I had the opportunity to spend time with a group of very bright people last week: CEOs, private equity guys, bit time investors (excuse the vagueness here, it was a private affair). The last question of the day was, “What did you learn this year?” The year isn’t done by a long shot, but the themes are worth passing along.
Every once in a while, a black swan happens
Similarly, no matter how hard it is, you need to think about black swans.
A dominant theme over the three days we were together. Black Swan refers to Nasim Taleb’s brilliant book of the same name but more generally to the idea that business thinking and modeling tends to follow normal distributions of risk and reward. The problem is, the world dishes up what are known as “power force” curves from time to time. They’re infrequent, but severe. We simply must do a better job accounting for things that fall outside the second standard deviation.
There are huge implication about setting goals too high . . . like affordable housing
This one is sure to generate debate, but it’s a point worth thinking hard about. We want to solve society’s wicked problems. We want to do big things like promote home ownership and ensure health care for all. But there are a lot of moving parts, a lot of second and third order implications, and because there is often huge money at stake, a lot of action on the edges that often overwhelms the good intention over time.
The importance of a liquidity plan
Another version of this might be: Capital is king, liquidity is queen.
Ours is an economy built on debt. Legally commercial banks are limited to roughly 10/1. Investment banks, a pair of words that will go down in history as an epic oxymoron, typically ran at 40/1. Plenty of American households are out over their debt skis as well. It’s all well and good as long as you can keep rolling over your debt (often called a Ponzi scheme elsewhere), rates stay low, and the value of your equity stays high . . . none of which goes on forever.
When you see something really out of whack, you need to do something about it
Another version of this was: Never forget that when something gets too concentrated, no matter how good it looks, don’t do it.
I’m old enough to have lived through several economic cycles and more stupid pronouncements that “this time it’s different” than I care to think about. If something seems to good to be true, it is. The problem, besides greed and stupidity is that we’re all like the frog that got put into a pot of cold water and then got boiled alive one degree at a time. We creep up on too much concentration, too little liquidity, too high valuations, and too stupid regulators a degree at a time. Most of us don’t notice the water is boiling until it’s too late.
The only trouble with a sure thing is the uncertainty in it
This one tracks the previous point. Investment banks were especially guilty on this front, trumped only by investors willing to buy AAA rated investments returning above market returns . . . ahh the sweet promise of riskless rewards. I myself fell prey to this one, buying something called a “Guaranteed Return Note” from Lehman Brothers without probing the concept of “guaranteed.”
Not to leave anyone out on this, the ratings agencies should all follow the path of Arthur Andersen and be found guilty of institutional fraud. Their level of malfeasance and culpability sets a new standard.
Organizations we think will be around forever, won’t necessarily be
I had a colleague years ago who used the phrase, “the indestructibility of large organizations.” His notion was a version of “too big to fail.” Once you get to a certain size and scale, the organization’s ability to absorb stupid decisions was nearly infinite. Turns out that isn’t even close to being true.
Bluntly, the general quality of business decision making is appallingly poor. As I wrote in an entry called “Decision Making in Turbulent Times” . . .
All of us are experienced decision makers, indeed we’ve been making them our entire adult lives. And how did we come by our decision-making skills? Through a combination of personal experiences, so trial and error, and to a lesser extent watching and learning from others (oh if we only did that better). But does that mean we are good decision makers? Trained decision makers? The data says no.
“In tracking the success rate of decisions made by executives and managers at 356 different companies, Dr. Paul Nutt from Ohio State University, found that ‘more than 50 percent of all decisions failed; they were quickly abandoned, only partially implemented, or never adopted at all.”
It’s time that business and government make decision making a Varsity Sport.
The scary power of fear
Another version of this was: The emotional component of valuation is way, way more important than we think.
When things turned, they turned with vengeance. There is no question that the market is presently oversold and that people are afraid. The propeller heads that build the models that drive so many investment portfolios and so much public policy simply have no way of factoring human behavior into their models . . . at our collective peril.
Focus on the core mission. Focus on what’s really important. Stick to the Basics.
This came up over and over in conversation. I’m of several minds on this one.
The cynic in me says it swerves precipitously into the realm of pablum. Why anyone at any time in business would want to focus on things that aren’t important is a question that simply defeats me.
More broadly, I think of conversations I’ve had over the years with executives who want more innovation. News flash. In order to spur true disruptive innovation, assuming that’s what you want, you have to by definition focus on what’s not core. Core means current offers through current channels to current customers, only slightly better, cheaper, faster, and with presumably less risk. Non-core is facing potentially disruptive technologies and finding a way to embrace them. I get why that’s a scary idea right now, but not one we should lose sight of.
Arguing the other side of the issue, in shaky times, it’s important that the dog wags the tail, that the horse draws the carriage, or whatever metaphor you prefer. If you can’t do the thing that defines your enterprise really, really well, you’re screwed.
Sometimes we get confused by the facts
I love this one. We are awash in data. It’s all good as long as we keep asking ourselves the same questions about the same things. Where we get in trouble is when we need to consider new questions about new problems. Looking at the old data in the same ways won’t get us there.
Adversity and impossible odds creates lots of upside
There was a lot of sentiment in the room that we are on the cusp of a significant bull run. Assets are dirt cheap, the market is oversold, companies are priced at historic lows. If you have the guts for it, it’s probably as good a time as any to buy: Plenty of savvy investors are buying hand over fist which doesn’t mean you should. But it’s at least worth thinking about.
On a broader front, it’s not guarantee that Obama will be a great president, but the conditions are all there.
Trust but verify
Quoted from Ronald Reagan.
The massive credit culture that’s inflated over the past decade or so was predicated on the lack of verification. This was true at the individual home owner level all the way up to corporate and governmental treasurers. We came, we saw, we closed our eyes, and we bought.
Arrogance creates lots of downside
I think historians will look back at the past eight years and remark at the stupefying levels of arrogance, and yes greed, at every level and in every geography.
We learned we could lose more money faster than we thought was possible
Yes we did. I guess I take small comfort in knowing that people with more smarts than me lost more than me.
This too will pass
It always does.
Tags: NassimNicholas Taleb, Black Swan, liquidity, capital, decision mkaing, Dr. Paul Nutt, rating agencies, arrogance, Ronald Reagan, lessons learned
