Building a Crisis Resilient Financial System


I consider the Financial crisis of 2007–2008 to be an inevitable consequence of “Moral Hazard” in the finance industry. Banks made profits on risky investments during the boom but taxpayers shared the losses when the investments went bad, thus encouraging riskier behavior.

In my view:

Capitalism generates wealth by allowing the free market to reward the good and punish the bad. If that can’t happen, capitalism does not work. Ideally, the banks which had lent irresponsibly and the individuals and businesses which had taken loans they could not afford would have all gone bankrupt and everyone would have learned their lesson.

Unfortunately, the financial system was characterized by Moral Hazard. The banks convinced themselves they could write bad loans and still make money, because they had devised complex financial instruments which spread the risk so widely that almost every bank in the world was exposed to it. The system became so interconnected that it wasn’t possible to let the “bad” parts of the system fail because they could not be distinguished from the “good” parts. Faced with the possibility of all their banks going bust or bailing them out, many national governments felt obliged to do the latter. This is textbook moral hazard because the entity bearing the losses is not the entity profiting from the original transaction.

The financial system may well have recovered more quickly if the bailouts hadn’t happened, but the suffering in the meantime would most likely have been unacceptable. Everyone who had savings would have seen them wiped out and a great many businesses would have ceased trading because they depend on credit for their cash flow, resulting in mass unemployment. Military coups in previously stable democratic countries could not have been ruled out and the prospect of extreme left or right wing groups taking control would have been a real possibility. The global economy was able to absorb localized banking collapses such as that in Iceland or of Lehman Brothers, but the human cost of a wider collapse would have been far worse.

The bailouts have been “successful” in the sense that some stability has returned, but they have not solved the underlying problem. Despite commitments in some areas to split up retail and investment banking and to improve capital ratios, the moral hazard remains because banks know they are too big to fail and will be bailed out again should the need arise. Only a total, irreversible disengagement of government from the financial sector could resolve this, and that is politically unrealistic. The main issue remains that the real cost of the bailouts is that they have reinforced the promise which was the root cause of the problem, that governments are there to rescue the banks when they fail.

How can we avoid another 2007-2008 type Financial Crisis in the Future?

I believe:

  • The section of the Glass-Steagall Act of 1933 repealed in 1999 which separated Commercial Banking from Investment Banking and from Insurance must be reinstated, because the Volcker Rule is too hard for regulators to operate/enforce. The bright line rule was much easier to enforce because the lines were very clear. Need to do something special across disciplines? Syndicate it. Money’s too fungible to rely on anything other than legally separate corporate entities, and having Bank Deposit Insurance (i.e. FDIC) on one side of the same house invites cross-subsidization of risk (i.e. abuse, moral hazard).
  • Too big to Fail Financial Institutions must not be allowed to exist – the “living will” requirement is silly nonsense, and will be found to have not been properly updated for a given such institution that gets in trouble in the future. If it’s too big to be allowed to fail, it’s too big to be allowed to exist at all, and the current ones must be cut down to size. This means setting hard limits in law, like the law that prohibits any single deposit-taking bank from having more than 10% of the deposits of the USA (Bank of America is just under the limit, and we might want to think about lowering that one to 5%). The limits must be stated in percentages of economic measures (e.g. GDP) rather than particular dollar amounts. This can be viewed as in the same economic policy vein as Antitrust Law: require a minimum number of entities (prevent cartels, oligopolies, and monopolies) to ensure competition and resultant efficient allocation of capital.
  • Once they’re separate again, Investment Banks must be prohibited from being Public Companies, i.e. selling shares of stock on the public markets to all comers – they must be legally restricted to being Corporate Partnerships. Investment banks walk on the high wire, taking lots of risk, and that risk shifts around much too fast for uninvolved investors to monitor the management – that’s a straight Principal-Agent Problem. I don’t want to restrict their ability to leverage to the skies if they want to – I just want to be able to not care if they screw up & go bust in so doing. If the managers are required to be the owners, the problem goes away. Hell, the managers have every incentive to monitor each other!
  • Credit Default Swaps are insurance, and must be regulated as such. I’m sure that a review of all financial instruments will find very little is actually new under the sun – just the names have been changed to avoid existing regulations (which are usually born out of hard-won experience). That has to stop, which is to say, again, bright line rules for what things are being bought and sold in broad categories, with established regulations on them.

The Dodd-Frank Wall Street Reform and Consumer Protection Act fixed exactly none of these problems – it papered them over. Paul Volcker is a very, very smart economist and legendary former chairman of the U.S. Federal Reserve, and his rule as he states it is the right thing in principle, but the regulations they wrote to define all the terms & conditions are so grey and messy (and probably pliable or go-around-able) that I think the point is probably lost. That’s why I want legally separated corporations in these differently regulated businesses back. Easy, obvious, bright-line rule.

Share your thoughts.


Winning Financial Support For Your Non Profit


As Founder & President of the Financial Policy Council since 2011, I learned over the last few years more than a few effective ways to win financial support for non-profit organizations.

I thought of sharing some with you in here for the benefit of anyone looking to enter the great world of non profits.

Here’s the lay of the land…

  1. Don’t Chase the Money – You have to qualify, qualify, qualify. Make sure your mission and purpose fits closely with the funding entity’s mission and purpose. Don’t apply for a grant because your business sort of, kind of fits it. Don’t tailor what your business does to get the funding. In hindsight, I learned to apply only for grants that look like they’re specifically written for me, my business.
  2. Be Laser Like Focused – Identifying private foundations, and other organizations that give grants to individuals or small businesses requires considerable time, effort and research. For starters, look in your own backyard to find grant-makers that have previously funded projects or services for businesses like yours. Use a rifle approach never a gunshot approach.
  3. Determine Your Approach – Once you identify potential funders, determine how you intend to approach them. Make a personal contact and cultivate relationships by e-mail, telephone call, office visit and/or letter of inquiry. During this stage you want to determine 1) their interest in your project or company, and 2) what they would like to see first as the initial document of entry (i.e., letter of inquiry or concept paper). Many funding organizations now prefer that requests be submitted first in letter format before accepting a full proposal.
  4. Get To Know Your Funder – Don’t write the proposal first and then go looking for funders. Your grant proposal has to be prescriptive to what that funder is seeking. Get to know potential grant-makers better by obtaining copies of their annual reports. Scrutinize their website. What buzz words do they use. You can even incorporate that funder’s colors into the fonts and graphics that you use in your grant proposal.
  5. Do Whatever the “Request For Proposal” Says – Most importantly, request a copy of the grant guidelines. Follow the requirements of the funding notice or application to the letter. Your guide for what to include or not to include in your document is the request for proposal (RFP) or grant application. Give the funder exactly what they ask for, no more and no less. If it says give a brief statement, you write a paragraph. If it says give us two to four pages that is what you will provide—not one page or four and a half pages.
  6. State Measurable Not Fluffy Objectives – In general, your proposal will start with an introduction, which includes the amount requested, followed by a description and brief history of your company and its products, services or programs. Your proposal should describe anticipated and immediate short-term and long-term results, proposed implementation, staff or key personnel, budget, methodology, benchmarks, and timetable. A common mistake in writing a proposal is failing to distinguish between a goal and objective. To provide value added services to financially savvy professionals helping to create wealth is a goal not an objective. Your objective must be S.M.A.R.T, that is specific, measurable, obtainable, realistic, and time bound. A measurable objective will have a subject, an action, a location, a timeframe and a percentage.
  7. Spell Out How You Intend to Spend the Money – The person giving you the money has to make sure you know how to spend it – line item by line item. Some reviewers look at the budget first to gauge applicants. People often are disqualified for providing an improper budget. They usually get tripped up by either over estimating or underestimating their costs.
  8. Consult a Professional Grant Writer – Don’t be fooled by advertisements and promotions for granting writing. There are a lot of scammers, especially on the internet. The Better Business Bureau is a good resource for checking the references of a grant writer. Expect to pay from $1,000 to $3,000 for a grant proposal for private or foundation funding and $4,000 to $15,000 for a grant proposal for government funding, since such grant applications tend to be more intricate.  Even if you don’t hire someone to write it, you should consider hiring someone to review it.

Now you know …. Share your thoughts if you believe I missed anything of significance.

Good luck with your funding.


Will the Venture Capital Industry ever go back to its glory days?


It seems, at first, like the logical next act in the classic entrepreneurial script. Having developed your software company on your home-built microcomputer, you pack your bags and set off on a pilgrimage to the venture capital Mecca of San Francisco in search of the help you need to turn your creation into a multi-million-dollar enterprise.

It is a well-worn path, that route from the entrepreneur’s garage to the investor’s suite. It is part of an initiation rite through which hundreds, if not thousands, of dreamers and doers had passed before.

What your company needs is capital and, equally important, the wisdom of those who had done it before in Silicon Valley’s venture capital community.

As you move from meeting to meeting, you look across the table at the people whose help you are seeking, and feel some kind of disappointment.

Are these the venture capitalists you had heard so much about? Scarcely believable. These guys act powerful and important, and they undoubtedly have access to a great deal of money, some of which they indicate they might be willing to part with. But they are hardly the experienced sages that you have been hoping to encounter, people who had built fast-growth companies from coast to coast. Some of these venture capitalists don’t even know very much about running a business, having only graduated from business school two or three years before.

Just because they have MBAs from Stanford or Harvard, they think they know everything about everything. Worse, their approach is pretty much antagonistic. ‘Why don’t you do this? Why don’t you do that?’ they say. They want you to redo everything you have done, and most of them don’t know anything about writing software. You feel you have been nursing this baby and these obnoxious morons are telling you that they don’t like the way the baby looks. But the fact is that they had done some things right…. Go figure.

In the end, you realize that these guys are a total waste of time and that you don’t even want them on board, telling you what to do. Maybe you wouldn’t go silk-stocking, but don’t care anymore. You are going to find a different route.

Welcome to the real world.

Yes there have always been young companies that, for one reason or another, have preferred to grow without venture capital, but lately it seems that more and more have.


Well as a starter, let me tell you that the vast majority of venture capitalists have no clue what they are doing. Most importantly, as I have been saying for years now, venture capital, by its very nature, distorts the process of growth.

Venture capitalists make you too ‘now’ — too profit-oriented, instead of quality-oriented. You introduce factors with venture capital that don’t really help build any company. As an entrepreneur you want to use your profits to do the things you want to do, not to please some investor who’s screaming, ‘Fifteen percent or you’re out!’ . No wonder the smartest entrepreneurs out there would rather have the steady, balanced growth that comes from pulling themselves up by the bootstraps.

That may be something of an overstatement, but it is also an increasingly common refrain in Silicon Valley, Route 128 in Boston or Silicon Alley in New York City. It reflects a growing disenchantment with an industry whose successes have become synonymous with the resurgence of the entrepreneurial spirit in America. Since the late 1950s, venture capitalists have played a crucial, even heroic, role in launching some of the nation’s most spectacular growth companies, from Digital Equipment and Federal Express to Apple Computer and People Express. At a time when the giant commercial banks, investment houses, and large corporations disdained small startups, venture capitalists were ready and willing to take the risks necessary to build their economic future.

I am afraid though venture capital today may well be becoming a victim of its own successes. Once a collection of small firms run by brilliant, if often idiosyncratic, individuals, the venture capital business is developing into a large-scale, highly institutionalized industry. The main impetus has come from pension funds, investment banks, insurance companies, and the like. Lured by annual returns as high as 40% to 60%, they have poured huge amounts of money into venture capital funds.

As the money has flowed in, the game has changed. You have to understand this is an industry where people are not used to having a lot of money. Then somebody gives you $150 million, and you start to feel you can walk on water. You read in the paper that you’re a genius, and you believe it. Some of the old constraints tend to get eroded away.

One manifestation of this tendency has been the recent emergence of so-called mega funds — venture capital funds of $1 billion or more.

Those are huge numbers for an industry in which, in the mid 80s the largest fund was about $50 million and the average fund was about $15 million. The problem of managing such mega funds, however, may be even bigger. In this business, you don’t multiply your talent with size. Stretched thin, the often illustrious general partners of the larger firms have had to depend increasingly on inexperienced subordinates for much of their investment decision-making and due diligence. This, in turn, has had an impact on the venture capital process itself. From the entrepreneurs’ standpoint, it means that they may not get the expert advice, or “intelligence equity,” which they often value more than cash. From the investors’ standpoint, it means that they are entrusting their money to people with limited knowledge of the business.

Part of the problem has to do, quite simply, with the dearth of available talent. Experienced venture capitalists are hard to come by, and their number has not kept pace with the explosion of the industry as a whole. It is a fact that venture capital is rapidly becoming a very talent-short market segment and there is a tremendous danger in this. Inexperienced people can be like the proverbial loose cannon on the battleship.

It’s like a large law firm. You can say you’re with the greatest law firm in the world, but, if a junior person is handling your account, I’d say that’s baloney. The question is: Who is your individual lawyer? This is not a profession for a lot of inexperienced “master of the universe” Ivy League rookie types in their 20s and 30s.

Then again, it would be unfair, and wrong, to blame most of the industry’s woes on MBAs, whose role, after all, is more a symptom than a cause of the problems. Certainly, there were very experienced hands involved in many of the venture-backed fiascos of the last decade…. clearly a broad pattern of mistakes and misjudgments. People get into situations with entrepreneurs or companies that they soon realize aren’t going to work out, but once you start, you often find a deal takes on a life of its own.

Exacerbating this situation is the growing involvement of major financial institutions in the venture capital process itself — not just as suppliers of capital, but as direct participants in latter, or “mezzanine,” round financing. As investment banks, insurance companies, and other large institutions have formed their own venture capital arms, they have added millions of dollars to the already huge pool of money available to companies on the verge of going public. The temptation is to pump these companies full of cash in hopes of increasing the appeal of their initial public offering. It is a temptation that some venture capitalists have found impossible to resist.

A lot of the troubles started when the institutions began co-investing with venture capitalists. It’s a fundamentally unsound process. It’s like believing in Santa Claus. The pressure is to short-cut the whole process. Instead of giving companies five or six years to grow, they try to do it in two years. Some companies have been rushed and grossly over financed as a result. The institutional involvement distorted everything. It’s a process that will lead – and is still leading — to disaster.

“Disaster” may seem like a rather strong word, and “over-financing” a rather strange concept — especially to young companies that are struggling to make ends meet. Yet that concept touches the root of the problems precipitated by the influx of new money and new players into the venture capital business. The business has become very chic. In the not too distant past, many of these same institutional investors would react to venture capital like venereal disease. Now they think it’s the greatest thing in the world, but they have picked up none of the skills.

In their enthusiasm, the new players often fail to comprehend the fundamental difference between venture capital and conventional financing mechanisms. They think it’s an investment business, but that’s wrong. Venture capital is not a business of trading stocks and investing for fast returns. Venture capitalists are not bankers. They are into building companies.

That is, indeed, what venture capital used to be all about according to General Doriot; the father of venture capitalism — building men and companies – and they have done a great job funding companies started by ARD back in the 40s to thousands of other companies since then such as Apple, Microsoft, Google, Facebook and the likes.

I think venture capital has been fantastic for the country. But this is past…not anymore today.

People then knew what they were talking about and were extremely analytical and unemotional. Exactly the reverse of what venture capitalists are today where most of them are just parallel investors who follow what other people do…Total sheep.

In my humble opinion, it is often later — after the company is up and running — that the knowledge and experience of a skilled venture capitalist becomes most important to the entrepreneur. Why? Well it is a fact that most entrepreneurs today run a tight ship and don’t need money. What they mostly need is somebody who could tell them what a big company is all about. Basically they need strategists who could tell them a problem and they set the guidelines, so you can get a solution.

People say power corrupts, but I think it’s money that does the trick. We have today the symptoms of the heightening of greed among venture capitalists and entrepreneurs. I suppose greed is okay up to a point, but it’s like wine. A glass is pleasant; a bottle will have a different effect.

This particular form of inebriation produced a variety of effects and manifested itself in a variety of ways. To begin with, it drew into the venture capital business a lot of people and institutions that were less interested in building companies than in scoring “quick hits” — that is, realizing enormous returns in a relatively short period of time. That was all right for entrepreneurs of a similar mind, but it posed a tremendous dilemma for those who were interested in something more than a fast buck.

Whether or not they were looking for weeds, that is what they found. All over Silicon Valley, companies began to spring up that were heavily promoted and heavily financed on little more than grand schemes. In place of expertise, the venture capitalists provided the companies with tons of money. The people who ran the companies often wound up spending it like oil sheiks on a weekend jaunt to Las Vegas.

There was, for example, the leading semiconductor start-up that added a totally unnecessary, albeit aesthetically pleasing, sloping roof to its headquarters at a time when losses were running at more than $1 million a quarter. An elaborate management information services staff, elegant workstations, and a host of other extravagances helped boost this company’s breakeven point as much as $4 million above that of its competitors.

Those types are still all around the Valley. Basically the hip shooters, the guys with a good front who feel they can do anything. It’s a lifestyle thing. They want to live like kings on other people’s money. What amazes me is that the idiotic venture capitalists backing them let them get away with it.

The consequences of all this are already being felt throughout the venture capital industry today. With the souring of the public market, many knowledgeable observers expect the returns of venture capital firms to plummet over the next few years, perhaps dropping by as much as half. That, in turn, will affect the supply of venture money available from institutions. If institutions are making venture investments on the basis of the returns we’ve seen over the past five years, I believe they are going to be disappointed.

The first casualties will probably be the industry’s “greener” players, particularly those venture groups set up by investment bankers and other traditional financial institutions. Venture capital doesn’t fit easily with the mentality of large corporations.

But the ripples of venture capital’s plunge are likely to spread far beyond the institutional funds. I fear in fact a backlash similar to the one following the “go-go” years of the late 1990s and early ’00s. That era, like the present one, had seen a spectacular boom in young growth companies, many of which went public with great fanfare. Aggressively promoted by stupid young brokers, hustlers and underwriters, these hot new issues soared briefly across the investment horizon, until the fundamental weaknesses of the companies brought them, and their investors, crashing back to earth.

Something like that could happen again, particularly if a significant number of the “living dead” don’t survive. Indeed, it is by no means inconceivable that a series of massive failures of venture-backed companies could send a chill across the entire entrepreneurial landscape, affecting all kinds of smaller businesses, even those that might never have been candidates for venture capital themselves. After all, the rise of venture capital helped generate new interest in small, growth companies in general; so, too, its decline could have the opposite effect. To a certain extent, this is already occurring.

But even if the worst doesn’t happen, entrepreneurs will increasingly have to look elsewhere for the money and expertise that they have traditionally counted on the venture capital community to provide.

Too many start-ups I’ve seen over the years started with too much money. The key thing is you have to go through the pain. If you sense pain in the beginning, the chances are you won’t have to deal with it later. The only way to stay focused is pain — and not being able to make the rent if you screw up.

In the future, that observation may apply as well to companies that have already received venture capital. The guys who spend lavishly will go under, and those who spend carefully will survive.

Much the same might be said for the venture capitalists themselves. While the newer firms begin to fade, some of the more traditional venture capitalists are pulling in their horns.

There’s a time to reap, and there’s a time to sow. Maybe this is the time to plant seeds and get through the long winter. The opportunities are still there at the end of the cycle. Survivorship never has been easy, but that’s the way this business has been from the beginning.

So, in the long run, the venture capital industry may yet emerge from its Big Chill stronger than ever. It will, that is, if venture capitalists put their shoulders to the wheel, and return — in the words of General Doriot — to the business of “building men and companies.”

You’ve been warned…. Now let’s see what you make of it next time you deal with venture capitalists.


Investing Post Crisis


The crisis of 2007 has clearly created a new financial landscape out there and most of us are looking to thrive or at least survive in this new environment in the making.

Some food for thought:

  1. Nine out of 10 people in finance don’t have your best interest at heart and even worse are clueless.
  2. Don’t try to predict the future but understand the facts like no one. Read, learn and start discerning facts from propaganda.
  3. Saving can be as important as investing.
  4. Tune out the majority of news. All baloney worth nothing but divert your attention.
  5. Emotional intelligence is as important as classroom intelligence. High stakes investing has much to do with nerves of steel as market savvy.
  6. Never talk about your money. Smart people know better.
  7. Most financial problems are caused by debt. Debt can be only be good for you when you can borrow at insanely low interest rates.
  8. Forget about past performance. Change is the only constant out there.
  9. The perfect investment doesn’t exist.

Now go and make a killing…

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