Wanna Build a Business? Go After a Poorly-Served Market

Seems pretty obvious, duh? Now, I know I said I wouldn't write about the iPhone again - and I'm not - but iPhone is the case study laid out by my friend Paul Kedrosky that most clearly illustrates the point I am going to make. Paul's smart piece in yesterday's Wall Street Journal titled The Jesus Phone puts its finger on the most elemental but oft-forgotten explanation of the iPhone's almost cult-like status and the ultimate opportunity for new business-builders: that the market will enthusiastically respond to a product that addresses a core need that is currently being poorly served. And in the case of the iPhone, it is addressing the complete disgust by many if not most of the people toting around mobile devices used for both communicating with others and surfing the Internet:

I'll tell you. First, people hate their cell phones. Other than making phone calls -- a downright dreary bit of business -- using phones for Internet, entertainment and pretty much anything else has been abysmal. Cell phones are best characterized as crippled, paternalistic devices best suited for people who think straitjackets are comfortable evening wear. They have horrible Web browsers, crummy screens, and obscure-to-the point-of-opacity interfaces. (After all, some of the iPhone's most hyped features, like maps, are on traditional cell phones as well. You just can't find the feature.)

But in addition to hating their phones, people hate their cell phone carriers. Hate, hate, hate, hate. The major cellular providers -- with their ham-handed "support" and fascist control of software that can run on phones directly -- are right up there with the IRS in terms of inspiring your average mobile phone user's disgust and loathing.

Right on. Cutting through all the noise (Steve Jobs' skills as a marketer, techies' love for anything Apple, etc.), this is, in fact, the bottom line. And it is not hard to analogize to other products that have erupted due to this same phenomenon, when a customer need is being met but being met in an inadequate manner:

• The rise of the Japanese auto industry by producing high quality, fuel-efficient vehicles (the need: moving from point A to point B. The problem: lousy cars that guzzle gas).

• The emergence of Google (the need: to quickly find relevant information on the Internet. The problem: too time consuming to find what it is you are looking for)

• The growth of Apple in personal computers (the need: to easily access and use a variety of applications in an intuitive way. The problem: non-intuitive operating system and user interface on DOS-based machines)

I could go on but you get the point. It is kind of Paul to knock us in the head to bring us back to what is most basic: if you build a better mousetrap they will come. If you invent a mousetrap, great, but how do you know that people actually want a mousetrap? In the case of Apple, it is irrefutable that people want fun, powerful, easy-to-use mobile devices for both communication and Web access. The fundamental risk of market need has already been borne by the mobile phone industry over the past 20 years. What they are doing is bringing the market a better version of something that already exists; a particularly low-risk, high return strategy if implemented well. And early indications are that it will be. The mobile phone industry left the door wide open for Apple, and they are simply walking through it. Makes sense, right? It does to me.

 

Hola and Bonjour - The Trip

Yes, I'm back - sniff, sniff (reaching for my hankie right now). After my longest break from blogging since becoming a blogger almost a year ago. And you'll be happy to know that traveling in Europe with my wife and boys was terrific. No, it was priceless. My wife Carin did an amazing job planning the gig, which was, essentially, a road trip across France anchored by an initial stay in Barcelona and a final stay in Paris. Different cultures. Different languages. Different sleeping/eating/partying patterns. It was good - all good. My little intrepid travelers Andrew and Ethan walked, ran, hiked, laughed, danced and whistled in and out of caves, museums, restaurants, chateaux, markets and other places too numerous to mention. And I am happy to say that we didn't step into a cab, take a bus or take a metro in either Barcelona or Paris - ever. We walked. Everywhere. Which is really the only way to get close to a city. I just couldn't believe that my boys, ages 10 and 7, could make this happen all the way. But they did, and they did it with style. Fueled by fine bread, croissant, pain au chocolate, and other treats, of course. But they did it. And I'm terribly proud of them. The only problem with our trip is that it wasn't longer. But we have a long list of stuff to do when we next hit Europe, which makes the anticipation all the more fun. Writing this will certainly bring me back, which will feel so, so good.

For those who care, here is what we did, in a nutshell:

Days 1-3: Barcelona

Stayed at the Hotel Palace on Gran Via de les Cortes. Nice. Great location for walking all over creation. Spent lots of time with family who live in Tarragona. Aside from the eating, Rambla-ing, selective museum-ing and Gaudi housing (La Predriera, Casa Batllo), we went to a cool amusement park on the top of a hill with panoramic views of the city called Tibidabo. Multi-tiered, beautiful perches for sightseeing and nice rides for kids. Also had a traditional Catalan meal at relatives of our relatives who took us in and treated us like royalty. Totally amazing. It was hard to leave Barcelona, not just because of its beauty and grandeur but because of our family. They have three kids who are ages 13, 12 and 7 and adored by my sons. It made for a very special beginning to our trip.

Days 4-6: Figures, Perpignan, Dordogne Valley

On the way to spending the night in Perpignan at La Villa Duflot, we stopped in Figures to see the Dali Museum. What a trip! The museum was perfect for the kids. Dali's whimsical architecture couples with his whimsical (and bizzare) art kept the kids (and the adults) interested and excited. We were sorry to not have more time to spend at the Dali but it was great to hit it on the way out of Spain. And La Villa Duflot was a nice place to kick it and unwind, have a great meal and catch some key sleep. It's all about truffles and foie gras in this region, and let's just say that I didn't get cheated! We also visited this amazing medieval city built into a cliff called Rocamadour, which we hiked up and enjoyed the panoramic view. Oh, and yes, I felt compelled to check my email:

I know, I know, I'm a clown. Bug off, ok? It's a disease. So, after this we stayed in this beautiful old town called Sarlat at a nice hotel called Clos la Boetie. Sarlat was home to amazing plazas and markets at which I bought fresh produce, foie gras, truffles and local wine to bring home. It was all good. Here is a picture of Andrew, Ethan and I all cleaned up and ready to chow after a day of hiking all over creation:

Saw reproductions of the cave paintings at Lascaux II in Montignac, checked out the Grand Roc cavern in Les Eyzies, and stepped back about 40,000 years in time. Great, great stuff for kids and adults alike.

Days 7-8: Rochecorbon in Loire Valley

We then drove from caves to chateaux. Amboise, Chenonceau, Chaumont, etc. Ethan ran down the bridge over the river at Chenonceau whistling "Take Me Out to the Ballgame" - not sure other visitors really understood what he was doing. Oh, well, a little slice of Americana brought directly to the Loire by my boy. Good stuff. We stayed at this interesting hotel literally built into the bluffs overlooking the Loire River called Les Haute Roches. It is a cool place in a great location but in need of a facelift. It served as a good launching pad for our various Loire excursions.

Days 9-11: Paris

Ah, Paris. We stayed on the Rive Gauche in the Hotel Lutetia, which we absolutely loved. It was the perfect place to serve as our Parisian hub for our mega foot-based excursions. I think we must have traversed 10-12 arrondisment during our stay; it was that crazy. From the Jardin de Luxembourg to the Tuileries, from the Lourve to the Pompidou, from the Musee Rodin to the Tour de Eiffel, it was a beautiful thing. We had the best hot chocolate and the most amazing sweet ever (called the Mont Blanc) at Cafe Angelina, took in a great meal at the Pied du Couchon, picked up the most amazing elephant ear and tarte tatin and munched it walking down the street from one of the thousands of sublime boulangeries in Paris, not to mention more than a few crepes purchased from street vendors who should be sainted. Ah, a nutella crepe. I could use one right now! Also, Paris's parks are great for kids. Climbing and swinging toys that brought home that point that their litigation environment must be very different than ours; you'd never see those toys in a U.S. playground for fear of lawsuits. What a bunch of bs. Anyway... Check out this picture at the Jardin de Luxembourg:

These were good times, friends. No, great times. If you have the opportunity to do the road trip Carin, Ethan, Andrew and I took in, I highly recommend it. A truly enriching life experience.

Using Stock Options as Currency: The Perils of Success

I'll admit it: I've been pretty critical of mainstream media on occasion. But Kevin Delaney of the Wall Street Journal penned an excellent piece today on the challenge Google is facing attracting and retaining talent given its scale and stock price. This is not a particularly new theme; I've written about this concept in the context of creative destruction several times over the past year. But Mr. Delaney provides many concrete and highly relevant examples of how Google is become a victim of its own success, something about which senior management is aware but has fewer levers to pull given its $500+ stock price and sexy pre-IPO companies like Facebook:

As Google Inc. exploded into a company of more than 12,000 employees, attracting a million resumes a year, the Internet giant rarely lost staff to start-ups or had prospective workers turn down job offers. Now, though, Google's magnetic pull on top Silicon Valley talent is showing signs of weakening.

Take Justin Rosenstein, 24 years old, a Google employee since March 2004 who invented its Web-site-building service, Page Creator. He joined social-networking start-up Facebook Inc. last month as a senior software engineer, and says Google's past success in hiring entrepreneurial people helps explain why it's seeing some of those people leave as it becomes larger: "That same caliber of people is naturally going to consider carefully whether it's at Google or somewhere else that they have the most potential to do big things and do them quickly."

Now, to be clear, Google's recruiting and HR department may well be the best on the planet. They have fostered a culture that is very enveloping, very supportive and very flexible for its brilliant, high-performance, creative workforce. And this is not an inconsequential lever in the face important quality-of-life issues.

It's unclear whether the latest departures will have any impact on Google's performance down the line. But the company acknowledges that creative and entrepreneurial people are the core of its success -- that's one reason Google lavishes them with extravagant free food and other perks. "If we do not succeed in attracting excellent personnel or retaining or motivating existing personnel, we may be unable to grow effectively," Google has acknowledged in regulatory filings.

But still, by having among the best, brighest, most ambitious and sought-after people in the technology world on your payroll, it inevitably comes down to the bottom line: money and a direct relationship between what you do and the payoff you get. This is very hard to achieve in a firm with 12k people and a $160 billion market cap:

Facebook, Mr. Rosenstein's new employer, is one company that professes having an easier time competing with Google for staff. Co-founder and engineering vice president Dustin Moskovitz says the 250-person start-up has managed to hire 10 out of the roughly 11 engineers who had rival job offers from Google since the beginning of the year, an improvement on the past.

"There are lot of people [at Google] who are talking about leaving now and what they want to do next," says Mr. Moskovitz.

Mr. Rosenstein says he still loves Google, but was attracted enough by the "huge potential upside" at Facebook and other factors to leave "a lot of value on the table" in stock options that had yet to vest when he jumped. After leaving, he posted a note online for friends describing Facebook as "the Google of yesterday, the Microsoft of long ago."

You know what this sounds like? Wall Street and the evolution of where money is made across the broker/dealer community. It used to be that you could mint money in the cash business. It was great! Then it got big and competitive, spreads came in, machines started doing the work of people, and the people-driven cash platforms began to wither. And then derivatives blossomed. First spreads were wide, it was the "wild west," then counterparties got more comfortable and transactions got more standardized, capital rushed in, the fun ran out of vanilla derivatives and ran into the structured end of the derivatives business. Then proprietary trading became hot. And on and on.

As capital flows into to attactive opportunities, be they companies, technologies or business lines, returns naturally compress and those opportunities need to be re-invented in order to continue their growth and prosperity. Or, as is frequently the case, the best and brightest that identified and extracted value from the opportunity in the first place move on to greener, more exciting pastures, where the direct relationship between work done and rewards received are immutable. As in entrepreneurial Wall Street groups. Or in pre-IPO, entrepreneurial companies. We're starting to see this happen with Google, which is simply a function of its overwhelming success. Will they be able to stem the tide and avoid the fate of Microsoft and Yahoo!? Maybe for a while, sure. But the inevitable weight of success will hamper them more and more over time. It is just the nature of things. And, as the old saying goes, "You Can't Fight Mother Nature."

 

Blackstone and iPhone? I'm Sick of Both

You know when you've reached the ISP - the Information Saturation Point? I've reached it with both Blackstone and iPhone. If I read one more article rehashing the same old stuff, or seeking to make some "insightful" point that has already been made 345 times I might barf. Truly. I can't bear to see another picture of Steve Schwartzman; I just can't. Or commentary around his stupid 60th birthday bash. And the iPhone? Yeah, Steve is great, the idea is great, the features seem cool, blah, blah, blah. It's just that I'm getting ill with every "new" story I read. PC Magazine ran a great article on this today titled Shut Up About the iPhone, Already, and I couldn't agree more:

Anyway, I digress from my point, which is that this week is going to be pathetic. Articles like the "insanely easy" analysis or the "it factor" piece are going to be coming out daily. Wake me when it's over. I've even told all my writers on the Dvorak blog that this topic is dead and verboten until the friggin' phone actually comes out! Sheesh.

Indeed. It's getting old, friends. Are we all really that bored that we seem compelled to read this crap? And what about Blackstone? Are they not in the paper every-single-day? Of course they are. And I'm getting ill. Aside from my "I told you so" piece on the BX post-IPO price reaction, I'm done. Enough is enough. I am drawing a line in the sand. Just say no. No more Blackstone. No more iPhone. For the good of our civilization and our collective sanity.

The Blackstone Post-IPO Plunge? Duh.

Friends, fellow denizens of the investment world, you could have predicted this, right? Right? Frenzy, rapidly pushing up stock price, followed by fear, generating a painful decline in stock price. This has nothing to do with the quality of Blackstone as a firm, of course. BX is great as I've written many times. However, it's valuation and price move out of the blocks was in cloud cuckoo land, putting the stock in a position where there was only one direction in which it could go - down. Why didn't market participants see this coming? We all saw how Fortress traded, and that wasn't a surprise, either. We saw how Blackstone rushed to get the deal out the door given the risk of changing tax legislation relating to carried interest. This was all in the public domain. And finally, you had my post on Blackstone from March 18th titled Blackstone Going Public? Watch Your Wallet, Brothas, where I laid this all out pretty clearly:

I have just a few things to say:

• That this (the Blackstone IPO) was coming was obvious, obviously;
• The offering will go out at and get bid up to a stupid valuation, just like Fortress (e.g., let the flurry of excitement subside, let the stock settle down to a reasonable valuation, and buy then. For proof see FIG, IPO and aftermath);
• This has 99% to do with monetizing Steven and Pete's stakes and perilously little to do with succession planning, creating "institutional permanance," or any of the other excuses commonly given for listing (and I think they were more valid in the case of Fortress, to be honest);
• Blackstone is a great business, likely a better and more diversified business than Fortress;
• Blackstone should, and will, trade at a higher PE than Fortress;
• As usual, Blackstone is a step ahead, letting someone absorb the IPO risk (Fortress) while quickly jumping ahead of other potential issuers (see Carlyle, KKR, Apollo, Citadel, etc.); and
• This is not a terribly good sign for either the private or public markets.

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But really, what does this mean? Mostly that Steve is calling the top. Not an absolute market top, but a valuation top for his firm. Why?

• PE is just getting so big. Too big. Too much liquidity. At some point in the not-too-distant future returns will degrade. He knows this. He is sitting the catbird's seat. He's smart. We're dumb. He's the deci-billionaire, remember?
• "The real and perceived growth of the Blackstone business will slow, so let's monetize it while we can extract the momentum from the market (read: dummies like us), right? And besides, guys, it's mostly my money, anyway."
• The public scrutiny of PE returns, its place in the market, and its adverse PR will only intensify. There is a real issue with the tax treatment of management fees - logic and reason implies that this may well change. Why not monetize these on a capital gains-tax rather than a ordinary income-tax basis? This is worth billions of capitalized market value.
• That whole issue of Steve's saying for the last 20 years "Being public sucks because of costs, complexity, scrutiny, etc." applies to everybody but him because, hey, now we're talking about his money and he wants it - now.

Am I cynical? No. Just realistic. God bless Steve, Pete and the rest of the gang. They've created an amazing amount of wealth for their investors. Now it's payback time. Let's just make sure that we dummies don't give them more than their due, because if it's up to them and their bankers, we will. Much to the chagrin of our wallets and our pride.

Well guys, you did EXACTLY what I told you not to do. And now it's time for the tears. Except for Steve, Pete, Tony, Tom et al, where it is Champagne all around.

 

Populist Regulatory Rhetoric? Ugh.

I feared this day would come. And it's here. No, not just the sabre-rattling and moaning about how hedge fund and private equity-types are too rich, how hedge funds are increasing investor risks and debt buyers are accepting overly-liberal terms fueling the private equity juggernaut and the like. But a newly-energized Democratic Congress starting the process of shaping the SEC dialogue around these and a host of other issues to flex their muscles. I'm trying to wake up and enjoy my coffee (jet lag, you know) and I have to click on a Wall Street Journal story titled (Entire) SEC Makes House Call - not the way to start a day:

WASHINGTON -- In the latest sign Congress is turning a skeptical eye toward Wall Street, an influential House committee is set to hear testimony from all five commissioners of the Securities and Exchange Commission today -- the first time that has happened in at least 10 years.

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With the Democrats in control of both houses of Congress, it is an opportunity for Democratic lawmakers to frame such issues as the rise of hedge funds, chief-executive pay and shareholder rights through their own prism and to sharpen the debate heading into the 2008 election.

"It's signaling power," said James Angel, associate professor of finance at Georgetown University's McDonough School of Business in Washington, of the invitation to all five commissioners.

Among the topics to be discussed at today's hearing of the House Financial Services Committee: corporate governance, the SEC's enforcement policy, shareholder lawsuits, hedge funds and a provision of the Sarbanes-Oxley Act dealing with reporting corporate earnings, according to an internal committee memo.

Congress is focusing on areas that have "populist appeal as we go into the 2008 election cycle," Mr. Angel said. He added that when populist lawmakers are looking to win votes, "when all else fails, blame the rich." One House Democratic aide said the committee will likely conduct many more examinations of the financial sector.

The last thing in the world the U.S. economy - or global economies, for that matter - need at this juncture is a bunch of politically-driven, vote-gathering rhetoric impacting investment decisions and global capital flows. One sure way to hurt the stock markets (which, by the way, impact the hot populist topics of public pensions and middle class wealth) - go after the hedge fund and private equity industries. As readers know, I am not an anti-regulation guy; I am an intelligent regulation guy. If the market is willing to reward a certain segment of society for generating a certain kind of value which benefits them, is that really a bad thing? I don't think so. But it sure makes for great political posturing. And if those in power lose sight of the unintended consequences of their actions (say, like damaging the climate for investment and innovation), that would be a bad, bad thing. And I hope this won't happen. But today's WSJ story and the upcoming SEC testimony does not give me great comfort that the next twelve months won't be full of politically-driven rhetoric at the expense of economic growth and vitality. Ugh.

Illiquid Assets: Dimensions of Risk

Exploding spreads in structured mortgage products, which have driven sharp drops in asset values and collateral calls have shined a bright light on the risks posed by illiquid assets. Bear Stearns is now being held up as the latest victim of flying too close to the Sun, loading leverage on top of complex, illiquid assets that, in fact, had values far lower than those reflected on its books in the wake of a liquidation. Today's article in the Wall Street Journal made some good points that plainly chronicle some of the issues facing those investing in illiquid assets:

Figuring out the risk profile of illiquid assets -- and funds that invest in them -- can be tricky. Typical methods for assessing risk rely on measuring volatility -- the choppier returns are, the riskier the investment. But because illiquid assets don't trade regularly, marking to market -- or using recent sales prices to determine an asset's value -- may not be possible. In these cases, a fund manager may instead use a mathematical model to value an asset, a practice called marking to model.

Such models tend to smooth returns, making an asset look much less risky, says Massachusetts Institute of Technology finance professor Andrew Lo, who is also a principal in AlphaSimplex Group LLC, an asset-management company that runs a hedge fund.

Using broker-dealer quotes for illiquid assets can also damp volatility because they are often based on an average of bid and offer prices rather than actual sales prices. What's more, price quotes can vary widely from one dealer to the next.

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Mr. Lo has found that returns for illiquid assets and funds that invest in them tend to have little variation from one month to the next. Paradoxically, it is this smoothness of returns that show how illiquid, and risky, a position might be.

Andrew Lo is a smart guy. He has done seminal work in the area of analyzing the properties of hedge fund returns. His statements are both accurate and logical and, not surprisingly, mirror those of someone who has written about the risks of running an illiquid asset book - me. From Broadening the Multi-Strategy Mandate 07/21/2006:

For instance, if you can't arrive at a fair value for an asset, a "thumb in the air" method is used like book value minus an illiquidity haircut. This approach dear friends, is not very scientific and is extremely prone to error. Beyond error, once an approach is used for a particular asset that approach tends to be used again and again and again. This has two potentially adverse effects upon disclosure and compensation: (1) compensation may be overstated because NAV might be much lower that the level reflected in the NAV calculation; and (2) volatility of returns will be understated since this asset, whose value invariably is moving up and down but whose value is difficult to measure, is being valued in the same way quarter after quarter after quarter. This is called autocorrelation. This skews the analysis of fund returns and makes a fair comparision across different firms and different strategies nearly impossible. Does any of this sound good?

Bottom line: if you are running an illiquid asset book, especially one that is leveraged, you'd better have some of the following working for you:

1. Immense liquidity to support margin calls in an eroding market;
2. A diversified portfolio so this one book doesn't drag down your entire firm (a la Amaranth);
3. Valid, conservative market data points on the bid side to back up "mark to model" valuations; and
4. A long time horizon.

And you don't need to be running a complex, leveraged mortgage derivatives book for this to be the case, which is why I kind of chuckle when all this emphasis is being placed on Bear Stearns. Risks of this sort abound across a wide array of portfolios, many of which are anything but exotic. How about the following:

1. A large short position where the borrow is tight and the market is rallying;
2. A large long position in an thinly-traded stock;
3. A highly concentrated portfolio of small- and mid-cap stocks;
4. A leveraged book of correlated large-cap longs in a declining market.

Are these "exotic" risks? No. Can they be marked-to-market and not just marked-to-model? Yes. Can you get competitive dealer bids? Yes. Is leverage the killer in each situation? No. Is illiquidity the killer in each situation? No. The nature of the risk differs based upon the situation. Sometimes it is liquidity-based. Other times it is leverage-based. Sometimes it is both. So let's not throw stones at Bear Stearns and make like they are another LTCM. Because they're not. Funds take risks. Stuff happens. Disclosure of these risks needs to be extremely clear, accurate and detailed. Investors need to know what they're getting, and valuations need to be done in a rigorous, transparent manner. If this is done and the s**t hits the fan, so be it. It is the by-product of playing the game. Hedge fund returns, as Mr. Lo and others have discovered, are generally negatively skewed, e.g., akin to selling options, collecting premium, generating superior returns for a period and then BANG - getting hit hard, and sometimes getting carried out. Hedge fund investment is not a business for the meek and certainly not one for the stupid. If investors thought they were getting a free lunch by investing in leveraged "high quality" paper and collecting juicy returns, shame on them. Because in the markets, you seldom get something for nothing.   

I'm Back

Big deal, right? It has been quite some time. I didn't think I could take a break from blogging for this long but I guess I was wrong. My family trip through Spain and France was terrific; almost magical, in fact. I'll write about that later. I just wanted to say hi and communicate that I'll try and get back into the swing of things, toute suite. I am a little discombobulated trying to fully re-engage after 11 days out of the country traveling with Carin and the boys. I had my blackberry and did email, yes, but that is a far cry from being back in the saddle in NYC and bombarded with the usual array of stuff I get bombarded with on a daily basis. Anyway, I hope the last two weeks have treated you well and that the sub-prime mortgage demons have stayed far, far away. May the force be with you and we'll be speaking soon.

School's Out!

Friends, I am going dark for a bit. My kids just finished school and we're taking them on a little European excursion. Actually, we're road tripping from Barcelona to Paris, visiting some family in Tarragona, driving across the Pyrenees and hitting several cool points of interest in between. Wending our way through the Dordogne Valley, checking out the cave paintings, chowing down on some truffles, foie gras and walnuts in the Perigord region and all that jazz. No time for Bordeaux, unfortunately. And the kids are only interested in the 1984 and 1997 vintages which, I'm sorry, you need to be at least 10 years of age to consume. Not the most restful of holidays but full of fun and culture - and I'm certain to gain 5 pounds in the process!

So may the beginning of your summer be full of fun and happiness for you and yours and I look forward to re-engaging later in the month.

Waking up to Risk Redux: Is Nassim Taleb the Regulatory Rock Star?

Systemic risk. "Fat tails." Six-sigma events. I've written about this stuff quite a bit during my time as a blogger. I've made the point that the real risk regulators should be focused on is systemic risk, not fund-specific risk. All the hoopla around hedge fund registration is, from my perspecive, a red herring. The goal of regulation should be to protect the markets, not to protect a group of institutional investors who conduct poor due diligence by hampering the flexibility and money-making ability of all hedge funds. And I've seen the leading regulatory regimes across the globe evolve to the point where they, too, are focusing on systemic risk as opposed to single-fund risk. And this is a very happy development indeed.

This point was made most recently during Anthony Ryan's speech at the Managed Funds Association conference in Chicago. Mr. Ryan is currently Treasury Assistant Secretary for Financial Markets. It is also interesting to note that I touched on this very same topic in my post on New York City last night. I am including some key points from Mr. Ryan's address; please let me apologize in advance for its length but his talk was very, very good.

...I would like to focus on the issue of systemic risk. We will never eliminate the potential for systemic risk, but we can seek to reduce the probability of it occurring and its impact. My purpose today is to sensitize all of us as to how systemic risk operates and urge all stakeholders in our capital markets to take the necessary steps to implement policies, procedures and efforts to mitigate it.

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Systemic risk can be defined as the potential that a single event, such as a financial institution's loss or failure, may trigger broad dislocation or a series of defaults that impact the financial system so significantly that the real economy is adversely affected.

Some may posit that the increasing sophistication of risk management systems coupled with other developments and efforts has placed systemic risk on the endangered species list. For supportive proof they point to the lack of extensive ripple effects upon the financial markets following some relatively recent shocks.

I'd like to elaborate why, given market conditions, I believe that subscribing to this thesis is both potentially misleading and imprudent. Let's begin with answering the question: how could a systemic risk event manifest itself? Meteorologists describe atmospheric conditions conducive to producing a perfect storm. What are the atmospherics for a perfect financial storm? While there would be several, let me name a few: easy credit and leverage, highly correlated strategies, connected and concentrated lenders, inadequate information, and underdeveloped financial market infrastructure.

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Could our capital markets practices' better play have influenced the distribution of risk events such that the tails of the distribution have shortened? It is true that the dispersion of risk is greater. The presence of so many derivatives strategies and instruments do help to hedge risk, and markets have adjusted to "tremors." At the same time, we can also observe that the capital markets, with a few periodic exceptions, are not pricing risk and future volatility anywhere near close to long-term averages.

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So, the long tails of some distributions may also be a lot fatter than people frequently assume. Besides baseball salaries, there are many other data series where the distributions are anything but normally distributed. Look at "book sales per author…populations of cities…numbers of speakers per language, damage caused by earthquakes, deaths in war, deaths from terrorist incidents…or the sizes of companies."

Could the same be true of capital markets, commodity prices, inflation rates, and economic data? If so, what are the implications? What if such events occur with much more frequency than people recognize, and what are the consequences if we do a particularly poor job in preparing for them?

One student of such distributions is Nassim Taleb. He defines an occurrence such as a systemic risk event as follows: "First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable."

If we can not predict a systemic market event in advance, and we seek to reduce the impact of such an event, we must prepare.

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So the tails may be longer than people imagine, and the tails could also easily be fatter. We must therefore be humble enough to realize that a systemic event in the financial markets cannot be discounted and its impact will be significant.  Preparedness is therefore key and all stakeholders in the capital markets must contribute to the effort.

So there you have it. I believe Mr. Ryan's characterization of the challenges facing both regulators and market participants alike are spot on. And he and his colleagues are now internalizing the risks long understood by Mr. Taleb, risk managers and traders at every major financial institution: the risk of long-tail ruin is real and it occurs far more frequently than normally-distributed models would predict. Tails in the financial markets are fat - very fat - and the best we can do is to make sure the system can withstand significant and unpredicted shocks, because they will happen. And we have history as our witness.

I'm in A New York State of Mind

There is something happening here in NYC. Like Billy Joel crooned in 1976, many of us just want to be here. The energy on the streets is palpable. Wall Street is humming. The entrepreneurial and technology scenes have never been more vibrant. Stores across the economic spectrum are filled with eager shoppers. There are loads of new - and good - restaurants opening every week. Hope is springing eternal, even if interest rates appear headed up, China's markets are getting hammered, Putin is flexing his muscles and the US equity markets seem jittery with the DJIA in the mid-13000s. Joggers and cyclists are everywhere; frisbees are filling the skies in the parks and baseballs are being launched at diamonds all across Manhattan. Adults, kids, bankers, artists, musicians, massage therapists, and yes, hedge fund managers, too. Everyone seems to be getting into the act.

I've lived in NYC for 20 years. I first moved here just before the crash in October 1987 (and was working as an M&A analyst, no less) and saw the era of the corporate raiders and junk bond kings. Names like Milken, Belzberg, Icahn (yes, the 1987-raider-turned-2007-activist), Rales, and Boesky struck fear in the hearts of sluggish corporate managements, while the 2007 private equity titans Carlyle and Blackstone were just getting started. Fortress? The principals were young men early in their careers. DE Shaw? Och-Ziff? Huh? 20 years seems like an eternity, and the financial landscape has been dramatically transformed. As rich as the hedgies and Goldman Sachs PMDs are today, the NYC of 1987 felt much more stratified, much more polarized than the 2007 version. It appears that a wider swath of the City is benefiting from the general economic climate, and the specific benefit of a booming financial sector that is permeating every inch of NYC life. I've got to tell you, I couldn't have imagined such prosperity and, more importantly, happiness in a post-9/11 NYC - but it's here.

I've been trying to think of exactly why this is. Some issues are clearly NYC-specific while others are more reflective of the global financial markets and the tools and techniques for playing in them. For better or worse, NYC is going through a gentrification process that is impacting every neighborhood in Manhattan and the outer boroughs. So while NYC - Manhattan, specifically - is certainly a safer, cleaner, greener place than it was 20 years ago, it is also less economically diverse. It's just freaking expensive to live here, period. At the same time, some major NYC public-works projects like the build-out and beautification of the Hudson River Park, the further enhancement of Rockefeller Park and Battery Park City (as you can tell, I'm a downtown-er) and many others across the island have come online, rendering the City a more attractive, liveable place for people of all ages. And this is good. Kids can go to public school, play in year-round baseball, soccer, football and basketball leagues, romp and climb in playgrounds, and ride bikes in safety along the river. NYC has actually become a great place to raise a family. It's true. I'm doing it as are many others across the socio-economic strata.

But this doesn't begin to answer all the questions. We are in the wake of a long economic boom cycle that has raised many boats in the City. Is this just a cyclical phenomenon or is there something else at work? I'd say the rise of derivatives, better tools and techniques for risk management and the globalization of the financial markets all play a part in this financial renaissance. Systemic volatility has dropped ever since I've been in the financial markets, roughly corresponding to the growth of the derivatives markets and the rise in liquidity across the global financial landscape. Does this mean shocks won't (or haven't) occurred? Of course not - there have been several "once in a hundred years" jolts in only the past decade (LTCM, emerging markets debt, Russia default, etc.) and they are sure to continue (but hopefully they'll be modeled better - fat tails, you know). But does it mean that the markets are better poised to bounce back from such shocks as risk is more broadly distributed to those who can absorb it? I'd say yes. And this is a very, VERY important point, and is particularly important for a town like NYC that is so dependent upon a vibrant financial sector.

In sum, this is a lot of words to convey a very simple point: NYC is rocking and it is fun. So I guess it's no surprise that I'm in a New York state of mind.

Calling all Quants - Help Wanted!

One of my portfolio companies, Clear Asset Management, is in search of a Senior Quantitative Analyst to join their leading-edge research and portfolio management team. If you are interested in pursuing this exciting and mind-bending opportunity, you can view the spec here.

Some Thoughts on Revitalizing Mainstream Media

My recent post on the decay of mainstream media (MSM) served its purpose - to put some thoughts out there and to stimulate debate. I was so pleased to have both Bill (a.k.a. NO DooDahs) and Priya (For the Record) weigh in, given their intellect, sharp wit and divergent perspectives. And while my post was quite harsh (and representative of what I believe), I personally value MSM and leverage its good elements all the time. Given this, I thought I might put forth some ideas of how MSM can better integrate with the online experience, doing what it does best (creating original, high-value content) while leveraging the unique power and breadth of consumer-generated media (CGM). Priya should be happy that I am doing this; props go to her for serving as a catalyst for this post.

So what are some of the things MSM might do to become a sticky destination for today's power information consumers?

1. Generate original content: Re-hashing prior stories just kills MSMs credibility and leads to frustration and boredom for readers in both online and offline worlds. The concept of filling column inches should be anathema to today's media world. It's about value, not volume. MSM should trade on its reputation, relevance and credibility and generate content that reinforces these perceptions, and re-purposing tired, old stories just shatters this premise.

2. Provide context: This involves mapping an array of related content from other MSM outlets, blogs, vlogs, podcasts, government filings and other sources. This approach could  create further stickiness among readers, as the pursuit of other interesting and relevant information can be achieved through the MSM portal instead of jumping to an alternative search engine. Tools like Sphere provide necessary but insufficient content to create a robust context map around a new story.

3. Open up walled gardens: I'm not convinced that subscription services like Times Select offer the best long-term revenue models, especially if MSM is able to provide the context described in 2 above. Opening up access to elite writers for free should only enhance the stickiness quotient of MSM sites providing value-added context maps, which I'd posit might have a more favorable economic impact due to high CPC advertising rates than a subscription service. This approach would also give the MSM outlet more street cred, as its approach would be enveloping, embracing and inclusive, not distant, rejecting and exclusive.

4. Incorporate content and perspective from online thought leaders: While this is sometimes done in technology and consumer electronics realms, it is seldom done in other vertical domains. The dynamic, real-time Internet is full of some of the world's greatest thinkers on a wide range of topics, so why are they so seldom quoted relative to those in the offline world? I'm not sure - could it be a perception by MSM that online experts somehow lack the gravitas and credibility of their offline counterparts? Could it be MSMs desire to avoid legitimizing online, non-MSM media such as blogs? I don't know the answer, all I know is that MSM is missing a wealth of intellectual capital by not fully incorporating leading online thinkers into their stable of experts.

5. Create new models for incorporating commentary into a story: A story on the Internet is a living thing; it represents an assemblage of facts and opinions, an initial "stake in the ground" from the writer. This then serves as a straw man that is gradually filled out by those who read, analyze and comment on the original story, building on top of both the story, other items in the context map and the comments that preceeded it. I personally do not know of an online MSM outlet that has figured out how to make a story feel and read like an evolving, living thing. I could see this being an incredibly powerful vehicle for stimlating discussion, arriving at new conclusions and effectively re-publishing the original story in light of the collective wisdom that weighed in, resulting in something akin to a Wikipedia-for-news-stories.

In sum, MSM is frequently really good at researching a topic and weaving a mixture of facts and opinions into a story. If MSM could broaden the pool from which it obtains research to incorporate online sources that would clearly make sense. The resulting story is a great launching point for a robust examination both through the study of context maps and the commentary provided by readers. And if MSM can develop a user experience that facilitates the ongoing enhancement of the original story through commentary and analysis, that would be a home run app that could fuel big-time ad revenues. I am eager to see if MSM is up to the challenge.

Why I Love David Swensen

This post stands in direct contrast to my earlier missive Why I Hate Jim Cramer. I have long admired David Swensen; his focus on asset allocation, his low-key, humble nature and his intellectual prowess impress me greatly. The catalyst for this post was a piece in today's Financial Times penned by John Authers, who heard David speak at the recent Yale commencement. Some of David's comments included:

“Investment management is a simple business,” he said. It came down to two principles. First, equities are best for the long run (as proved by many surveys). “With a portfolio like Yale’s, with a time horizon measured in centuries, everyone would come to the same conclusion: it’s far better to have equities in your portfolio than bonds or cash.” By equity, he means any asset where there is a potential upside that can be taken by the investor.

His second principle is simpler: “Diversification is important.”

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What of security selection? CAPM suggests this is a mug’s game. If prices adjust to include all known information, good stock-picking can be done only by luck.

His solution was to buy assets outside the public markets that are not so efficient. Assets such as private equity and timber have the added advantage that they are uncorrelated.

Is this something you should try at home? Swensen thinks not. “I know it’s necessary to be humble,” he told the gathered alumni, “but I think Yale is set up to make high-quality active management decisions.” It has a staff of 20, and its time horizon means it can buy illiquid investments such as forestry.

Alternatively, he says, “you are in the category in which most investors find themselves, where they aren’t set up to make quality active asset allocation decisions. They should manage their portfolio passively, through low-cost index funds.”

David Swenson, for me, is an investment deity. He simply speaks the truth - period. Where David speaks softly and carries a big stick, Jim shouts loudly and carries a pencil behind his ear. David speaks of long time horizons, the importance of asset allocation and the over-emphasis on market timing. Jim speaks of "get in now," single stock positions and places extreme emphasis on market timing. David understands the limitations of individual investors and counsels them to focus on low-cost index funds and passive investing, whereas Jim "empowers" people to make decisions which they are largely unqualified to make, leading to a sharp divergence between perceived skill and actual results. And this is both dangerous and a shame. The kind of investment advice David proffers isn't sexy and doesn't lead to bragging rights, at least until it comes time to retire. At that point Swensen devotees will be bragging all the way to the bank. And Jim's acolytes? Well, they might be bragging on the golf course today, but as to the future, I'm not so sure.

Interpol's 6/5/2007 Bowery Show: Just Diggin' It in NYC

I am a fan of the band Interpol. I have followed them for quite some time and seen many of their shows, the most recent of which was this past Tuesday at the Bowery Ballroom in New York City. This picture on Flickr was taken courtesy of Crackers United, who has a post on the show as well.

My reaction to the show was somewhat different than Mr. United. His post reflects a certain cynicism both towards the band and the crowd, notwithstanding his statement that they played a "tight set." My reaction to the "private" show was quite different: it brought me back to another great and memorable show I saw a few years back, when the Strokes played Central Park Summerstage for the first time. In each case I took away a strong sense of something special: a couple of NYC bands playing in front of the home crowd, in a setting that was memorable for both of them. And this is what made the June 5th Interpol show special for me.

When Julian Casablancas came onstage at the Central Park show you could see his emotion. This was his first time playing Summerstage, close to where he grew up, right near his homies. Even though the Strokes had achieved significant commercial success by this point the venue and the moment was still extremely powerful for him - and it showed. And this made the show a powerful exhibition that rippled through the crowd.

Now, I'm not going to tell you that Paul Banks is as emotive as Julian Casablancas. Because he is not, and neither are his bandmates. That said, there were a few moments in the show when he and Daniel Kessler really connected. They smiled. They laughed. They were grooving on each other in the moment. Very un-Interpolesque. Which is what made it so cool. And to me it seemed that playing the Bowery, a meaningful place for the band and one of the more intimate venues on the NYC indie music circuit, made it really special. They have released two successful albums and are on the cusp of their third, which is sure to be a commercial success as well. They will soon hit the road for a long time. This is the calm before the storm, a chance for them to play the home crowd in an awesome, cozy venue, to have some fun and to feel the love. And I think they felt it. I felt it.

Sam Fogarino was, as always, right on time and banging the shit out of the drums as only he can, and Carlos was sporting a new Billy Bob Thornton look which was, shall we say, different. For me it was a great night - a night to remember. Best of luck to the Interpol boys with Our Love to Admire and a fun and successful tour. My words of advice: just keep feeling it and showing it. And keeping it real.

Is Microsoft's Xbox 360 Team Waking Up?

Some have accused me of not really understanding Microsoft's "gateway to the living room" strategy, where they are willing to incur billions upon billions in operating losses over many years in order to establish a beach head for offline and online gaming, music, video and streaming content. I've been pretty brutal in my assessment of the risks of such an approach, calling their strategy "niche" and overly-focused on the hard-core gamer, especially at the price point they've established. And I've also commented that this positioning stands in stark contrast to their messaging of becoming more mainstream. Finally, I've claimed that Microsoft really doesn't understand the mass market, focusing on the technical shortcomings of the massively successful Wii and not on the fact that, bottom line, it provides a fun experience for game players across the spectrum. Something is wrong here, inconsistencies abound. So what gives? Am I being overly critical and missing the boat or is Microsoft's gaming strategy seriously broken? The answer: they are wrong - and they know it. What they do with this knowledge will be fun to watch.

Microsoft Knows Their Strategy is Broken - Finally

And how do I know this? Read these quotes from a recent Bloomberg interview posted on spong.com 06/08/2007:

Microsoft has indicated that it plans to make a stronger play for the casual market in order to expand its demographic.

Speaking with Bloomberg, Peter Moore, head of Microsoft's interactive entertainment business division, said of the wider audience that the Nintendo has reached, “If we don't make that move, make it early and expand our demographic, we will wind up in the same place as with Xbox 1, a solid business with 25 million people. What I need is a solid business with 90 million people."

Microsoft's director of Xbox global platform marketing, Albert Penello, echoed the sentiment. Discussing Microsoft's assertion that it's winning over female gamers with Guitar Hero 2 (you can check out this week's Girl Gamer column to test that assertion), Penello said, “If you don't start building that content and reputation it never comes. I don't want to be pigeonholed as a hard-core machine.”

Microsoft also acknowledged the appeal of a sub-$200 console, with just the faintest whiff of a hint that it might be looking towards a lower price-point for the 360. “We are well aware that the sweet spot of the market is really 199 bucks (£101),'' said David Hufford, a director of Xbox product management.

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Clearly there's no solid commitment to a price cut in Hufford's comments. That said, unless he loves Nintendo far too much and missed PR training day, Microsoft would appear to have a price drop on its mind.

Doh! When you've got your Head of Interactive Entertainment, the Director of Xbox Global Platform Marketing and a Director of Xbox Product Management all publicly saying that they've got to crack the mass market and that lower price points are attractive, does this indicate a seismic strategic shift? I'd say so. It seems like an implicit endorsement of Nintendo's strategy, which has clearly been very successful and taken the wind out of both Xbox 360 and PS3. It almost reminds me of when James Allchin, then head of Microsoft's Vista project, said that he'd buy a Mac if he wasn't working at Microsoft. But what does this mean in terms of building a broader array of mass market T and E games (and, say, placing less emphasis on M games like Halo 3?) and dropping prices in order to effectively compete for the mass market gamer? Only time will tell. But a reading of the tea leaves indicates that Microsoft is waking up - and not a moment too soon.

Bill Still Doesn't Get It - Bad for MSFT

Notwithstanding the statements from the gaming guys in the Microsoft trenches, Bill is still working at cross-purposes, which is neither good for his H&E business nor the morale of his troops. During his jousting on a panel with Steve Jobs, Bill projected a vision of a motion-sensing game with high-tech 3D positioning, video recognition, blah, blah, blah. Oh, but not like the Wii. Readers should be aware the "interviewer" who suggested that Bill's vision is already existant - and it's called the Wii - is none other than technophile-cum-columnist Walt Mossberg himself. From Eurogamer 06/05/2007:

Bill Gates has revealed that his vision for the future of gaming involves a new control system where players swing a bat or racket as they would in real life - but said it won't be the same as the Wii.

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Turning to the subject of how the home PC's role is evolving, Gates said, "As we get natural input, that will cause a change... Software is doing vision and so, you know, imagine a game machine where you just can pick up the bat and swing it or the tennis racket and swing it."

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The interviewers suggested Nintendo has already created such a machine in the form of the Wii - but Gates replied, "No, that’s not it. You can't pick up your tennis racket... And swing it. You can't sit there with your friends and do those natural things.

"That’s a 3D positional device," Gates continued. "This is video recognition. This is a camera seeing what's going on."

Gates has previously been critical of Nintendo's strategy with Wii. Back in January he was quoted as saying, "Look at the resolution you get with a controlled experience like that. Say to yourself, how in terms of using a game for a long period of time, what kind of accuracy and capability do you want?"

You know what the problem is here? People don't want technology; they want a fun and exciting user experience. Technology is merely a means to an end, something that Bill loses sight of on a regular basis. He would be better served by letting his team that are closer to the customers drive vision and for him to stay out of it. Because he just doesn't get it. And every time he opens his mouth he just digs Microsoft a deeper hole out of which to climb.

Learning from Mistakes - Some do it Well While Others...

It's not as if Nintendo has always made the right moves. They've made tons of mistakes, as they did with the GameCube console. That said, they learned from their mistakes, internalized key lessons and built a better machine and a better model, and we are seeing the benefits of this learning in the runaway success of the Wii. This learning process was extremely well-covered by Martin Fackler of the New York Times and carried on CNet 06/08/2007:

Nintendo is known for turning out hits with memorable characters like Donkey Kong and the Super Mario Bros., but it has had a reputation for cold-shouldering game software developers because it preferred to make both its hardware and software internally.

The company, based in Kyoto, Japan, certainly produced innovative designs like the GameCube and the touch-screen on the portable Nintendo DS, but it was perennially outclassed and outsold by the more powerful Sony game machines. Sony's PlayStation 2 outsold the GameCube six to one.

Contrast that with the success of the Wii. The Wii and Sony's technology-packed PlayStation 3 went on sale in the United States in November, a year after Microsoft rolled out its Xbox 360. As of the end of April, Nintendo has sold 2.5 million Wii consoles in the United States, almost double PlayStation 3's sales of 1.3 million and heading in the direction of Xbox 360's 5.4 million sales, according to the NPD Group, a market research firm.

What changed? The secretive company is coming out of its shell. It has made a concerted effort to woo other makers of game software as part of a broader change in strategy to dominate the newest generation of game consoles.

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"I had not seen that attitude from them before," said Namco Bandai's chief operating officer, Shin Unozawa, who was at the meeting. "Nintendo was suddenly reaching out to independent developers."

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Nintendo's new strategy is two-pronged. Making the Wii cheaper and easier to play than its rivals attracts a broader range of new customers, including people who never bought a game machine before. With Wii, Nintendo has avoided one mistake it made with GameCube, which was competing with its wealthier rivals on expensive technology-driven performance. While Wii lacks the speed and graphics of PlayStation 3 and Xbox 360, Wii sets itself apart with novel ideas like its wireless motion-sensor controller that gets game players off the couch and jumping around.

The other thrust of Nintendo's new strategy is to enlist software developers like Namco Bandai to write more games for Wii than they did for previous Nintendo machines. Nintendo's hope is that this will help erase one of Sony's biggest past advantages: the far greater number of game titles available for its machines. The more games a machine has, the industry theory holds, the more gamers want to play it.

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"Nintendo is determined not to repeat past mistakes," said Masashi Morita, a games analyst at Okasan Securities in Tokyo. "It is taking a whole new approach with Wii."

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The Wii's simplicity is also the selling point for software makers. Wada said developers had been slower to write games for PlayStation 3 because of the greater complexity of the console's main processor, the high-speed multicore Cell chip. He said PlayStation 3's production delays had also made Sony slow to provide developers with the basic codes and software needed to write games for the new console.

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Now, game developers and analysts say, Nintendo is showing itself more willing to be a partner and not just a rival.

"Being cool toward other game developers didn't work," said Masayuki Otani, an analyst at Maruwa Securities in Tokyo. "Nintendo has learned that it pays to be friendly."

Turning self-awareness and learning into cash - this is Nintendo's story with the Wii. How Microsoft internalizes its lessons learned and reacts will be absoutely critical for the Xbox 360's mass market success. But one thing is for sure: Bill has to let his product guys drive the bus. Because if he let's his technology-vision-thing drive strategy they are screwed.

The REAL Reason for the Decay of MSM or When It's Right to Write

The quality of my mainstream media (MSM) user experience - be it online or offline - has been in steady decline for the past two decades. And it is only getting worse. And I even detect this disappointment and hostility in my writing, as there are many of my posts that contain the theme "Hey, dummy, I've been talking about this for months - why are you just discovering and/or re-hashing this now?" And I'm tired of writing this way. I didn't start this blog with the idea of being a media watchdog - though I am glad there are those whose serve this important function. It's just not me. What I want to discuss is why so much of MSM is so awful, and why there is so much great, original, value-added content being deposited on the Internet each and every day. And then I can get back to writing my own content without throwing stones at others; all the stones are being thrown today.

Why MSM Sucks

1. A giant portion of what's created is not original, either the ideas or the commentary around them.
2. It is hard to separate the good from the garbage, as such a high percentage of MSM content is, in fact, garbage.
3. The medium is not designed to have a conversation, an exchange of ideas that is dynamic and has life and can help readers achieve greater understanding.
4. It looks and feels tight and inflexible.
5. It artifically places itself on a higher plane, leading to perceptions of elitism that once was an asset but now has become a crushing liability.
6. It is not by the people, for the people. It is by a small group of individuals for a small group of individuals. And that is ok - but then don't call yourself "mainstream" and purport to be serving a higher purpose. Mainstream is now the blogosphere.
7. It is clear that it is not comfortable in its own skin, and it is working to cultivate an online, "hipper," more conversational identity that just isn't working.

Are these generalizations? Of course. But, in general, I think these points are directionally correct.

What is the Media Value Stack?

The success of media models - regardless of the medium - is just like the financial markets: it is all about value creation. So where is the value? Is it in the creation of original content? Is it in aggregation of top content creators? Is it in providing users with the opportunity to share, comment and collaborate? Is it in the ability to excite, interest and stimulate users? Does it have to do with tagging and labeling interesting content for future reference? The answer: yes to all of the above. In fact, this might be my cut at the media value stack:

• The creation of original content, that
• Is mixed and presented with other relevant content, which
• Excites, interests and stimulates users, and
• Provides them the ability to share, comment and collaborate about the aggregated content, be it the content itself or comments about the content, which
• Can be tagged and labeled for future use.

Now look at this value stack and tell me: how well does MSM do delivering this stack? In general I'd say pretty poorly. Could this be why MSM is coming under so much pressure? Is the threat really about the rise of the blogosphere or is it because MSM is failing to deliver against the stack I've listed above? I'd posit that the "Internet threat" is pretty much a red herring - what it's REALLY about is a failure of culture and business model to adapt to changing times. And has the blogosphere specifically and the Internet in general hastened these changes? Sure. But does that mean, by definition, that MSM doesn't have the means to rise to the challenge? No. They have all the assets in the world with which to compete. They just don't use them properly, and this is a failure of culture and leadership, not of some fundamental inability to compete. Rupert Murdoch understands this. He is the one MSM media-type that kind of gets it. Politics aside, his moves across an array of media assets shows that he is much more in touch with the value stack than any other media leader. And it shows in News Corporation's results and growth in asset value.

When is it Right to Write?

When you have something to say, not when you need to fill column inches. When you care what people think about what you are writing, and when you are able to put your thoughts out there openly, honestly and without prejudice.  When you want to solicit other's views on a topic by seeding a conversation with your own thoughts and opinions. When you are driven by a passion to be heard, not because someone says you have to crank out a story. You get the picture.

People are smart. MSM thinks they are dumb. People can smell bullshit and a lack of passion a mile away. And this is what's wrong with much of MSM. It has become pro forma. It has lost all affect. And it shows. People are voting with their feet, their pocketbooks, and their clicks. And unless MSM wakes up, really tries to understand what is motivating their constituency and shifts their business models and business strategies accordingly, they are dead. And it has nothing to do with the Internet. The problem lies within.

Online Job Search: Leveraging the Subscription Model to Create a Better User Experience

TheLadders.com, the online source for job seekers targeting positions paying $100k and above. What a great company and what a great product. I am proud and privileged to be one of the original angel investors in the Company back in early 2004, placing my belief in founder Marc Cenedella and his vision of turning the online job market on its head. How? By creating a natural self-selection mechanism on the part of job seekers, requiring them to pay to access the full slate of $100k+ jobs in its database. Job posters, i.e., corporations, financial institutions, etc., conversely, pay nothing. In essence, TheLadders.com created a subscription model geared around the job poster user experience, where the goal isn't to collect the greatest number of resumes, but the right resumes to fill a position. This stood in marked contrast to the way Monster and HotJobs were (and still are) running their models, ones in which the job posters, i.e., corporations, government agencies, etc., pay to have their job specifications posted on the site, while job seekers view them for free.

The problem: under the conventional model, job posters are bombarded by both qualified and unqualified seekers alike, as there is no barrier to responding to any job posting, regardless of how unqualified a candidate might be. However, with TheLadders.com, why would an individual who is more likely qualified for a $50k job pay for the privilege of responding to a posting for a $100k job when they are invariably going to get shot down? Answer: they wouldn't because it costs something. Just like health care deductibles. Paying makes the individual think about resource allocation and probabilities. It forces the consumer of resources to become economically rational and to allocate scarce resources accordingly. This, in turn, creates a much better user experience for the job poster, as they don't have to spend enormous amounts of time culling through 10,000 resumes of which maybe 100 are pretty good, where TheLadders.com might generate, say, 200 resumes of which 80 are really good. I am pulling these numbers out of the air but you get the picture.

Bottom line: Marc and his team have done an amazing job changing the face of both job posting and job seeking at the high-end of the market. And this success was recognized in a terrific article in today's New York Times:

RECRUITERS with six-figure jobs to fill know better than to post them online and start a stampede of marginally qualified job seekers. But they also know that the Web is the easiest way to find applicants.      

The Web’s surprising answer to the problem? Charge them to look.

A growing number of niche sites devoted to high-end jobs are finding that applicants are willing to shell out a few dollars — or a few hundred, in some cases — for the chance to get access to job ads. The strategy will not help the big online job boards find more applicants for entry-level positions, but analysts say it is ideal for sites like TheLadders.com, ExecuNet and others seeking the senior executive crowd.

“It turns out that having the job candidates pay is a great screener, and employers love it,” said Charlene Li, an Internet analyst with Forrester Research.

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The upper-level jobs niche has been slower to develop, though, because companies typically hand off such jobs to corporate recruiting firms. Those firms, like DHR International and Korn/Ferry International, set up their own Web sites, but those sites are used mainly to market the firms’ offline services instead of connecting applicants with companies online.

To fill that void, several former HotJobs executives introduced TheLadders.com in 2003, with the mission of posting only those jobs with annual salaries of $100,000 or more. At the time, the company made an odd bet — that it could attract more applicants if it charged them a monthly entry fee of $30.

That is precisely the opposite of the approach used by mass-market employment sites, which charge applicants nothing but charge companies varying fees to post job openings.

In its early years, TheLadders.com was slow to grow, partly because it did not attract enough job postings to justify the site’s cost. But as employers and corporate recruiters learned that they could find qualified applicants for nothing, the number of job postings jumped.

Now, according to Marc Cenedella, the chief executive of TheLadders.com, the site listed 70,000 jobs last week and is on pace to exceed $30 million in sales this year from about 1.4 million subscribers. And the site now counts Microsoft and the EMC Corporation as clients.

Rock on, Marc. Your idea made sense in 2004 and it makes sense today. Congratulations on your Company's meteoric growth and its bright prospects for the future. You see, it's easy: just come up with a great idea that is totally different than what the market leaders are doing, build it deliberately and smartly over a three year period and begin raking in the cash. Easy, right? Not.

Pricing Risk: Taking it all Into Account, and No Tears, Please

As a follow-on to my earlier post on OTC derivatives, I have just one thing to say. If you are going to swim in the shark tank, you've got to know where ALL the sharks are. Because if you miss even one, well... And this applies to more than just derivatives. Remember the VNU bond-holders fiasco, where a private equity-proposed leveraged buyout that intended to leave existing debt outstanding caused CDS spreads to blow out by 250 bps practically overnight? Sure sucked for existing bondholders, right? Well, this kind of outcome was possible given the bond covenants and, therefore, it happened. Surprise, surprise. But it shouldn't have been. It wasn't like a debt-funded VNU buyout was some three-sigma possibility. Then why did spreads blow out so much? Because bondholders didn't anticipate that they would get jammed. But it is a gentlemen's market no more, my friends. The risk existed and VNU bondholders simply didn't price it properly. Ok, but that's kind of the game, isn't it? And now we see something similar happening with the subprime mortgage meltdown. As outlined in today's Financial Times:

In the latest twist to the tale, it emerged last week that a group of US hedge funds were up in arms over the banks’ involvement in derivatives based on sub-prime mortgages. The banks both create and sell the derivatives – which offer insurance against mortgage default – and manage the mortgages. The hedge funds say they have been relaxing terms on defaulting mortgages so they will not have to pay out on the derivatives.

Leaving aside the unappealing spectacle of America’s richest – the hedge fund managers – betting on the poorest losing their homes, the question is how the banks can wind up writing insurance against risks that they themselves partly control.

There are two issues