30 April 2010

Provo: Awesome or Boring?

The April 24 edition of Forbes listed my city of Provo, UT as the second best city in the United States for Business and Careers (following Des Moines, IA). Meanwhile, Portfolio.com rated Provo the least fun among the 100 largest cities in the U.S.

If you believe the rankings, "good for business and careers" and "fun" seem to be contrary pressures. For example, New York City ranks #1 on the Portfolio "fun" list and #99 on the Forbes "business" list. Nearly an exact reversal of Provo's ranking (#2 for business and #100 for fun). However, I think that the Portfolio ranking is badly flawed. Their categories for ranking are Shopping, Gambling, Popular Entertainment, Culture, Food and Drink, Low-Impact Sports and High-Impact Sports.

There's little question that Provo's not a very good gambling destination (#92 on their list) and I also have a hard time disputing New York's #1 rank for shopping and culture. But how do they get away with ranking Provo as #98 for high-impact sports (represented by an icon of a skier) vs. New York's #2 ranking? I can be on the slopes at Sundance 20 minutes from leaving my front door. And best-in-the-world resorts like Alta, Snowbird, Brighton, Solitude, Deer Valley and Park City are all within an hour's drive. Where do New Yorkers go to ski, much less hike, mountain bike, camp, drive off-road, fish and so forth?

Oh well, I like New York too. And despite it's #99 business ranking I think a brokerage would be better off locating in New York than in Provo. There's a lot more subjective influence than these rankings would suggest.

26 April 2010

Toxic Assets Revisited

I just attended a fascinating lecture by Dr. Hal Heaton who was my MBA Business Finance teacher 16 years ago. He outlined what he called the "Perfect Storm" of events that lead to our current financial crisis. Much of what he had to say is summarized in this business case though his live presentation included some nice graphs illustrating many of the financial trends.

Following the lecture I asked him about my theory that the markets could self-correct the problem of toxic assets (outlined in my previous blog post on this subject). It turns out that he has been serving as an expert witness in several lawsuits related to the meltdown and has direct experience in this area. He assured me that, indeed, the derivatives market has mostly shut down and that the remaining derivative instruments are treated as the risky instruments they really are.

According to Dr. Heaton, one lingering problem is that the Community Reinvestment Act that I talked about in my history of the banking crisis remains in place along with enhancements that were passed in 1999 and 2005. Presently the provisions aren't being enforced but if they are, banks will be required to continue to issue the kind of high-risk loans that helped create this problem in the first place.

From his primary lecture I learned that Dr. Heaton views the sub-prime lending and the associated financial derivatives as only two components in a six-part "perfect storm." Here's the full list.

  • High-risk mortgages spurred on by the Community Reinvestment Act and it's more recent kickers. (The requirements remain in place though they aren't currently being enforced).
  • Enormous increase in the money supply with interest rates reduced to nearly zero. (Rates are still there.)
  • Hybrid mortgages that had a two-year low introductory rate. Homeowners expected to be able to refinance after two years because "home prices always go up as they had done almost continuously for the 40 years preceding 2008. (Many of these have already been foreclosed upon but there remain several waves of ARMs yet to create problems.)
  • Asset Securitization -- the financial derivatives used to finance high-risk mortgages and an enormous variety of other investments. (Mostly out of favor.)
  • The transfer of manufacturing to China and other emerging markets. This results in an enormous trade deficit. Under normal circumstances, such a deficit would strengthen the yuan and weaken the dollar thereby bringing things into balance. But the Chinese government, not wanting to slow the growth, purchases dollars from manufacturers in exchange for Yuan and then invests those dollars in US Treasuries. (The recession has reduced the trade deficit by half but it remains tremendously high by historic standards.)
  • The complicity of Moody's and Standard and Poor's in giving excessively high ratings to mortgage-derived securities based on the incorrect assumption that housing prices would not decline. (This has been corrected.)
Possibly even more concerning is Dr. Heaton's Assertion that many of the "rules of economics" he taught me those years ago have been violated in ways he would never have foreseen. Examples: The money supply has been tripled but interest rates and inflation remain extremely low. We've been able to sustain an enormous trade deficit without currency corrections. The Fed has been purchasing treasuries and yet the sky hasn't fallen.

We are in unprecedented territory. What happens next is anybody's guess.

21 April 2010

Quote of the Day: Plastic

"Humanity's plastic footprint is probably more dangerous than its carbon footprint." -- Charles Moore, Ocean Researcher

20 April 2010

Toxic Assets

With health care seemingly out of the way, congress is turning its attention to finance reform. Last fall I posted my summary of the crash of 2008. I think there's little doubt that reforms need to be made in the financial markets. However, I've been wondering if those reforms need to be brought about through legislation or if there might be another way.

Most of the blame for the financial crisis has been leveled at investment banks and other institutions that hid risky investments behind complicated financial instruments. However, Credit Rating Agencies like Moody's and Standard and Poor's were complicit in creating the problem because, like the banks, they ignored the possibility of market-wide problems.

So, just as the cooperation of Credit Rating Agencies helped create the problem, CRA's could likewise drive much of the reform. Unfortunately, there continue to be allegations of inflated ratings and the agencies have avoided liability for past mistakes. Despite this I have hope that reform can come from this sector without legislative pressure.

The term "Toxic Asset" was invented in 2008 to describe the financial derivatives for which a value cannot be determined with confidence. The presence of large quantities of toxic assets on corporate and bank balance sheets froze the financial markets. There's are markets for high and low-risk securities. But when a risk or value cannot be determined with confidence, that's when markets freeze up. "Toxic Asset" is very descriptive term for such things.

What I would like to see is an agency that would report on the portion of a security -- stock, bond, or derivative -- that is composed of questionable derivatives. To do so with accuracy would require cascading fractions through the network of ownership. For example, if 15% of a bank's balance sheet is composed of toxic assets and 20% of a mutual fund is invested in that bank then the mutual fund would be rated 3% toxic (15% * 20% = 3%). Of course, some portion of other stocks in the mutual fund might also be considered toxic so the total toxicity of the mutual fund might be higher.

Creating a database that tracks the network of ownership would be complicated but not impossible. The information required is all in the public record. There would have to be a objective way of determining whether a fundamental asset is toxic. However, once the system is in place, it could also be used to rate cascading ownership in many other types of assets. Fractional ownership in business sectors such as manufacturing, education or hospitality could be measured through the cascading layers. Involvement in totalitarian regimes, conflict assets or vice business could also be tracked.

I suppose this is another of my Business Concepts. It would take a considerable up-front investment and a continuing investment to maintain the database but the ability to analyze cascading ownership would be a potent investment tool.

16 April 2010

Scotty, We Need More Power!

Energy production and standard of living are directly connected. My neighbor, Dr. L. Douglas Smoot has a presentation (as yet unpublished) that he's made to various audiences in the last year. His thesis is that in order to raise the standard of living for impoverished nations we have to raise the corresponding energy production. That's because energy is required for the production of food, for manufacture of goods, for the treatment of illness, for the management of indoor temperature and for the transportation of everything.

The graph above, extracted from this excellent Department of Energy study shows the correlation between the Human Development Index (a measure of standard of living) and per-capita energy use. It's arguable that the energy consumption of U.S. citizens could be reduced while still maintaining a comfortable lifestyle. Nevertheless, per-capita energy production of developing countries would have to be increased to somewhere around U.K. levels if poverty and disease are to be reduced to levels seen in industrialized countries

The DOE study indicates the threshold is about 4,000 kWh per person which is somewhere between Spain and South Korea on the the graph. Of course, electricity is only a fraction of total energy use. The same DOE study indicates a ratio of total energy to electricity use of 7.5 should be used for standard-of-living calculations. Therefore we need approximately 30,000 kWh or 108 gigajoules per-person.

There is a lot to be gained through improving energy efficiency. Insulation, hybrid cars, smaller vehicles, public transit, high-density housing and so forth are all important pieces of the solution. However, the initial figures I have used here are less than half of U.S. energy consumption. So, efficiency gains are more likely to reign in high-consumption populations like U.S., Canada and Japan then they are to reduce the needs of developing countries. Besides, it costs energy to manufacture all of these efficiency improvements.

The current world population is estimated at 6.8 Billion. So, in order to eliminate poverty, increase freedom and improve the human condition we need approximately 734 exajoules (734 * 10^18 J) of net energy production per year in addition to massive improvements in energy efficiency. In 2008, worldwide net energy production was 474 exajoules. Given that population continues to grow, we should be seeking to more than double worldwide energy production while still seeking to improve energy efficiency.

If energy production is increased at the cost of environmental damage, we'll miss the goal. Clean air, clear water and wild spaces are just as important to quality of life as good health, nutritious food and a comfortable home. In future posts I'll look into where that energy might come from.

Other posts in this series:
Increasing Energy Production
Energy: The Future is Nuclear

14 April 2010

OfThat is Back!

After being down for about 45 days (and a posting hiatus before then) "Of That" is back -- this time hosted by Google's Blogger.

What Happened to Azure?

I originally started hosting on Microsoft's Azure. During the technology preview stage, hosting was free. I was also evaluating it as a platform for future products and based on the early information I could find, it appeared that the cost to host on Azure following it's full release would be modest. However, once the product released I found that the cost was going to be prohibitive.

I'll write more about Azure in a future post. For now, it's sufficient to say that it should grow to be a good platform for enterprise apps and possibly hosted services but it's not appropriate for small-scale things like my blog. There are things they could do to fix that weakness but I don't know if it's a priority for Microsoft.

What About BlogEngine?

I chose BlogEngine because it's a solid solution written in C# on ASP.Net -- a platform I'm familiar with. I wanted the ability to customize more than just the appearance of the blog and I have plans to launch active widgets as tools and experiments. However, it took me hours of programming to adapt BlogEngine to Azure and there was a lot more that I wanted to do. This all took away from any time spent on the widgets and experiments themselves. My new strategy is to let Google/Blogger worry about the blogging side. I'm confident that their available customizations and APIs will be sufficient to let me integrate my stuff.

Why Blogger?

Why did I choose blogger instead of WordPress or TypePad or <insert your favorite here>? First, because hosting is free even when using a custom domain name. Second, because Google allows monetization by placing ads on my site if I ever choose to do so (not yet). Third, because it's simple and straightforward. Sure, it doesn't have all of the features that some other platforms carry but it has all of the features that I need. By avoiding unnecessary bells and whistles I gain ease of use.

Shortly I'll write about my experience in transferring my existing posts from BlogEngine to here.