28 October 2009

Quote of the Day: Steve Forbes

Steve Forbes"People say, 'Well, when you make it, you should give back.' ... But 'give back' sounds like you took something that didn't belong to you."
   -- Steve Forbes

23 October 2009

A Brief History of the Crash of 2008

There are a number of contributing factors to our present financial crisis but the biggest issue (and the catalyst that set it off) is the collapse of the financial derivatives market. My friend, Paul B. Allen, has started Crashopedia.com to document the causes of the crash in detail but it can get pretty thick. Here’s my simplified summary of what happened:
1970GNMA "Ginny Mae" issues the first Mortgage Backed Security (MBS). A MBS is a way of collecting money to lend out in the form of mortgages. Bonds in the MBS are sold and the resulting cash is invested into a pool of mortgages. FNMA "Fannie Mae" and FHLMC "Freddie Mac" follow suit.
1977Under pressure from the Community Reinvestment Act banks and other mortgage vendors begin issuing high-risk (also known as sub-prime) mortgages with correspondingly higher interest rates.
Early 1980sIncentivized by the government and attracted by the high interest rates of these mortgages, bankers begin seeking a way to attract capital to invest in high-risk mortgages. Unfortunately, the market for high-risk investments is relatively small and interest rates are high.
1983Bankers invent the Collateralized Mortgage Obligation (CMO) which is a type of MBS in which shares are divided into risk "tranches." The idea is that if a lot of high-risk mortgages are pooled together the risk is reduced because only a fraction are likely to default. Risk can be further reduced for some investors by dividing the bond pool – decreasing the risk for premium tranches and increasing it in lower tranches. Bond rating organizations like Standard & Poors agree with this theory and offer high ratings.
1987Realizing that splitting risk into packages can work for more than just mortgages, bankers invent the Collateralized Debt Obligation (CDO) which is just like a CMO except that it may be backed by corporate bonds, commercial paper or other kinds of loans.
Early 1990sIn pursuit of ever higher interest rates (from higher-risk mortgages) but having trouble placing the higher-risk tranches of CMOs and CDOs, bankers find ways of enhancing the ratings of these tranches by using Credit Default Swaps. This is just a fancy name for an insurance policy. The bankers pay an insurance premium and the insurer pays up if the underlying asset (mortgage or bond) fails to make payments. Bankers can afford the insurance premiums because they collect more interest from the high-risk loan than they have to pay to the low-risk bond. AIG becomes one of the leading insurers of these obligations.
1990s and 2000sBankers come up with all kinds of new derivative instruments such as CDOs that invest in other CDOs (CDO squared), Single-Tranche CDOs in which insurance is used to raise the rating of the entire package, Strips, REMICs, PACs, Floaters and more. The tantalizing returns of these investments cause people to ignore Warren Buffet’s advice to invest only in things you understand.
2001Driven largely by growth in financial derivatives, the Financial sector surpasses Information Technology to become the largest sector in the S&P 500 as measured by market capitalization.
2002-2005Continuation of the longest sustained growth period in U.S. history masks the real problem with derivative instruments. That problem is that an overall decline in the housing sector or in the economy as a whole would cause simultaneous defaults – something that diversity and insurance don’t account for. Unencumbered by hidden risks, derivatives continue to offer stable income to investors and while enriching the investment banks that handle them.
2006The housing bubble bursts. Due to the ease of obtaining mortgages and the recent history of good real estate performance, a great deal of speculative building occurred in the early 2000s. By 2006 there was a surplus of homes in key markets like the West Coast, the Southwest, the Northeast Corridor and Florida. A mild recession at the time coincided with interest rate increases on Adjustable Rate Mortgages. The result was a wave of mortgage defaults.
2007The mortgage crisis cascades into the whole economy. Rumors grow that we may be in for a recession. Mortgages become increasingly difficult to get as investors pull out of the mortgage market.
2008Derivatives turn out to much riskier than their ratings indicated. AIG becomes insolvent as large numbers of CDOs default and they are required to pay up. Only a bailout by the Federal Reserve prevents it from going under. Credit markets freeze because bankers can no longer reliably determine the value of derivates which now account for an enormous part of the financial market. A new tern, Toxic Asset, is used to describe these because not only can they not be valued but neither can any institution that owns a substantial portfolio of them. Hundreds of banks with large portfolios of toxic assets fail and are taken over by the FDIC. The First Bailout Act including the Troubled Asset Relief Program is passed allowing the Treasury and the buy up toxic assets in an effort to relieve the credit markets.
2009As of this writing, the bailouts have had little success except to protect the profits made by irresponsible financiers. Credit markets are still extremely tight, the country is in a full recession, and unemployment is approaching 10% with certain markets well into double digits. Despite this, Congress and the White House have focused efforts on Healthcare Reform rather than considering regulations that might prevent irresponsible use of financial derivatives in the future.
Missing from this history are all of the forewarnings. For example, the General Accounting Office warned in 1994 that regulation of the market was warranted. Congress held hearings on the subject multiple times in the 1990s and 2000s and Warren Buffet famously wrote in 2002 that derivatives are "time bombs." There were many opportunities to prevent the train wreck before it happened. Unfortunately, the financial lobby was strong enough to prevent any meaningful reform.

I have some thoughts on how reform can be achieved without government intervention but those will have to wait for a future blog post. Meanwhile, this is yet another example of how government seems to be immune to forewarning. Action, if taken at all, occurs after the crash.

19 October 2009

Business Concept - A Virtual Secure Network


This is the first in a series. Over the years I have come up with dozens of new business ideas. Some fraction of those dozens are viable and quite a number of them have appeared – though I haven’t been involved in most cases. This has taught me several things. My biggest lesson is that if I have a good idea, most likely someone else has that same idea and if I don’t pursue it, someone else is likely to do so.

Despite this long-known lesson my typical approach to a good idea has been to speak little of each idea in hopes that I may someday have a chance to make money from it. This, of course, hasn’t happened except in a few cases. I’m ready to challenge that strategy. Henceforth I’m taking an Abundance approach to new ideas. So long as it doesn’t compromise my obligations to my current employers, I intend to share my best ideas and simply see what grows.

Of course, if you get serious about pursuing one of these ideas we would both benefit if you were to contact me. I’ve given a lot more thought to these ideas than I can fit in a simple blog post.

A Virtual Secure Network

Most people are familiar with Virtual Private Networking (VPN). In a nutshell, a VPN allows you to connect your computer over the Internet to a private network. Usually this is used by businesspeople to connect to their office network and access private resources. It’s also used to interconnect networks between branch offices without the cost of dedicated private lines. Data that passes over the internet is encrypted to prevent eavesdropping. It may be argued that VPN is a misnomer since what you really have is a virtual connection over the internet to an actual network back at the home office.

I propose a true Virtual Private Network that would allow my laptop, my home desktop and my wife’s computer to all communicate regardless of where they are located on the internet. This would enable secure file sharing, Remote Desktop, Remote Assistance and a host of other things to work conveniently without worrying about firewall traversal, routing and other things. It would also use encryption to protect such communications from external scrutiny. To distinguish this from existing Virtual Private Networks and to emphasize the built-in security features I call I call it a Virtual Secure Network or VSN.

The biggest problem with any virtual networking protocol (VPN or VSN) is getting through the firewall. Most firewalls and routers will allow connections to originate inside the firewall but not from the outside. For example, my desktop PC at home can connect to Google.com but Google can’t contact my desktop because the connection is blocked by my home firewall/router. Specialized protocols such as UPnP NAT Traversal and Teredo have been introduced to fix this problem but adoption is limited.

A couple of years ago a colleague pointed me at this paper: Peer-to-peer Communication Across Network Address Translators by Bryan Ford, Pyda Srisuresh and Dan Kegel. It introduces a method of Hole Punching that opens TCP and UDP communication through a majority of firewalls including NAT firewalls. The system requires a publicly available server to coordinate the connection between two computers but once that connection is made, the individual computers are able to connect directly so the bandwidth demands on the public server are modest. This is the primary method that Skype and as those who have used Skype know, it simply works without any special network configuration.The Internet Engineering Task Force has worked on standardizing the similar methods to those proposed by Ford et. al. The original draft proposal is in RFC 3489 and an update is in RFC 5389.

I propose creating a virtual network adapter driver similar to those used for VPN connections. The virtual adaptor would use the real network adapter in a computer to connect with a public server on the internet and register the computer’s availability and the IP address of its firewall. Other computers in the same VSN could connect to that public server to discover the necessary information to broker a direct, encrypted connection.

From the user’s perspective, it would appear as if all trusted computers in his/her VSN are immediately available and things like Remote Desktop, Remote Assistance, File Sharing, Printer Sharing and the like would "just work" like Skype.

From a business model perspective it’s convenient that a public server is required to set up the connections but the server isn’t involved in the actual transmission of the data. This means that a company could set up the public server and charge a modest subscription fee without the bandwidth cost of actually relaying the traffic. Even if IPv6 and Teredo become popular, the VSN would retain security advantages that preserve the business model.

14 October 2009

Failure Subsidizes Success

Some successes would never occur if it weren't for prior failures.

My father was head of the Mechanical Engineering department at Utah State University when he and others started the annual Small Satellite Conference there. At one of the first instances of the annual event a group of engineers presented a revolutionary idea. A set of small relatively low orbit satellites could form a world-wide cellular phone and data network! Moving the satellites into low orbit would allow the use of simple antennas and satellites would hand off connections as they move past a customer the same way that cellular phone towers hand off as a mobile customer moves around the city.


The initial design was christened Iridium because it utilized 77 satellites -- the same number of satellites as the iridium atom has electrons. As the concept evolved, the number of satellites changed but the name stuck. Iridium is a mesh network; messages are collected at the nearest satellite to the customer then handed off from satellite to satellite until being relayed to a ground station. For such a mesh network to work reliably the entire constellation of satellites plus a couple of spares had to be in place.

The capital cost of launching a satellite network was enormous – estimated at more than $6 Billion. The first phone call was placed on 1 November 1998. Only nine months later they had to file for Chapter 11 bankruptcy protection; the expected business subscribers hadn't materialized. A Wikipedia article offers a number reasons for the failure including better ground-based cellular networks, inter-carrier roaming agreements, unappealing handsets, a bad pricing model and mismanagement.

I think the biggest problem was that real potential return wasn't enough to justify the original investment. If the eventual customer base had been accurately projected, the system would have never left the ground. (Puns are easy in this subject.) The Iridium system shut down service and was considering de-orbiting the satellites and ceasing all operations before the assets were purchased by a coalition of private investors in 2001. The purchase price? About $25 million.

Of course, the new investors had to plow a lot more money into the company to restart operations, run sales and marketing and so forth. Those numbers aren't available as Iridium is privately held but a good guess is a total investment of around $150 million. For the year 2008, ten years after operations started and seven years after the buyout, Iridium LLC reported $320.9 million in revenue with operational earnings (EBITDA) of $108.2 million. This means that the 2008 return-on-investment was around 72% for the buy-out investors. However, if the original investors had hung on instead of writing off most of their investment in 2001, the annualized return at the end of 2008 would only have been 1.8% – certainly not enough to justify a high-risk investment like this.

So, today we have a fantastic asset that supports military communications, offers live television reports from remote locations, keeps our Antarctic scientists in contact with home, provides continuous phone service to aircraft and ships worldwide, offers telemetry from automated outposts and a host of other services. The system is operationally profitable and earning enough money to be maintained and improved. The system exists because the business plan that convinced the original investors was fantastically wrong. Those investors took a loss but society benefitted.

The only other way I can think of for such a system to emerge would be for government to step in and offer a huge subsidy. What's better, subsidy from business failure or subsidy from government? I think we need both which is why I believe capitalist societies must preserve the freedom to fail.

09 October 2009

The Future of Promotion

Though my professional email address at Agilix isn't published it's not too difficult to deduce. Based on the quantity of spam I get, a lot of people have deduced it.

Since my title is CTO, I get a lot of email promoting outsourcing or placement services. This is really surprising to me given that people with my title are very spam-averse and sending the CTO unsolicited commercial email (spam) is a good way to get you on the company-wide blacklist. The success rate of regular spam is extremely low. It's got to be even lower when spamming an email list of CTOs (unless there are a lot of unqualified people out there that share my title).

Despite the low rate of success on emailed solitations the method remains popular due to its extremely low cost. Thus, for some products (Viagra and Mortgages to name a couple) it remains cost-effective though illegal. But there's a broader issue involved. Our society is becoming increasingly advertising-averse. Among the reasons for TiVo popularity is its ability to skip commercials. So, if people are throwing away junk mail, filtering and deleting spam and skipping commercials, how will future vendors make contact with customers?

A related question is, "How will TV and radio programming remain profitable?" I'll save that one for a future post.

We can find a microcosm of this problem in my experience with outsourcing providers. With the advent of the recession, they've become increasingly aggressive (probably out of desperation). At present I average between fifteen and twenty individually addressed placement or outsourcing solicitations a week. I would get more if I wasn't so aggressive about shutting them down. There a few variations, some offer offshoring services to India, China or Russia. Others offer contract programmers based in the U.S. and others are executive placement firms. The last type are the most entertaining. There are several utah-based placement agents that have been calling and emailing me for the better part of a decade. They treat me with familiarity since they've been doing this so long despite the fact that I have never responded to an email or a phone call.

About a year ago I decided it might be rude of me to ignore some of the more personal messages (or blacklist their addresses). Pasting a canned reply only takes slightly more time than deleting the message. Here's my original version:

Dear Outsourcing, Consulting or Placement Provider:

Your inquiry is one of dozens we get every week. Unfortunately the inquiry rate has increased dramatically with the recession. We are presently fully staffed with very capable engineers. We also have one outsourcing partner that offers excellent service. As a result, we have no need for additional services at this time. If, at some future date the need for outsourced services does arise, our first choice will not be someone who sent unsolicited email to a purchased contact list or interrupted my day with an unsolicited phone call.

Brandt C. Redd
Agilix Labs, Inc.

I got some replies to my reply. Some took offense at my attitude. I suppose that they think their messages are in some way above the rabble of conventional spam. I don't see the difference. Whether you're promoting Viagra or offshoring the message was unsolicited, useless and it clutters my mailbox. However, I decided to lighten the message. The new one is more polite but also less informative:

Dear Outsourcing, Consulting or Placement Provider:

Your inquiry is one of dozens I get every week. Unfortunately I don't have time to offer individual replies or to discover what distinguishes your organization from all of the others. Suffice it to say that we are content with our current service providers and are not shopping for new ones.

Brandt C. Redd
Agilix Labs, Inc.

One soliciter called me (I didn't answer) and followed up with an email. After receiving my canned reply he complained: How did I expect him to do his job? If I thought it was bad receiving these messages, did I have any idea how difficult cold calling was? Didn't my company generate sales the same way?

I have no doubt that cold calling is difficult. But the difficulty is due mostly to its ineffectiveness. When cold-calling someone you have no idea whether they are shopping for your product. And, in cases like mine an unsolicited interruption is unlikely to buy you favors. Of course, there are much better options. The key is knowing where CTOs shop for services and being in those places.

I was in a charitable mood that day and so I took the time to respond:

I usually don't offer a personal response to blind inquiries. For some strange reason I feel like making an exception this time.

Our sales people follow up on leads generated by the marketing department. The marketing group uses advertising, conference attendance, viral marketing programs, business partnerships, and word of mouth. I think some of our resellers use cold calls but they aren’t very effective.

The point is that I'm not shopping right now so it doesn't matter how you contact me, I won't be interested. Your challenge is to find those who _are_ shopping. Then figure out how to appear in the areas where they shop.

Google Adwords is a good start for CTOs like me. That's usually my first stop when shopping for goods and services. My second stop is to ask colleagues in my industry who they work with. So, the next best thing is to cultivate a word of mouth network.

You need to be very careful when cold-emailing tech people. The usual response is that you get quietly added to their blacklist and there's a lot of blacklist sharing in this industry. We have a strong bias against the mailing list vendors and as a result we actively strive to make that marketing method as unrewarding as possible.


In my opinion, that's the future of product promotion. Find out where people shop and then be in those places. Tech people shop on Cnet and we share experiences on various forums. For other products or audiences, the shopping areas may be different but the principle is the same. Find out where people shop and be there.