Sunday, June 17, 2018

Carreyrou, Bad Blood

On Friday Elizabeth Holmes, the founder of Theranos, and its former president Ramesh “Sunny” Balwani were criminally charged with wire fraud. These charges came three months after the SEC sued Holmes and Theranos for a “massive fraud” at the company.

John Carreyrou, a lauded investigative reporter at the Wall Street Journal who covered Theranos extensively from 2015 on, has written a spine-chilling book, Bad Blood: Secrets and Lies in a Silicon Valley Startup (Alfred A. Knopf, 2018).

It’s hard to imagine, amid all the suspicions, firings, and general upheaval, that Theranos got away with its alleged fraud for as long as it did. It was the persona of Elizabeth Holmes (along later on with some heavy legal fire power) that kept it going, that attracted big dollars from normally savvy investors and big names to the company board, that convinced companies such as Safeway and Walgreens to offer Theranos’s flawed finger-stick blood tests (although they later pulled back). People were bewitched by her “mixture of charm, intelligence, and charisma.” They didn’t see her much less flattering side.

Put Bad Blood at the top of your summer reading list. You won’t regret it

Wednesday, June 13, 2018

Yu, Leap

Legally or illegally, companies have for centuries copied the intellectual property of their competitors and encroached on their market share. One has only to think back to the commercial espionage of Francis Cabot Lowell, who in 1810-11, while strolling through dozens of British cotton mills, memorized critical details of mechanized textile manufacturing. Using this information, his Boston Manufacturing Company and eventually mills throughout New England took the growing American mass market away from British textile exporters.

Leap: How to Thrive in a World Where Everything Can Be Copied (PublicAffairs/Hachette, 2018) by Howard Yu is, in the best sense of the word, a story book. It tells tales of woe as well as tales of resilience. These case studies all have a point, but, even if they didn’t, they would be fascinating in and of themselves.

Wu, a professor at the International Institute for Management Development (IMD) in Lausanne, Switzerland, believes that the key to outlasting copycat competition is to leap. “Pioneers must move across knowledge disciplines, to leverage or create new knowledge on how a product is made or a service is delivered. Absent such efforts, latecomers will always catch up.”

Wu articulates five principles necessary for making a successful leap: (1) understand your firm’s foundational knowledge and its trajectory, (2) acquire and cultivate new knowledge disciplines, (3) leverage seismic shifts, (4) experiment to gain evidence, and (5) dive deep into execution. These principles, as stated, are somewhat telegraphic, but Wu develops them through compelling case studies from companies spanning the globe: for instance, Steinway (an example of what not to do in the face of competition, in its case, from Yamaha), Procter & Gamble, Novartis, WeChat, Recruit Holdings, and John Deere.

Leap is the kind of book that everyone with an interest in business can profit from. And here’s a lesson that everybody, active investors/traders in particular, can profit from. “Successful executives often exhibit a bias for action. But it’s even more important to separate the noise from the signal that actually pinpoints the glacial movement around us. Listening carefully to the right signals requires patience and discipline. Seizing a window of opportunity, which means not necessarily being the first mover but the first to get it right, takes courage and determination. To leap successfully is to master these two seemingly contradictory abilities. The discipline to wait and the determination to drive, in balanced combination, often pay off handsomely.”

Monday, June 11, 2018

Batnick, Big Mistakes

Consistently beating the market is insanely difficult. Whether it’s because the market is for the most part efficient, whether it’s due to the paradox of skill, whether it’s the result of the behavioral bogeymen that prompt us to do the wrong things at the wrong time, whatever the reason, no investor, not even the most successful, remains unscathed. Michael Batnick, director of research at Ritholtz Wealth Management, who admits to having made thousands of unforced trading errors himself, delves into this phenomenon in Big Mistakes: The Best Investors and Their Worst Investments (Bloomberg/Wiley, 2018).

In 16 chapters he writes about the mistakes of Benjamin Graham, Jesse Livermore, Mark Twain, John Meriwether, Jack Bogle, Michael Steinhardt, Jerry Tsai, Warren Buffett, Bill Ackman, Stanley Druckenmiller, Sequoia, John Maynard Keynes, John Paulson, Charlie Munger, Chris Sacca, and himself. Even though most of these mistakes are well known to students of investing history, Batnick frames them in a new, for the most part behavioral, way.

He distinguishes between “a lousy investment” and an unforced error. “Your thesis was wrong, or what you thought was already in the price; things like this are all part of the game. But oftentimes, we’ll act impulsively, even when we ‘know’ what we’re doing is a mistake. Few people are spared from unforced errors, and the way they usually manifest themselves is because we can’t handle people making money while we aren’t.” Stanley Druckenmiller, for instance, “played the game at a level few ever have.” He was 130% net long going into Black Monday and still made money in October 1987. And yet even he made an unforced error when he “couldn’t bear to see Quantum grinding its gears as a bunch of small-potato upstarts were racking up huge returns” in the late 1990s and bought $6 billion worth of tech stocks. … [I]n six weeks I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself.”

Elaborating on a quotation from Livermore and further fleshing out the distinction between a bad investment and an unforced error, Batnick acknowledges the limitations of learning from investing mistakes. “Investing is inherently an act of uncertainty, so we can never say to ourselves, ‘I’ll never let that happen again!’ Sure, there are very specific mistakes that you won’t repeat, like buying a triple-levered inverse ETF and holding it for three months. That’s something you do one time and never repeat. But like Livermore said, the mistake family is too large to avoid all of them. And no amount of market quotes will change the fact that losing money is a part of investing. Risk management is a part of investing. Repeating mistakes is part of investing. It’s all part of investing.” Even so, we can, and should, focus on avoiding unforced errors—errors such as straying outside our field of competence, confusing skill with luck or genius with a rising market, over-concentrating a portfolio (think Sequoia with Valeant or Charlie Munger with Blue Chip Stamps), buying at market tops and selling at market bottoms.

Big Mistakes is a humbling book. Sentences such as “Imagine that you were physically exchanging stock certificates with Jim Simons of Renaissance Technologies every time you went to buy or sell a stock” might be enough to send investors scurrying to buy an index fund. But the lure of joining the pantheon of great investors/traders remains powerful. Batnick may not provide the path to such success, but he demonstrates that perfection is not required. “Mistakes,” as Peter Bernstein once said, “are an inevitable part of the process.”

Wednesday, June 6, 2018

Pearson, How Hard Can It Be?

I read a lot of fiction, mostly mysteries/thrillers, for relaxation and/or escapism, the vast majority of which I never write about. After all, who cares about my reactions to the latest exploits of Armand Gamache or Jack Reacher or all those girls or women “on/with/in,” pick your preposition?

Perhaps no one cares about my reactions to Kate Reddy either, but since I requested a copy of Allison Pearson’s How Hard Can It Be? (St. Martin’s Press, 2018) from NetGalley, I feel a duty to write a few words about it. Moreover, the reason I requested it was that, in the novel, Kate returns to the hedge fund she started years earlier, even though, as it turned out, this was the least realistic thread of the storyline.

How Hard Can It Be? is a sequel to Pearson’s blockbuster (four million copies sold worldwide) debut novel, I Don’t Know How She Does It, described by Oprah Winfrey as “the national anthem for working mothers.” I didn’t read the original novel, but its sequel is both incisive and hilarious. It speaks, of course, more to women than to men.

Kate Reddy, now pushing 50 and impatient to relinquish her all-engulfing role as wife and mother, sets out to re-enter the workforce. Of course, the kids, now teenagers, don’t go away, nor does her increasingly distant husband. And the financial world isn’t exactly scrambling to hire a 50-year-old whose only “relevant” work experience in seven years was serving as treasurer of the village parochial church council and chairman of the governors at a community college.

How hard can it be? Very hard. But Kate didn’t compile an impressive track record in the City and survive years of motherhood to be daunted by little things like forgetfulness, a spreading middle, and the truth (does she really have to be nearly 50?).

This novel is a paean to grit, resourcefulness, humor, and new-found love. Women can rightfully be proud of Kate.

Sunday, June 3, 2018

Ball, The Fed and Lehman Brothers

Laurence M. Ball, a professor of economics at Johns Hopkins University, is convinced that (1) the Federal Reserve Bank had the authority to rescue Lehman in 2008 and that (2) in any event, the beliefs of Fed officials about their legal authority were not the real reason they chose not to rescue the firm. In The Fed and Lehman Brothers: Setting the Record Straight on a Financial Disaster (Cambridge University Press, 2018), based on publicly available sources, Ball makes his case.

After a deal to sell Lehman to Barclays fell apart on September 14, what could the Fed have done to avert Lehman’s bankruptcy the next day? Actually, as Ball points out, not all of the Lehman enterprise failed on the 15th. LBHI, the holding company, filed for bankruptcy, along with most of its subsidiaries. But one subsidiary did not: Lehman Brothers Inc., the company’s broker-dealer in New York. “The Fed kept LBI in business from September 15 to September 18 by lending it tens of billions of dollars. After that, Barclays purchased part of LBI and the rest was wound down by a court-appointed trustee.”

The usual explanation for the Fed’s refusal to lend to LBHI was that, under Section 13(3) of the Federal Reserve Act, the loan had to be “secured to the satisfaction of the Reserve Bank.” Fed officials took this to mean that the Fed cannot make a loan if there is a significant risk that it will lose money on the deal. This provision did not require that Lehman be solvent, but “examining Lehman’s solvency helps us to understand what assistance the firm needed to survive its liquidity crisis, and to assess its longer-term prospects.” Ball contends that, with mark-to-market valuation in the distressed markets of September 2008, Lehman was near the edge of solvency, so “it was probably solvent based on its assets’ fundamental values.” The problem, of course, was not solvency but liquidity. Lehman, Ball calculates, “would have needed about $84 billion of assistance to stay in operation for a period of weeks or months” while it looked for long-term solutions to its problems.

Ball argues that the real villain in Lehman’s bankruptcy was Hank Paulson, that he insisted on the bankruptcy and that Fed officials acquiesced. Moreover, he suggests, neither Paulson nor Fed officials fully appreciated the severe damage to the financial system that Lehman’s bankruptcy would cause.

Ball supports his hypothesis with ample documentation. Whether readers come away convinced that the Fed made a grievous error in not being the lender of last resort to Lehman will probably depend on their view of the Fed. And even if future Fed leaders “take the Lehman lesson to heart,” they may be hamstrung in their actions. The Dodd-Frank Act revised Section 13(3) to limit the Fed’s lending authority and to make all lending subject to the approval of the Secretary of the Treasury, a political appointee.

Wednesday, May 30, 2018

Edwards, American Default

No, this is not a dystopian account of the consequences of bad tax policy, wanton spending, and political gridlock. American Default (Princeton University Press, 2018), by Sebastian Edwards, is, in the words of the subtitle, The Untold Story of FDR, the Supreme Court, and the Battle over Gold. And a fascinating story it is. I couldn’t put this book down.

At its heart is “the great debt default of 1933-1935, … when the White House, Congress, and the Supreme Court agreed to wipe out more than 40 percent of public and private debts” by abandoning the gold standard, devaluing the dollar, and abrogating gold-denominated contracts retroactively.

Edwards takes the reader on the long, tortuous path to devaluation. FDR was largely ignorant of economics, not that economists of the day themselves understood the intricacies of the monetary system. He used commodity prices, especially the price of cotton, as the benchmark against which to measure the success of his economic policies. (In 1932 about half of the American population earned their living by farming.) During the first year of his administration he “obsessively” followed these prices, and “their movements often guided public policy. When commodity prices went up, the president felt confident; however, when prices faltered, the president would become very upset, and his tendency to experiment and try new policies would rise to the surface.”

The president was taken with agricultural economist George F. Warren’s “elegant charts drawn on onionskin paper.” The theory was that if the price of gold increased, higher prices for agricultural commodities would immediately follow. The New York Times reported that the administration’s goal was to adopt “a ‘commodity dollar’ which will fluctuate in line with general commodity movements instead of remaining as a constant factor through all periods of changing values.” Despite spurious theory and many stumbles, between March 1933, when Roosevelt was inaugurated, and December 1934, “the price of corn quadrupled, that of cotton almost doubled, the price of rye doubled, and that of wheat increased by 114 percent. During the same period, the Dow stock market index had increased by 67 percent.”

One of the most controversial policies, enacted at the behest of the Treasury Department, was the congressional joint resolution voiding the gold clause for both past and future contracts. If the White House’s policies rested on spurious economic theory, the legal basis for them seemed even dodgier. After all, the sanctity of contracts was part and parcel of accepted legal theory. The Supreme Court took up four cases challenging the joint resolution.

The Court, by a 5-4 vote, ruled that “the abrogation of the gold clauses for private contracts was constitutional, and debtors could discharge their debts using legal currency.” As applied to public debt, however, the Court ruled 8-1 that the abrogation of the gold clause was unconstitutional. But, again by a 5-4 vote, it “accepted the government’s secondary argument that the abrogation of the gold clause had not produced any damages to bond holders; in terms of purchasing power over goods and services, bondholders were at least as well off in 1933, as they had been at the time the Liberty Bonds were issued.” So bondholders could not sue for damages, and “there was no practical economic consequence for having passed an unconstitutional law.”

Contrary to the dire predictions of the Court minority, there was no major fallout from the rulings. The government had no difficulty rolling over its debt or issuing new securities. The U.S. abrogation was an “excusable default.”

Could an American default happen again? Yes, but, Edwards maintains, it would not be related to deflation, exchange rates, or the monetary system. The debt crisis that looms on the horizon “has a completely different genesis: it is rooted in unsustainable promises made in the present for future delivery of services.” And, presumably, this time around a default would not be excusable.

Sunday, May 27, 2018

Hall, Ideas, Influence, and Income

I’m not sure what prompted me to read Tanya Hall’s Ideas, Influence, and Income: Write a Book, Build Your Brand, and Lead Your Industry (Greenleaf, 2018). I have a hard enough time writing a few paragraphs about books for this blog. I have absolutely no desire to write a book myself.

But I thought that some of my readers, especially those who want to promote their brand or company, might be more ambitious. If you are, Hall’s book is a remarkably useful guide. Yes, this book promotes her own company, Greenleaf Book Group, a hybrid publisher and distributor that offers the benefits of both traditional and self-publishing. But in the process it explains a great deal about the new realities of publishing and marketing. Start with the sobering fact that more than 800 books are published in the U.S. every day.

If you’re contemplating writing a financial book, be forewarned that publishers are cutting back dramatically on titles in this area. (You may have noticed that the number of reviews I write has shrunk over the years. This, I assure you, is not from sloth.) So you’ll probably have to do all of the work yourself, not just write the book but see it through publication and market it. And expect to come out on the short end of the stick financially.

Hall cites a survey of book-buying behavior that says that author reputation is the most important factor in a book purchase decision. So, she recommends, build your platform early through tweets, social media platforms, newsletters, blogging, videos, presentations, webinars, and articles. Become known to a wide audience as an “expert” in the field you eventually plan to write about. Connect with your potential readers. Only then do you stand a chance of having your book end up on some kind of bestsellers list.

Let’s put it this way, Hall’s marketing suggestions only reinforced my decision never to write a book. But for those who are not deterred, Ideas, Influence, and Income is an informative read.