwarranted $22 million severance package.
  • the top seven executives agreed to pay freezes and no bonuses.
  • the next 50 highest-ranked executives agreed to forgo pay raises through 2009.
  • Paula Rosput Reynolds, the former CEO of Safeco Corp., was hired in October to lead AIG’s restructuring.  She agreed to no compensation in 2008 and further agreed her 2009 compensation would be directly tied to performance (i.e. sale of assets to repay the government bailout loan).
  • Liddy had already agreed to freeze $19 million that was contractually due to Willumstad’s predecessor, Martin Sullivan, who was forced out in June 2008.
  • Liddy also froze $600 million in discretionary bonuses for other executives.

At the time, Andrew Cuomo, the New York State Attorney General praised the insurer for having taken a “positive step” and deemed the moves by Liddy as “appropriate” given the $150 billion in aid AIG was receiving. So why then, did Cuomo send a letter to Barney Frank on March 17th reopening this can of worms? Hmmm.

In the March 17 letter, Cuomo discussed his ongoing investigation of AIG and reiterated his “positive step” comment regarding curtailment of discretionary bonuses. But he later claimed “dismay” at the fact that AIG made payments on its retention bonus plan.  Hmmm. If Cuomo’s office was conducting an “ongoing investigation” of AIG, why was he surprised to learn about a contractual obligation that had been put in place in December 2007 and was available for his review at the time of the original bailout?

Later on in the letter, he struck a tone of righteous indignation when he said, “Something is deeply wrong with this…”  I suspect, instead, that something is deeply wrong with Andrew Cuomo.  Let’s first go over a few facts.

  • The Retention Bonus Plan was put in place in December 2007.
  • The New York State Attorney General’s investigation into AIG dates back to 2005 when Spitzer ran the office.  They should be intimately familiar with the company.
  • Edward Liddy  & Paula Reynolds are new to AIG, but in less than six months, they have taken full control of the company.
  • Liddy & Reynolds have no incentive to hide information from Cuomo, Secretary Geithner, Congressman Dodd or their new owners, the American taxpayer.
  • AIG’s Financial Products Group was a highly specialized unit. They were an unregulated hybrid of an investment bank and an insurance company.
  • Key members held intricate knowledge of the complexities of its transactions and they could not easily be replaced.
  • The retention plan was put in place to keep key employees from abandoning ship or jumping ship to a competitor (like Chase, Barclays, Lehman or BofA).
  • At the time the agreement was signed, AIG employees had many job opportunities if it looked like AIG was going to go under.
  • The retention plan covered analysts, associates, vps and directors, effectively the worker bees, grunts and support personnel of the organization. Not senior executives.

and finally,

  • Andrew Cuomo wants to be Governor.

This AIG bonus debacle seems like a “staged” opportunity for Andrew Cuomo to generate headlines in advance of the 2010 gubernatorial race.  No other explanation makes sense.  Sure, the bonuses are outrageous, but so are the bonuses at Chase, Bank of America, Goldman Sachs & Morgan Stanley.  They all received government protection in some form or another; but Cuomo hasn’t rubbed salt in their wounds.  Why did he single out AIG? I think Cuomo borrowed a page from the Bill Clinton playbook. When asked by Dan Rather why he engaged in inappropriate relations with Monica Lewinsky, Clinton replied “I did it … because I could.” Oy vey!

The smoking gun resides on the Office of Attorney General website.  On March 16th, Andrew Cuomo wrote a letter to AIG’s CEO reiterating a prior request for the names of the employees who had received retention bonuses. I haven’t found that prior request but the statement alone confirms that Cuomo knew about the retention plan.  In the letter, he further requested  detailed contact information about bonus recipients and demanded it by 4:00pm that evening.  The notice period seems a tad unreasonable for even the most nimble of CEOs, but that is just an opinion.  Later that night, Cuomo issued a press release indicating that Liddy was unable to comply. But then, one day later, Cuomo wrote a letter to Barney Frank in which he detailed with exacting specificity who at AIG received a bonus, how much was received and the current employment status of each recipient.  Perhaps Liddy was able to comply, but did so after the 4pm deadline.  But that wouldn’t explain the March 17th letter.  Another alternative is that Cuomo had always planned to write the March 17th letter to expose the retention bonus issue for his own political gain.

Cuomo’s behavior was at best underhanded, at worst disingenuous and rogue. Neither the Treasury Secretary nor Congressman Chris Dodd, both of whom are intimately involved in the supervision of AIG, were informed of Cuomo’s actions. Nor were either men a party to the March 16th and March 17th letters. This is clearly a case of a local official not working in partnership with the Federal government.  To paraphrase President Obama’s stump speech “the challenges of our financial system exceed the capacity of a broken system to fix them.”  The President and his staff are under a great deal of pressure and the last thing they need is a rogue politician calling in audible.  New Yorkers deserve better as do AIG, government official and American taxpayers. This stunt smells of investigative misconduct on the part of an ambitious politician.  I could not be more clear: the Office of the Attorney General knew about the retention bonuses; Andrew Cuomo, nevertheless, sought to exploit public outrage with a “gotcha PR campaign” of his own.

Some might assume that because the Attorney General is related to a former Governor and because he is also a member, however peripheral, of the Kennedy clan, he stands on solid political footing. But that is not the case.  In 2002, then candidate Cuomo was put in the Democratic doghouse, especially by black voters, when he kept raising money after having lost the Democratic primary for Governor against H. Carl McCall. McCall lost the race to Pataki and Cuomo earned the moniker of “bad-Democrat.”His persona took another hit one year later after public allegations of his wife’s infidelity proved to be true.

Things, however, started to turn around. In 2006, Cuomo resuscitated his self-pitying victim image long enough to squeak a victory in the primary for his current job against an equally, though intellectually, impotent Mark Green. His come-back was furthered when he won the general election against a controversy-laden Jeanine Pirro. But recently, current Governor David Paterson twice passed him over as a candidate to replace Hilary Clinton as New York’s junior Senator. Given the quest to follow in his “deddy’s” footsteps, Andrew Cuomo’s motives for leading an ineffectual but populist movement against AIG should become extremely clear.

While Cuomo may be New York’s rising star, AIG’s value has moved in the opposite direction.  In late February, MetLife made an $11.2 billion offer to acquire an AIG life insurance unit.  Apparently Met doesn’t pay because they later hinted the price could be lowered to $8 billion due to concerns about the brand. Thanks Andrew! Maybe they had advance warning of an upcoming PR stunt. Perhaps, they sensed a change in the public view of AIG and felt it would affect clients whose policies come up for renewal. Thanks again Andrew.  A competing bid had been sought from AXA but it appears AIG has been unsuccessful in getting a fair price. Once more, thanks Andrew! AIG has since suspended negotiations on the sale of the unit, forcing Tim Geithner, the United States Treasury and American taxpayers to have to wait for a partial repayment of the bailout loan.

In summary, Cuomo’s public relations stunt may very well have cost the American taxpayers at least $3 billion in lost value, not including the time value attributable to a delay in the sale of AIG assets.

Again, thanks Andrew! Good luck in 2010.


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Why Good Mortgages Go Bad

In Finance, Lifestyle on March 21, 2009 at 11:27 pm

There was a time when the banker who approved a loan was the banker who opened the account, handled deposits, accepted the payments and issued a handshake when the debt was retired. Those days have long gone.  With the advent of teller-less transactions and electronic transfers, the movement of money has become so fast that nobody can afford the time to get to know you anymore. The bank on Wall Street whose tagline was “The right relationship is everything” was a liar.  That statement couldn’t be farther from the truth, because there are no relationships in the financial sector anymore.  Everything is a transaction.  And this, my fellow Americans, is at the heart of our financial problems today.

Specialization of duties was supposed to improve efficiency in the banking sector. But instead all it did was add complexity to a system that was already hard to understand. The pace of financial innovation was too fast for even the smartest and brightest of accountants and financiers.  Sufficient checks and balances were never put into place and this vacuum of mutual accountability is what allowed the barons of greed to corrupt America’s once proud banking infrastructure.  I do not envy the challenges faced by Tim Geithner; he carries a heavy load.

There are so many moving parts that comprise a loan transaction.  While no one entity was responsible for creating the house of cards, an attitude of indifference at all levels was absolutely responsible for tipping it over.  In any mortgage transaction, there are even more moving parts and the risk of system collapse was greater which each successful transaction.  Everybody was making money and no one thought to ‘slow things the fuck down’ because they assumed some other entity would do it instead.

America’s financial collapse was a creation of our own undoing.  While it is easy to point to Bernie Madoff or AIG for the failures of the system, their trepasses don’t scratch the surface of what is at the heart of the problem.  We are the problem. We, you and me, can at times be our own worst enemies. Until we take a good look at our contribution in creating the monster, there won’t be anything Secretary Geithner, President Obama, Sarah Palin or Rush Limbaugh will be able to do to save us from ourselves.  So where shall I start? The following is my list of culprits and the reasons they are in desperate need of an attitude adjustment.

  1. homebuyers, especially the snot-nosed yuppies who want what they want, when the they want it and at any cost.
  2. the friends of homebuyers, who compete socially with their friends and one-up each other, resulting in peer-pressure to buy more house than they can afford.
  3. mummy and deddy, who spoil their kids with down payments for houses instead of teaching them the value of savings, trade-offs and deferred gratification.
  4. real estate brokers, who create a false sense of scarcity and urgency to drive up the values of homes and ultimately increase commissions.
  5. renovation contractors, who underbid to get a job then underdeliver until the promise of more payment is made from the proceeds of an unnecessary second loan.
  6. mortgage brokers, who steer borrowers into loan products, some of which may be unsuitable.
  7. home appraisers, whose payments are made by the mortgage brokers and lenders and whose compensation volume is tied to successful loan placements.
  8. boiler room telemarketers, who targeted the elderly with 30 year cash-back loans as a supplement to an underfunded retirement and social security.
  9. local governments, who don’t investigate local corruption because of the additional tax income generated by a corrupt system.
  10. lenders, who sell approved loans into a secondary market and bare little, if any, of the risk for the ones that go bad.
  11. subprime lenders, who compete with traditional lenders for traditional mortgage clients by offering ‘too good to be true’ teaser deals which end up being just that.
  12. moneycenter banks, who set up single-purpose corporate entities that package the loans into a new financial instrument that gets resold into a tertiary market.
  13. financial engineers, who bundle the new financial instruments with cute ‘tricks’ like credit enhancement, over-collateralization and tranches as a portable hedge against risk.
  14. insurance companies, who sell a credit enhancement product but don’t set up internal controls to limit exposures, monitor performance of the product or hedge the impact on the rest of the organization
  15. re-insurance companies, who use one financial ‘trick’ to hedge the risk of another financial ‘trick’ not realizing that, as a result of their being 4x removed from the original transaction, they’ve inadvertently doubled or tripled down on the same risk.
  16. rating agencies, whose investment-banker-wannabe underpaid salaried staff can’t tell the difference between a true credit enhancement and ‘lipstick on a pig’
  17. television networks, who canceled classics like One Day at a Time, Good Times, Alice & M*A*S*H in favor of aspirational shows like Dallas & Dynasty, effectively shaming the ‘have-nots’ for how little they actually have.
  18. financial regulators, underpaid, understaffed, underfunded beaurocrats who are  underinformed as to the newest financial innovations on wall street
  19. legislative overseers, who are as financially illiterate as homebuyers
  20. legislative aids, who spend less time on policy and governance issues (despite Ivy League political science degrees) and more time on raising funds and getting their boss re-elected so they don’t have to go into the private sector and ‘get a real job.’
  21. hedge fund managers, who think their Harvard & Wharton MBAs render them invincible so they start their own firms and lure investors by promising a higher return than is statistically possible, ceteris paribus.
  22. Robin Leach, whose Lifestyles of the Rich & Famous showed the ‘haves’ in America how little they actually have.
  23. hedge fund investors, who aren’t satisfied with the consistent 8% returns of the equity markets yet miraculously expect to achieve higher returns without higher risk.
  24. financial media, who are journalists at heart but eventually succumb to the market’s incessant demand for entertainment over information.
  25. lifestyle media, who stimulate demand for house and home products by encouraging a sense of entitlement while understating the responsibilities of homeownership with programs like ‘Extreme Home Makeover’ and ‘Design on a Dime.’
  26. real estate speculators, who played a game of hot potato by entering into ‘no-money-down, interest-only, balloon payment’ exotic (read toxic) loans but mistimed the market, abandoned the property, left the banks holding the bag and then pointed the finger at government-sponsored working class homeownership programs when the crisis was made public.
  27. people, who believe everything they see and hear, then act on what they believe; all without applying a scintilla of common sense or asking someone who knows better.
  28. Other _____________________________________

I can’t stress it enough. America’s financial collapse was a creation of our own undoing.  While it is easy to point to Bernie Madoff or AIG for the failures of the system, their trepasses don’t scratch the surface of what is at the heart of the problem.  We are the problem. We, you and me, can at times be our own worst enemies. Until we take a good look at our contribution in creating the monster, there won’t be anything Secretary Geithner, President Obama, Sarah Palin or Rush Limbaugh will be able to do to save us from ourselves.

Is Executive Pay Really the Problem

In Finance on March 21, 2009 at 7:19 pm

Recent discussions about bonuses for AIG executives inspired me to give more thought to the role of executive pay in American business.  I recognize that financial literacy is sorely lacking and this is one topic where more clarity is needed.  First, a few facts on CEO pay:

  • A CEO who commands a hefty compensation package doesn’t earn it all in cash.
  • Most Fortune 500 chief executives earn between $350,000 and $3m in the cash portion of their total compensation.
  • The IRS allows a company to deduct up to $1 million of executive compensation for for tax purposes. So unless a CEO has extraordinary skills, s/he is unlikely to earn a cash salary much higher than that million dollar mark.
  • The cash component of the bonus, which averages $4m to $5m and usually tops out at $10m, is almost always tied to the achievement of agreed upon and verifiable milestones.
  • The remainder of CEO compensation is in the form of stocks and options, whose value is subject to change at any point in time.
  • Some portion of the bonus and equity components may be unachievable, due to market conditions, vesting restrictions, strike prices on options, blah blah blah.
  • Very few executives actually earn the “marquis” compensation that is published.

Overall, this structure of executive compensation (base salary + performance bonus + equity) reflects good corporate governance. Tying the bulk of CEO pay to performance milestones aligns their interests with that of investors. It also leads to positive results.  The average American may not know the finer details of executive pay; no one explains it properly and this information doesn’t sell newspapers, draw YouTube viewership or generate Facebook posts. But, this is the truth, so help me God.

Some clarity is also needed on the AIG bonuses being debated.  In a service economy, there is a role for retention bonuses, believe it or not.  Unlike in manufacturing, the business executive is the product.  Unlike in manufacturing, value is created from the thoughts, unique abilities and relationships of that business executive.  Unlike in manufacturing, the value of a business executive is not easily replaced. The fact that business executives, invariably a company’s most valued asset, can walk out the door at any time, creates a continuity problem.  Because the loss of key executives can bring any service institution to its knees, many companies rely on retention bonuses as an economic incentive (read contractual bribe) to achieve loyalty.  It is actually an efficient market solution; it’s also the nature of the beast.

On average, chief executives, like politicians, start out with good intentions.  If they fall, it is more likely the result of their having been corrupted by the machinations of a broken system than anything else.  What is needed in American business are structural and regulatory safeguards that fix the system and keep good executives from going rogue or ‘breaking bad.’  One example of a break in the system may be finance-driven strategy.  CEOs whose compensation is heavily tied to stock price tend to manage for the short term at the expense of long term growth.  This was a problem when I was an M&A banker and it is still a problem now.  A FIX IS SORELY NEEDED.  Another problem may be the prisoner’s dilemma of employee turnover. “Why should I be loyal, creative or efficient if I suspect everyone else isn’t?”  A FIX IS SORELY NEEDED. Another  problem may be stacked boards and poor internal oversight. Again, A FIX IS SORELY NEEDED.  And there are many more.

In my humble opinion, CEO pay is not the problem. Retention bonuses are also not the problem. I stipulate that there is greed and incompetence in the system and recognize that Madoff, that thief, ripped us off. These topics, indeed, sell newspapers but they don’t address the root causes of our down economy. The real problem is baked into the fabric of how we see ourselves, live our lives and make everyday decisions. Until we address our tendency towards myopia and lack of empathy for other economic stakeholders, we cannot begin to fix the problems in our system.

Self-interest is a powerful motivator and it is the essential catalyst for innovation, progress and growth. But capitalism, at its purest, has limits.  With the exception of the German Empire, the First Reich (think Gutenberg & Martin Luther, not Hitler), every great empire has been overtaken by attacks from within.  Civil war is the likely result of any society purely focused on self-interest. Similarly, mutiny is the more likely fate of a pirate than is retirement. The fathers of our Revolution recognized this and took steps to build the American Empire on a more solid foundation.  The rocks on which our society stands are mutual accountability, systems of checks and balances and limits against the perpetual consolidation of power, status and wealth. Fixing the American economy involves a return to these fundamental values.

As a banker, I conducted due diligence on healthy and bankrupt companies, many were turn-around situations and a few were downright houses-of-cards, perhaps too many. Overall, I remain convinced that business executives are inherently good and that they are adequately compensated. Interviews of employees and mid-level managers at bankrupt companies are surprisingly easy to conduct; many can’t wait for a restructuring consultant to ask about the kinks in the company’s armor. They can all identify the economic weak joints and information bottlenecks as well as discern the value creators from the fraudulent fiefdoms of fear and control. [I’m so dramatic, I know.] Although they know the problems of the company, most ignore them because they feel powerless to implement real solutions. This is the tragedy of American business.  Only by fixing the incentive, empowerment, reporting and regulatory systems that impact all levels of performance within our companies can we work our way out of this economic quagmire and restore faith in market-based systems.

It is going to take a concerted effort on all our parts since there are no silver bullet solutions in business anymore.  Paraphrasing Benjamin Franklin, “we must all hang together, or most assuredly, we shall be hanged separately.” Well the economy is doing to us what King George could not do to the colonists.  Until we recognize that we are in this together, AIG executive, government worker and consumer alike, we’ll just continue to spin of our wheels, build monuments of nothing and cross expensive bridges to nowhere.