Monday, March 23, 2009

Percentage Pricing - the Key to Investment Banking

Of course, traditionally, the key to investment banking has been OPM - Other People's Money. That vital insight was conveyed to me when I was in a Fellowship at Yale, and two of my classmates, Steve and Fernando, were seniors interested in business. One day they came bubbling back from a class to let me in on the secret. Someone from Wall Street had come up to lecture to them and told them about OPM. Yes, they were bubbling, chortling. Such a key they had had introduced to them! There was also a bit of wonder about it - my God, can you do this?!

A variation of this is the observation of some, convincingly, that the major step to perdition in Wall Street has been the abandonment of partnerships in favor of public ownership. This has meant that risks incurred are not to one's own money, but public money. Before, partners had to question themselves severely about the risk they took. They were using OPM, but they were also injecting their own.

But it strikes me that in addition to OPM, a key element is what I call Percentage Pricing. This term simply means that, if you are an investment banker doing a deal, you price your participation not by your hours, but as a percentage of the total deal. Large deals in the billions - and all I want is one-half of one percent. Isn't that what they do? And what is the justification? Probably just that a very small percentage, and you're a CEO, what do you care?

In economics, I imagine this issue comes under "setting prices." I remember what the Russians asked in the 1990's when the Americans were trying to help them set up their new economy. They got the structure, that was pretty easy. But they kept asking the Americans: "But how do you set prices?" The Americans didn't really have an answer. There is plenty of literature on how prices adjust in a free market, but it involves costs, and costs involve prices themselves. It's one thing to go from an equilibrium; it's another to set up the equilibrium to begin with.

So, in investment banking, if you want to do a deal, you need to figure how much you will pay the investment bankers. This comes from what they have charged in the past, so you can figure on that. If they have competition for their time and effort, the same expectation of fees holds - depending on what they have gotten before.

It's similar to CEO pay - abroad, it's far less than in America. Does this mean their CEO's are worse? That's doubtful. It's just tradition and expectations.

So, back to Russia - I would love to know how it worked out, and where they got their inspiration of where to start out. In the end, it's probably who's got the cajones to set the price he wants and stick by it.

It reminds me of ecology. You might think that given a certain percentage of various species in a set environment, that the eventual equilibrium of how many of each species gets established in the environment would be constant. X percentage of this animal, y percentage of that. But that's not the case at all. It's widely variable, but in each case, once an equilibrium is established, that's where it sticks. One case can have X percentage of species A, and the second case, with identical start point, will come out with Y percentage for species A, and X and Y are very different.

I see the same thing in medical care. In the USA, specialties rule - the specialists get paid a lot. the primary care docs don't get so much at all, despite the fact that it is widely recognized that the best systems have primary care as the base, and in this country we are becoming very deficient in primary care docs. Abroad, primary care docs can earn more than the specialists. Specialties like orthopedics have very dominant personalities populating their ranks; these assertive people make a lot of money, because they demand it. No other reason I can think of.

It is no coincidence that the culture of investment banking is one of very dominant personalities. They simply set the price at what they can get - as percentages of the deal, even though what they do has really no connection at all with the underlying worth of the businesses involved. These guys have balls, and balls brings money.

C'est la vie.

Budd Shenkin

Friday, March 20, 2009

Iraq and Afganistan

I have had a running conversation with my old high school friend, John Bernard, about matters political. John has been a centrist, and a realist, and typically follows news and politics with a stance that questions at each point. Very un-ideological. So he pointed out Fouad Ajami's latest article in the WSJ (see below). John said this is something that he has been worried about. Here is my response. It's not the deepest thing in the world, but I thought it might be of interest. Maybe.


Well, I've never actually been that impressed with Ajami. Writes well and with conviction, but I've just never been convinced by him, and that applies to this article as well.

Iraq - still a big unknown. I read a good book recently, by the correspondent from WaPo - what's his name? what's the book? -- aha!
The Gamble: General David Petraeus and the American Military Adventure in Iraq, 2006-2008 by Thomas E. Ricks (Hardcover - Feb 10, 2009). I recommend it. Details Petreus' strategy and Odierno's conversion to it. Moderately supportive of the war. Amazing how long it took Bush to understand it. Petreus and his strategy were in the NYT Magazine, I think, years before Bush bought into it. Cheney and Rumsfeld were the problems, and Condi is a cipher. We are hoping that the Obama team - Clinton seems to be doing very well so far, and the special area envoys for Obama are terrific - will come up with good steps forward - I nearly said solutions, but that's too optimistic.

It is not so, as Ajami asserts, that Iraq is now obviously worth it. Far too early to tell. Still could be a Yugoslavia, or worse, could come apart, and we could still be there in 10 years. The financial cost has been a back-breaker. Yes, good to get rid of Saddam, but the overall hope, that this would be a beacon of light to the rest of the Muslim world and would ignite enlightened West-oriented reforms worldwide, is clearly not to be.

It might be true that Democrats have criticized the Iraq war but endorsed the Afganistan war. But all they were saying really was that the heart of terrorism was in Afganistan and not in Iraq, and that we got into Iraq by slight of hand, which is unalterably true. The Administration clearly had another strategy in mind with Iraq that they weren't sharing (what I said above, about spreading democracy). This is clear from public sources, and I know it from private DOD source as well.

No one has ever thought that Afganistan would be easy, or that the objective would be the same as Iraq. The objective was simply to excise the source of the terrorism infection. The strategy has been unimaginative. I think the Democrats said from the start that there should have been an intensive incursion into the caves of Baluchistan to find Mullah Omar and Osama and extirpate the source. They never said much more than that. It was Bush who didn't do that, and then went nation-building instead. So, just as with the economy, the new Administration is forced to take a seat at the table and pick up the hand it was left with by the departed Administration.

As far as I can see, the current strategy in Afganistan is to replicate the clear and hold and win hearts and minds strategy that Petreus brought to Iraq. It's a lot harder in Afganistan, which has no middle class whatsoever, I guess. They are and will be a tribal society. I guess what I would do would be to use the inkblot strategy around the cities, try to get some NATO or other cooperation in projects to protect women and girls and centers of commerce, and have a separate effort to go into Waziristan and Baluchistan and beat the hell out of the Taliban there in a long war. The problem is troops - who wants to go there? That's why they use the drones. But money talks, and targeted assassinations can go a long way.

We'll see what Holbrooke comes up with. He is top flight.


(Copyright (c) 2009, Dow Jones & Company, Inc.)

The Wall Street Journal

March 20, 2009 Friday


LENGTH: 1348 words

HEADLINE: Obama's Afghan Struggle

BYLINE: By Fouad Ajami

We face today the oddest and most unexpected of spectacles: On its sixth anniversary, the Iraq war has been vindicated, while the war in Afghanistan looks like a hopeless undertaking in an impossible land.
This is not what the opponents of the Iraq war had foreseen. After all, Afghanistan was the good war of necessity whereas Iraq was the war of "choice" in the wrong place.
The Afghan struggle was in truth a rod to be held up in the face of the Bush administration's quest in Iraq. Some months ago, Democratic Party strategist Robert Shrum owned up to this fact. "I was part of the 2004 Kerry campaign which elevated the idea of Afghanistan as the 'right war' to conventional Democratic wisdom. This was accurate as criticism, but also reflexive and perhaps by now even misleading as policy."
The opponents of the American project in Iraq did not know much about Afghanistan. They despaired of Iraq's sectarianism and ethnic fragmentation, but those pale in comparison with the tribalism and ethnic complications of Afghanistan. If you had your fill with the Kurds and the Sunnis and the Shiites of Iraq, welcome to the warring histories of the Pashtuns, the Uzbeks, the Tajiks, and the Hazara Shiites of Afghanistan.
In their disdain for that Iraq project, the Democrats and the liberal left had insisted that Iraq was an artificial state put together by colonial fiat, and that it was a fool's errand to try to make it whole and intact. Now in Afghanistan, we are in the quintessential world of banditry and tribalism, a political culture that has abhorred and resisted central authority.
Speak of colonial fiat: It was the Pax Britannica that drew the Durand Line of 1892 across the lands of the Pashtuns and marked out a meaningless border between Afghanistan and Pakistan. It should have taken no great literacy in the theories and the history of "state-building" to foresee the favorable endowments of Iraq and the built-in disadvantages of Afghanistan.
Man battled the elements in Mesopotamia, and the desert and its ways of plunder and raiding pushed against urban life, but the land gave rise to powerful kingdoms: the Assyrians, the Babylonians, the Sumerians, the Abbasids. In more modern times, oil and the central treasury knit the place together, often in terror, but kept it together nonetheless.
Contrast this with Afghanistan's impassable mountains and anarchic ways, and with the poppy cultivation and its culture of warlords and bandits. A Nouri al-Maliki in Baghdad can dispense of oil largess and draw the provinces toward the capital; a Hamid Karzai in Kabul is what foreign donors and benefactors make of him and enable him to do.
The flattering cliche that Afghanistan is the "graveyard of empires" is a hollow boast. Empires that wandered there did so by default, for there never was anything in Afghanistan -- save for geography -- that outsiders coveted. It was the primitiveness of the place -- the landscape that evoked the imagined early centuries of Islam's beginnings -- and its age-old way of extracting booty from outsiders that had drawn the Arab jihadists, and their financiers and handlers, to Afghanistan.
Now the Democrats own this Afghan struggle. They have to explain and defend it in the midst of a mood of introversion in our national life. It is hard to sound the trumpet at a time of economic distress. Plainly, our country has been living on its nerves since 9/11. It had not willed an Islamic imperium, but it had gotten one. It was bequeathed this terrible duty by the upheaval in the lands of the Arab-Islamic world, and by the guile and cunning of a generation of jihadists and their enablers, who deflected the wrath of their people onto distant American power.
George W. Bush answered history's call -- as he saw fit. The country gave him its warrant and acceptance, and then withdrew it in the latter years of his presidency. Say what you will about his call to vigilance, he had a coherent worldview. He held the line when the world of Islam was truly in the wind and played upon by ruinous temptations. He took the war on terror into the heart of the Arab world. It was Arabs -- with oil money, and with the prestige that comes with their mastery of Arabic, the language of the Quran, among impressionable Pakistanis and Afghans -- who had made Afghanistan the menace it had become. Without Arab money and Arab doctrines of political Islam, the Taliban would have remained a breed of reactionary seminarians, a terror to their own people but of no concern beyond. It thus made perfect strategic sense to take the fight to the Arab heartland of Islam. Saddam Hussein had drawn the short straw.
President Barack Obama -- another "decider" with an expanded view of the presidency's power -- faces a wholly different challenge. It was the economic distress that delivered the state into his stewardship. A cerebral man, he has presented himself as a "realist" in foreign affairs. Not for him is the Bush "heat" about liberty in distant lands.
By the appearance of things, Mr. Obama is undecided about Afghanistan. He has neither embraced this war, nor ditched it. In a perfect world, that AfPak theater (Afghanistan/Pakistan) would hold still as the administration struggles with AIG, the crisis in Detroit, and the selling of the budget. But the world rarely obliges, and sooner or later the administration will have used up the luxury of indecision. It will not be easy for this president to summon this nation to a bigger endeavor in Afghanistan. Set aside his fear that his domestic agenda could be compromised by a bold undertaking far from home. The foreign world simply does not beckon this president.
In fairness to him, his hesitancy in the face of foreign challenges is a fair reflection of the country's fatigue with causes beyond its borders. He could link Afghanistan with 9/11 and with the wider war on terror, but he put forth the word that the vigilance and zeal of that struggle is best forgotten. By his admonition, we are not to speak of the global war on terror. The world is full of reconcilables and deal-makers, bazaaris one and all in Damascus and Tehran and Palestine. In the Obama worldview, it is now time for diplomatic accommodations.
The president is on the horns of a dilemma of his own making. In his determination to be the "un-Bush," he has declared his intention to repair what some have called "Brand America" and to pursue a nonideological foreign policy of multilateralism and moderation. His aloofness from what played out in Iraq is a hindrance to him when it comes to issuing any call to arms in Afghanistan.
He can't build on the Iraq victory, because he has never really embraced it. The occasional statement that we can win over the reconcilables and the tribes in Afghanistan the way we did in the Anbar is lame and unconvincing. The Anbar turned only when the Sunni insurgents had grown convinced that the Americans were there to stay, and that the alternative to accommodation with the Americans, and with the Baghdad government, is a sure and widespread Sunni defeat. The Taliban are nowhere near this reckoning. If anything, the uncertain mood in Washington counsels patience on their part, with the promise of waiting out the American presence.
Mr. Obama does not have to offer the Iraq campaign post facto vindication. But as he does battle in the same wider theatre of that Greater Middle East, he will have to draw the proper lessons of the Iraq campaign. This Afghan war can't be waged in stealth, and in silence. Half-measures will not do. This war will have to be explained -- or explained away. For it to have any chance, it will have to be claimed and owned up to even in the midst of our economic distress. It's odd that so articulate a president has not yet found the language with which to describe this war, and the American stakes in it.
Mr. Ajami is professor of Middle East Studies at The Johns Hopkins University, School of Advanced International Studies and an adjunct senior fellow at Stanford University's Hoover Institution.
License this article from Dow Jones Reprint Service

Saturday, March 7, 2009

Anonymity - A Curse

I want to know who it was. And I never find out.

Some of the big shots we hear about. John Thain, a wonderful target of hate. I think he should be hung. Bernard Madoff, ditto.

But the media shield the individuals who I also want to hear about. We know that the Challenger disaster was due to faulty O-ring materials. Wikipedia: "The material of the failed O-ring was FKM which was specified by the shuttle motor contractor, Morton-Thiokol. FKM is not a good material for cold temperature applications." OK, it was Morton-Thiokol - but that's a company! Who was it who did it? There had to be a few engineers who chose that material, who then did not test it or didn't think what the cold would do to it, etc. We're talking personal responsibility here! Who done it? You'll never know who it was in the bowels of the company who did it - and who didn't do what they could have.

What about the Hubble Telescope reflector disaster? We know it was the Perkin-Elmer corporation that screwed up, and that NASA could easily have caught it. Wikipedia: When the Board measured the RNC, the lens was incorrectly spaced from the mirrors. Calculations of the effect of such displacement on the primary mirror show that the measured amount, 1.3 mm, accounts in detail for the amount and character of the observed image blurring. No verification of the reflective null corrector's dimensions was carried out by Perkin-Elmer after the original assembly. There were, however, clear indications of the problem from auxiliary optical tests made at the time, the results of which have been studied by the Board. A special optical unit called an inverse null corrector, designed to mimic the reflection from a perfect primary mirror, was built and used tpalign the apparatus; when so used, it clearly showed the error in the reflective null corrector. A second null corrector, made only with lenses, was used to measure the vertex radius of the fished primary mirror. It, too, clearly showed the error in the primary mirror. Both indicators of error were discounted at the time as being themselves flawed.

I want to know - who were these miscreants? Who were the John Thain's at Perkin-Elmer and at NASA? In Japan I imagine there would be public apologies and humblings, and as a consequence they quality of their automobiles would be awesome. But here - no personal identification, and we have the specter of bankruptcies as the wages of sins past. I want to know.

What about AIG? Who were the people in the London office who personally devised the credit default swaps strategy and placed the bets? I want to know who did it! It isn't just AIG - who did it? I don't go for that "it's bureaucracy" stuff. Somebody does it personally. I want to know who to hate. Maybe in this case we will find out. It's really so huge, the economic journalists surely see a bonanza in a Barbarians at the Gate type story and an interview on Jon Stewart.

We sometimes hear about heroes. Like thalidomide, as in Wikipedia again: "The impact in the United States was minimized when Frances Oldham Kelsey refused FDA-approval for an application." Now, she was someone in the bowels of the bureaucracy who became a hero, deservedly. But if she had been the person on the other side of the problem, if she could have saved the day for hundreds of patients but didn't, we would never have heard of her. It would have been "the FDA bureacracy" that failed.

I think we need more individual responsibility recognized publicly. It's not "bureaucracies" that act, it's people within those bureaucracies. Sure, there are strong organizational factors, but there is personal responsibility. People acting on their own we hear about; people in companies are shielded.

I had thought for a while that I'd like to do a weekly column, hopefully published in the Maui News, but that's such a mainstream publication I'd really probably have to put it into the local free newspaper, entitled Who I Hate. Or, as somebody said, How to Make 52 Enemies a Year. But because companies shield miscreants, it's probably a project that will never be. Also it won't ever be because I'm too lazy.

Feel free to place into nomination your own "I wish I knew who did it so I could hate him or her personally."

Budd Shenkin