It’s Worse Than You Imagined

March 8th, 2009

Warning: If you are easily frightened, upset and can get depressed, please do not read this article. The content is strong not in its language, but in its implications.

On Twitter I have acquired a reputation for my “Tweets of Doom”. For the most part, I do not consider myself to be a pessimist but a realist. My main area of interest in the unfolding financial crisis is how economics, history, demographics and politics come together and give us hints about future trends and show us where we are heading to.

Recently, I have read a fine article by Michael Lewis in the April Vanity Fair, Wall Street on the Tundra (also called “How Iceland Went Splat”), about how the crisis unfolded in Iceland, first transforming it from an economy based on fishing, to a country based on investment banking at the peak of the boom, then when the economy collapsed, back to fishing again.

Three paragraphs in particular stuck in my mind:

Back in 2001, as the Internet boom turned into a bust, M.I.T.’s Quarterly Journal of Economics published an intriguing paper called “Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment.” The authors, Brad Barber and Terrance Odean, gained access to the trading activity in over 35,000 households, and used it to compare the habits of men and women. What they found, in a nutshell, is that men not only trade more often than women but do so from a false faith in their own financial judgment. Single men traded less sensibly than married men, and married men traded less sensibly than single women: the less the female presence, the less rational the approach to trading in the markets.

One of the distinctive traits about Iceland’s disaster, and Wall Street’s, is how little women had to do with it. Women worked in the banks, but not in the risktaking jobs. As far as I can tell, during Iceland’s boom, there was just one woman in a senior position inside an Icelandic bank. Her name is Kristin Petursdottir, and by 2005 she had risen to become deputy C.E.O. for Kaupthing in London. “The financial culture is very male-dominated,” she says. “The culture is quite extreme. It is a pool of sharks. Women just despise the culture.” Petursdottir still enjoyed finance. She just didn’t like the way Icelandic men did it, and so, in 2006, she quit her job. “People said I was crazy,” she says, but she wanted to create a financial-services business run entirely by women. To bring, as she puts it, “more feminine values to the world of finance.”

Today her firm is, among other things, one of the very few profitable financial businesses left in Iceland. After the stock exchange collapsed, the money flooded in. A few days before we met, for instance, she heard banging on the front door early one morning and opened it to discover a little old man. “I’m so fed up with this whole system,” he said. “I just want some women to take care of my money.”

This made me ask myself a question: Maybe it was not enough to look at how economics, history, demographics and politics come together in this unfolding crisis? Maybe I should also take a look at human psychology and the role it played in the financial services industry? Were there certain personality traits which made it to the top of the financial services industry, making individuals with these personality traits captains of industry?

Armed with this question, I went to Wikipedia and looked up the term psychopathy and found this definition:

The psychopath is defined by a psychological gratification in criminal, sexual, or aggressive impulses and the inability to learn from past mistakes. Individuals with this disorder gain satisfaction through their antisocial behavior and lack remorse for their actions.

Now some of the characteristic symptons are:

Factor1: Aggressive narcissism
Glibness/superficial charm
Grandiose sense of self-worth
Pathological lying
Cunning/manipulative
Lack of remorse or guilt
Shallow
Callous/lack of empathy
Failure to accept responsibility for own actions
Factor2: Socially deviant lifestyle
Need for stimulation/proneness to boredom
Parasitic lifestyle
Poor behavioral control
Promiscuous Sexual Behavior
Lack of realistic, long-term goals
Impulsivity
Irresponsibility
Juvenile delinquency
Early behavior problems
Revocation of conditional release
Traits not correlated with either factor
Many short-term marital relationships
Criminal versatility

This was getting interesting, so I went to a Time magazine article which listed the 25 people to blame for the financial crisis. The behavior of some of these individuals is, to say the least, very interesting.

Then I went back to the article and read more about the traits of psychopathic behavior. Where appropriate, I have added emphasis. They are:

In practice, mental health professionals rarely treat psychopathic personality disorders as they are considered untreatable and no interventions have proved to be effective.[18] In England and Wales the diagnosis of dissocial personality disorder is grounds for detention in secure psychiatric hospitals under the Mental Health Act if they have committed serious crimes, but since such individuals are disruptive for other patients and not responsive to treatment this alternative to prison is not often used.[19]
Because an individual’s scores may have important consequences for his or her future, the potential for harm if the test is used or administered incorrectly is considerable. The test should only be considered valid if administered by a suitably qualified and experienced clinician under controlled conditions. [20][21]
Hare wants the Diagnostic and Statistical Manual of Mental Disorders to list psychopathy as a unique disorder, saying psychopathy has no precise equivalent[20] in either the DSM-IV-TR, where it is most strongly correlated with the diagnosis of antisocial personality disorder, or the ICD-10, which has a partly similar condition called dissocial personality disorder. Both organisations view the terms as synonymous. But only a minority of what Hare and his followers would diagnose as psychopaths who are in institutions are violent offenders.[22][23] The manipulative skills of some of the others are valued for providing audacious leadership.[24] It is argued psychopathy is adaptive in a highly competitive environment, because it gets results for both the individual and the corporations[25][26][27] or, often small political sects they represent.[28] However, these individuals will often cause long-term harm, both to their co-workers and the organization as a whole, due to their manipulative, deceitful, abusive, and often fraudulent behaviour.[29]
Hare describes people he calls psychopaths as “intraspecies predators[30][31] who use charm, manipulation, intimidation, sex and violence[32][33][34] to control others and to satisfy their own selfish needs. Lacking in conscience and empathy, they take what they want and do as they please, violating social norms and expectations without guilt or remorse”.[21] “What is missing, in other words, are the very qualities that allow a human being to live in social harmony.”[35]

This was getting very interesting. I would encourage you to search through Google or your search engine of choice and make your own observation whether these individual/s showed any psychopathic personality characteristics.

Basically, what the American financial services industry created an industry where individuals with psychopathic traits could rise to the top to positions of power, making decisions about billions of dollars in investments and assets.

Intelligent psychopaths exist in every society, and many become actors, politicians and lawyers. The genius of the American system was that it put them in charge of large sums of money.

But this is only the beginning. In the name of industry deregulation, they were given, by the US government the power to create financial instruments. In plain English, they were given the power, through leveraging, to make money out of thin air, out of nothing.

Over the past twenty years, using their talents and creativity, they have leveraged approximately every single US dollar 35-40 times, inventing CDOs, CDSs and other financial instruments in the process, all of which were interlocked. As if that were not enough, some of these personalities co-opted the whole financial media, earning their trust and selling their investment ideas directly to the American people over leading TV stations and print media. At no time did any of the financial media say “Wait a moment. These guys are shysters and are cheating and lying to the American people.” Instead, the media went along and played the game with them, becoming actors in the play when they should have questioned what was going on.

The lines between advertisers, corporations and media became completely blurred, and dissenting voices were simply not heard. It became a vortex which benefited all the players, who hyped the same worldview about finance.

What was missing in the whole equation? In one word, trust. The quants had created formulas such as the Gaussian copula formula to provide a rough measure of risk, but banks had become completely separated from their clients through a complex ecosystem which also included mortgage brokers, who originated loans, even for individuals who did not have work and had no chance of being able to make the monthly payments for the homes they bought.

The house of cards began to collapse in 2007 with the subprime credit crisis, and is continuing to unwind. At this stage, we do not know where it will all end.

What is even more interesting is that the personalities and personality traits which got us into the mess are still there, negotiating with US Secretary of Treasury Geithner in the belief that they should receive money from the government for their bad assets, which they believe will recover some value after the economy bottoms out. Others believe that these assets have no value, and the sooner the government recognizes this fact, the sooner recovery can begin.

American society had become one where competition and competitiveness were rewarded without regard to the implications for the society as a whole. The society was always looking for the next big thing, the instant hit without caring about the cost. Now it is paying the price for a screwed up values system. Now we know that there are no quick fixes, and none of the choices are good.

In the meantime, we are helpless in this world they have created for us.

If you haven’t poured yourself one already, maybe it’s time for a whiskey. A strong whiskey. Neat.

Baidu’s Problems: The Other Side of the Equation

December 4th, 2008

Lately, there has been much discussion about Baidu’s problems re the disclosure that they were accepting payments from makers of less than consumer-friendly products for higher rankings. David Wolf has an excellent posting about how Baidu has hurt itself in the public relations battle, with some significant assistance from CCTV and Google. According to David, Google China has positioned itself to benefit from some advertisers who eschew Baidu’s former position of accepting money for high positioning, without taking a second look at some of those companies which paid for those high rankings.

On one level, Baidu is a victim of its own success. Search engines are really mapmakers: they show what’s in the neighborhood. In its early days, before Baidu became pervasive, it may have been alright to take money for businesses to show up on the map without caring too much about the reputation of the business. After all, search was a comparatively new thing, and Baidu, not yet public, wanted to grow as fast as possible, both in terms of its indexes and database, and in financial terms. But now, everyone knows what a search engine does and expects it to basically tell the truth. And if it doesn’t, they are shocked and outraged. (Whether this is real or feigned shock and outrage is another story. We’ll get into that later.) Unfortunately, Baidu’s management failed to take into account their own success, and failed to make the transition to a more open, fair, ethical and transparent model before it became a full-blown shitstorm. Making the change would have hurt the company’s earnings, something Wall St. analysts would not have taken to kindly, so they were stuck. Instead of acting proactively, they took the other path, which was waiting for something to happen to them.

And it happened.

So does this mean the beginning of the end of Baidu’s erosion as search engine market leader in China? Actually, it’s not that simple.

Ultimately, it depends on Robin Li, Baidu’s CEO, and how he chooses to handle Baidu’s salesforce, who have aggressively brought in the bacon so that Baidu would look good for its investors and Wall St. The big question for Robin Li is: “How can he rein in his salesforce just when he needs them the most?” The Baidu salesforce is the main differentiator for Baidu; it has been able to sell keywords to China’s SMEs, getting it far greater penetration than Google in the Chinese tier 2 and 3 cities and in the countryside. Can you imagine Robin calling in his salesforce and telling them to do business and background checks on customers? That would be a very good way to get your salesforce to rebel in a split-second! Can he afford such a rebellion just when global economies and markets are tanking and Chinese are cutting back on spending, and when Baidu is expanding aggressively into e-commerce and other fields?

I don’t think so.

But then, it’s a stalemate for Baidu’s salesforce too. It’s not like they can up and leave and go to Google China, taking their clients with them. Sure, Google China likes the sales numbers they generate, but they cannot accept their sales practices.

Checkmate.

That is why the only thing Baidu can do is stay quiet, and hope the crisis is soon forgotten by its SME customers, and the wider audience, and can get back to business as usual. Of course, Baidu’s challengers will do their best to keep the issue in the public spotlight as long as possible. That is what the public relations battle which is now shaping up will be all about.

Baidu’s strategy of hoping that the issue will be soon forgotten is not a good strategy, but it’s the only strategy left in the eyes of their current management. But a strategy based on hope is not really a strategy, especially when you are under attack.

It’s time for a change.

If Chinese companies were more like most publicly listed US companies, somebody would step forward and take the knife, setting the stage for widespread change in direction and a whole new team. (Except if you are one of the Big Three from Detroit or a Wall Street banker. But, for the most part, those industries are exceptions and their gravy days are over.)

And that is why Chinese companies cannot make dramatic change, just when they need it the most. And, in short, that is why Chinese companies will not become global leaders.

What’s Global and What’s Local?

November 18th, 2007

With all the talk about globalization, as well as what is working and what isn’t about it, it’s time to drill down and find out what businesses are global by nature, and what businesses are local by nature.

For companies who are entering China, or are planning to go from China into international markets, this is a very important issue. There are some businesses which by their nature are global and others which are more local.

There are several businesses which by their nature are global. They are:

  • Raw materials and commodities
  • Transport, logisitics and distribution
  • Manufacturing
  • Commoditized services such as back-office operations and software outsourcing
  • Finance, especially wholesale banking
  • New technology development and research

Then there are other businesses which are more local/national in nature:

  • Retail and brand marketing
  • Most legal services
  • Internet services
  • Accounting services
  • Foods and food-related services

My experience is that the businesses which are more wholesale in nature tend to cross national borders and become more global in nature, while those which are closer to end consumers tend to be more local and national.

If there is an irony, it is that the least sexy businesses are the most global in nature, while the more sexy brands and Internet businesses are in fact, local. I believe that there are several reasons for this:

  • The large global businesses operate on smaller margins but make up for it on volume
  • Local businesses are more relation dependent. Most relationships are locally-based.
  • Relationships are location and context-dependent. Often this means culture.

    • Some of you may be surprised to note that I include Internet services in local businesses. If fact, they are. The struggle between Baidu and Google is largely a struggle over who has the larger local language search advertising market, Google, which gets most of its revenue from its home US market in English, or Baidu, whose services are almost entirely in Chinese. Even though China has four times the population of the US, the time when Baidu will overtake Google in terms of advertising revenue is still far far away.

    One of my pet peeves is the amount of hype first-time visitors to China swallow, thinking that they can plan their retirement on a “China strategy” without in fact coming and living in China and making an effort to understand the people and culture and building relationships on the ground. More often than not, the people who have dollar (or yuan) signs in their eyes come from the services sectors, which are in fact, more local in nature. The ones who are making the money in China are the big wholesalers, but they have enough presence of mind to keep their mouths shut.

    Lately, Dan Harris of China Law Blog has been talking about the opportunities opening up in the Chinese services sector because of policy changes. Most likely these changes will be led by another wave of service entrepreneurs coming into the country, or as is more likely, a new batch of local Chinese entrepreneurs offering services to China’s urban middle class. After all, they know the language, have the opportunities and can make the fast move.

    For businesses which are local by nature, and are mostly in retail, the challenges come in several forms. The costs of crossing national boundaries to establish a name presence are always huge. This is an area global ad agencies are designed to address, even though their market has undergone huge changes.

    The other huge challenge is human talent. How do you find the human talent who understand the needs of the parent company, and at the same time, can build relationships in a new market and understand what consumers want?

    This is the real challenge of globalization.