The Lessons of History & The Financial Crisis

I’ve been re-reading Ron Chernow’s excellent book – Titan: The Life of John D. Rockefeller, Sr.


This is a wonderful book in every respect – but during this time of Financial Crisis it is also very illuminating to see the parallels between the period of 1870 – 1900 and the last 30 years or so.

The Industrial Revolution transformed the US from a largely rural agrarian society to an urban industrial society. In the process it forced us to adapt our culture, politics and laws to cope with this transformation. What most people have forgotten is that prior to the industrial revolution the US operated an almost entirely free market economy. Regulation was unknown, and regarded as an evil force. Sound familiar?

The result of this lack of regulation led to a series of economic disasters – boom/bust cycles, political corruption and mega-companies referred to as trusts (who often, but not always practiced monopolistic practices).

The industrial barons of this time were not evil men – as a matter of fact many of their greatest legacies are their charitable works, Carnegie, Rockefeller, Vanderbilt, and Stanford set new standards for charitable works – as are Gates and Buffet today.

They simply sought out the most efficient means to make money given the environment they operated in.

Those who today advocate for extremely limited regulation (or no regulation at all); or for the lack of intervention by governments in business should read Chernow’s book. Contained within it’s pages you will find the world for which you advocate.

Please don’t misunderstand me – excessive regulation is as problematic as none. What is important to understand is that the market is not perfect – it is a contrivance of human beings, just as is government. Neither is perfect, neither can solve all our problems. The solution is in the balance we create between those forces and regulation is necessary to create that balance.

I give credit to Shel Isreal for prompting me to write this post with the following tweet:

I’m starting to tire of warning that US is killing free market & going socialist. No oversight or governance is as much anarchy as FM.

It seems to me we have forgotten the lessons of our past and are busily repeating them. Those lessons do not come from the great depression – but from the Industrial Revolution. It is not our reaction to the crisis – but our decisions which led to this (and more properly stated – this series of) crisis.

It is time we began working together to re-define the balance needed between a free, agile and prosperous market and the society (government) within which it operates.

A few thoughts on “Mortgage Rescue Plans”

Slightly off topic for me… but what the heck.

In May of this year I left my lucrative position at Intuit (hey – that is the first time I’ve ever mentioned where I worked) to start my own company. At the time it seemed I had all my ducks in a row.

My wife is also a capable executive and we had made very conservative and pragmatic decisions to prepare for my entrepreneurial adventure.

  • We purchased a home in Chandler, AZ for about 40% of what we could have afforded on both salaries – and we only bought because we had moved from Tucson.
  • We eliminated all other debt. No car payments, nothing.
  • We front loaded our 401k(s) and our children’s 529 accounts.
  • We built a sizable cash savings.

In short we did everything right… Until:

We knew housing was bursting. So we didn’t over buy. What we didn’t anticipate was everything going bust. The capital markets have frozen – so my business plan to raise capital by March 2009 is more or less out the window. We didn’t anticipate unemployment spiking – so getting a job in Arizona is more or less out the window.

It isn’t that we are going to be out on the street next month – the savings, 401k and 529s are still there (but worth 45% less now than they were in May). And I’m not asking anyone to feel sorry for us… not at all. I just want to point out that all the mortgage rescue plans leave people like us out in the rain.

Why? Because we are not insolvent. We have the resources and history that makes us the kind of people you want to keep in a mortgage. Instead – if things go badly – we (and thousands of people just like us) will be faced with two choices:

  1. Drain our savings, retirement and children’s education funds to make payments on a house on which we are 100k upside down.
  2. Mail the keys in to the bank.

Simply put – burn up your nest egg (if you were smart enough to create one) OR destroy your credit.

If, however, you are insolvent you can get all kinds of deals to keep you in your mortgage. You’ll still have limited income, no savings, and any negative event will again cause you to be behind on your mortgage.

In short – make them another NINJA loan so they can keep the house they cannot now and could not then afford.

I know some/many/all of the people with ARMs and Interest Only loans were convinced to do something they didn’t really understand. And I’m not saying they are bad people. I’m simply suggesting that “rescues” of these homeowners is the equivalent of a payday loan. It may get you through the month… but it won’t change the fundamentals that caused the problem in the first place.

The banks need to get realistic – and so do our congressional leaders. It is time to start fixing the mortgages for those who did the right thing but now find themselves in different circumstances. It is time to make rate adjustments and principal write-downs terms of the bailouts to financial institutions – not just for those who are already insolvent – but also for those who purchased at peak and who’s financial situation has substantively changed. We should demand that if we (the taxpayers) are handing them billions they should take the write-downs NOW – and pass the lowered values along to homeowners.

Anything less is simply a two pronged tax on the middle class:

  1. Pay taxes to bail out the banks
  2. Pay the bank all of your nest egg in mortgage payments.

I don’t know about the rest of you – but I’m not signing up for that.

Value = Signal, Cool = Noise

Great post today from John Furrier on

He points out – rightly – that:

I fully agree that it is the best time to start a company both for entrepreneur and the venture capitalist. In fact the angels are out there. I ran into one yesterday (granted I live in Palo Alto and you can swing a dead cat without hitting an angel or VC). There is big interest in seed, super seed, and full blown Series A deals.

In these downturn times the opportunities just fall out of the trees. In a downturn the noise level is reduced and it’s all signal. Thanks to the memo from Sequoia which was a strong signal from the Silicon Valley elite money machine on which behavior will be tolerated (translation they want less Seesmics and more real companies). The other them is that innovation is coming out strong. The real opportunities are presenting themselves. The real web 2.0 will emerge from this downturn.

Or – in the language I would use:

If you are building a startup that delivers real value to your prospective customers – real value they will pay for – now is a great time to get started. If you have a cool idea that lots of people will sign up for, but you are not sure anyone would pay for – keep your day job.

The idea that you can do something cool and aggregate subscribers and only then “monetize” the subscriber base is dead (and hopefully gone for good).

Pandora joins the 15% club (layoffs)

Pandora announced today that they have laid off 14% of staff in reaction to the state of the economy.

Via TechCrunch:

Music-streaming service Pandora joins the growing list of startups laying off employees to survive in a worsening economy. The company let go 20 people yesterday, or 14 percent of its staff. Founder Tim Westergren broke the news in a blog post:

This is a very sad day for Pandora, and for me personally. Today we reduced our staff from 140 to 120 employees. Like virtually every company, Pandora is not immune to the challenges presented by the current economic turmoil. We are trying to react quickly and responsibly to the new environment.

[From More Layoffs: Pandora Cuts 14 Percent of Its Staff]

Paul Graham’s Advice to Startups

TechCrunch published a post referencing Paul Graham’s (of Y Combinator) advice on why you should start a company now. He makes some great points. I would argue that Mr. Graham’s advice should apply in any economic environment.

A financial nuclear winter may be upon us, but many startups will still survive and even thrive in this environment. Y Combinator’s Paul Graham argues that, in fact, now may be the best time to launch a startup. In an essay titled “Why to Start a Startup in a Bad Economy,” he notes that “what matters is who you are, not when you do it.”

[From Paul Graham’s Startup Survival Guide For The Coming Nuclear Winter: Be a Cockroach]

One of the downsides to VC funding is that it forces a company to immediately chase exponential growth – ready or not. Often that leads to strange thinking. The metrics become out of touch with reality and revenues (and profit) take a back seat to subscriber growth, or aggregating eyeballs (remember when portals were huge and search was not?).

Listen – VCs are smart. But they want big multiples (if the invest 3MM they way 300MM back – that is their ideal deal). The problem with that is it is really, really rare. You should take Mr. Graham’s advice and focus on managing costs, generating revenues and being sustainable.

Can we please stop talking about monetization?

I can’t take it anymore – I just can’t.

NOTE – this post was triggered by a fine post (and subsequent FriendFeed discussion) by Mark Evans – which you can find here.

The idea that you can create a “cool” service, attract massive numbers of subscribers, and then monetize the subscriber base is insane. Always was, always will be. But it is the Google model. They created a web search service (cool) and then once they became a powerful player in web search they became an ad platform (monetization) – right?

That however, is a myth. The reality is Google was solving a real, important problem. The web was growing really fast. Creating a way for people to find the content they were looking for was a known problem with existing solutions (remember Yahoo and Excite were already out there). The existing solutions were already generating revenue – by placing adds in their content (remember the whole aggregating eyeballs thing?). What Google did was create a better search solution (product innovation) and refine the exiting business model from ad placement (putting ads on your blog) to becoming an ad platform (business model innovation).

So the reality of Google is that they solved an important problem via product innovation and solved an important problem via business model innovation – by creating an advertising platform which could be leveraged by any advertiser.

But the myth is so much more fun – couple of guys create a really cool way to index the web for relevance and everyone wants to use it. Now they can figure out how to make money. We all took the bait. The Bubble 2.0 story became “create a cool service, generate buzzz, aggregate tons of users, and then generate revenue”.

Here is the bad news – that is the same myth that created Bubble 1.0 – remember? Bubble 1.0 said – “Don’t worry about revenues – just grow really, really fast – once you have lots of growth revenue and profits will come.”

As Britney Spears would say “oooops, I did it again“.

What is real is that the winners solve important problems that have enough value that people will pay for them. Finding a business online (Google) – huge problem, great solution = $$$. Selling stuff I don’t want/need to someone, anywhere who does want/need it for as much as possible (eBay) – huge problem, great solution = $$$.

So let’s make a deal. Let’s stop talking about “cool” services, how fast they are generating page views or subscriber growth or any other measure until they tell us how they are going to make money. Let’s get back to creating services that generate value for the prospective customer – value that they are willing to pay for (again – ad placement is just a way of getting your user to pay for the service).

It isn’t important that the first business model is the “right” business model. What is important is that we are re-focusing all of our frenetic energy on what really matters.


Only 55 VC Funds Raised Money In The Third Quarter (Down 29 Percent).

From TechCrunch. This pretty much speaks for itself. The important note is that all of this happened before the last 3 weeks during which the dow has fallen ~ 3000 points.

This is not about doom and gloom for startups – it is about understanding the environment you are operating in.

The third quarter saw the number of U.S. venture funds raising new cash decline by 29 percent to 55 funds, according to data from the National Venture Capital Association and Thomson Reuters. That compares to 78 new funds a year ago and 76 new funds in the second quarter of 2008. And 45 of that 55 were follow-on funds rather than new funds.

Each of those funds, though, raised a lot more money on average. The total raised for the third quarter was $8.1 billion, down only 6 percent from the third quarter of 2007 (but down 12 percent from the $9.2 billion raised in the previous quarter of this year).

And remember, all of this was before the financial meltdown of the past two weeks that had alarm bells ringing at every VC firm.

The three largest funds in the quarter were Sequoia Capital’s $930 million late-stage fund, Austin Ventures’ $900 million balanced-stage fund, and InterWest Partners’ $650 million early-stage fund. In general, more money is going towards later stage, proven businesses than early stage financings. (More at VentureBeat).

Crunch Network: CrunchBoard because it’s time for you to find a new Job2.0

[From Only 55 VC Funds Raised Money In The Third Quarter (Down 29 Percent).]

The financial crisis – Finaly a levelheaded assessment: Fareed Zakaria GPS – Interview with George Soros

This morning I watched Fareed Zakaria GPS on CNN. He interviewed George Soros who presented the most intelligent and balanced view of the current financial crisis I’ve seen yet. Soros – a free marketeer – points out that free markets are human constructs, just like governments – as such both are imperfect. His stance is the market is more efficient and perhaps better at solving problems – but not perfect – and left to it’s own devices suffers from problems as bad or worse than well designed regulation.

SOROS: Every bubble has two components: something – some real trend, and a misconception about that trend.

Now, the real trend has been credit expansion, ever-increasing use of leverage. And the misconception has been what I call market fundamentalism, the belief that markets correct their own excesses, that you can leave it to the markets, give them free rein.

And, of course, that’s false. The markets don’t tend towards equilibrium. And occasionally, therefore, they create financial crises.

But it really started with President Reagan, who talked about the magic of the marketplace, Margaret Thatcher. You see, when they came to power in 1980, then this belief became the dominant creed. And this, then, led to the globalization of markets, the deregulation of markets and the increased use of leverage and all those financial engineering.

Now, since markets don’t tend towards equilibrium, but are – left to their own devices, go to extremes and create bubbles. And then the bubbles burst.

We have had a number of financial crises since 1980, and quite a few of them. But each time the authorities intervened, and, you know, merged away the failing institution, stimulated the economy if necessary, lowered interest rates, fiscal stimulus, and so on.

And so, the crises, the previous crises actually reinforced the mistaken belief that markets correct their own excesses.

What Soros is telling us is that we’ve swung too far to free market thinking. And I’m with him. It isn’t that I want socialism or government control of the economy – it is that I want balance. Our error was swinging the pendulum too far to one side – and it has to come back.

Will we swing it too far toward government involvement and regulation – probably. But that isn’t what we should be afraid of – we should be afraid that dogma will outweigh outcomes. If that happens we will insist on free markets and vilify regulation because we believe it to be so. That is what will cause the current situation to spiral out of control.

To be clear – I’m a fee marketeer – but the market exists within the bounds of society. And governments are social contracts designed to form well ordered societies. They define the guardrails within which we operate freely. It is time to put the regulatory guardrails back in place.

You can read the transcript of the interview here.