One of the first things I noticed is the way people dress here, in this up-market part of Madrid. Spanish men, especially, stand out compared to their American counterparts. The men here seem to take particular pride in their appearance. The other day I saw a man in what had to be the height of the Madrid "pijo" (preppy) look--cantaloupe-colored cotton slacks with a Kelly-green linen blazer. Now that summer's arrived, sherbet colors abound here--lemon, lime, orange, raspberry, pink has always been popular, for men. Shirts come with loud stripes and checks, and everything is always impeccably ironed. Los Pijos also seem to love labels as much as their American preppy counterparts. As my sister-in-law put it, when Izod and Burberry came back, it wasn't a problem, because, in Spain, they never went out of style.
My father who was an American child of the fifties grew up with (and continues to wear) a vibrant color-themed wardrobe. If you saw "Wedding Crashers" and the outfits that Owen Wilson and Vincent Vaughn borrowed from their hosts (I think some patchwork pants might have been involved)--you get the idea. However, for later generations of American men, it's primary and neutral colors only, scruffy dressing, absolutely no ironing except for the dry-cleaned work button-down. For a man to take any interest in his appearance and grooming immediately labels him as homosexual, although, lately, in the generation younger than mine, this has expanded to the more inclusive "metrosexual."
The children's clothing in Spain is very classic and beautiful. Think Liberty prints with color-coordinated cardigans and stockings, and Mary Janes for girls--cotton dress shirts, pull-overs or cardigans, shorts, knee socks and loafers for boys. People also take pride in dressing their children in coordinating or matching outfits. It's possible to find these sort of tasteful, coordinating clothes in very reasonably priced, mass-market stores. In the US, my complaint is homophobia-wear only for boys--see description of US menswear above--add massive truck or professional sports logo and, once your girl is older than six--and you don't want to dress her like a tart (hello JonBenet Ramsey) good luck. No I don't think little girl's party shoes need to have heels, nor do I think I should have to pay a premium to buy my children tasteful undergarments and sleepwear aka the type that does not come in heinous colors and is not emblazoned with the latest movie or cartoon themes.
For womens' clothing, I can't say much because I "don't got the look," (nor did I in the US). In contrast to the men, I would say that colors are darker or neutral and there are less patterns or large prints involved. Except for the long tops, pants and skirts are more tailored-fitting. They wear a lot more jewelry (costume and real) and accessories than their American counterparts and, if they go out, it's usually with make-up and their hair "done." Absolutely no sportswear anywhere outside the gym. They look at me with disapproval when I walk out the apartment in sweatpants, or jeans and schleppy t-shirt with barely brushed hair and no make-up. So now, I don't do that so much. I smooth my hair, wear dressier clothes, grudgingly put some powder and lipstick on my face--as some sort of armor against the disapproving stares of the neighbors.
The women my age are not so much judgmental as curious. My Spanish women friends ask me, Nathalie, how is it that in the US, with so many stores selling nice (and cheap!) clothing you Americans dress so poorly? I tell them that depends where they go in America, but they probably are right, in general. I say I don't know, I think it's because we have a car-based culture, where people drive everywhere and generally aren't walking in the streets (at least in "real" America :) Yes, we're an overweight nation but we do try to work out. So, if I am driving my car to drop off my kids at school, go through the drive-through at Starbucks, and then go to the grocery store, and trying to get a run in before the day gets too hot, it doesn't matter how I'm dressed, because nobody sees me, or if they do, it's just other mothers like me...
Thursday, May 28, 2009
Madrid Blog-Barbarians at the Gates
I liken the decision to live in some place where you have no cultural, family or professional ties to "dropping off the grid." This sort of move is easier to do if you are the sort of person who felt "a few degrees off the grid" in the place where you grew up. Even if you did fit in wherever it is you grew up or live today, you need not travel far to find someplace you don't.
I remember, the kind of reception I got in the 80's when I traveled with the debate team from my private preppy (we send 20 kids a year to The Ivy League!) Atlanta high school (see The John Knox Institute) to compete against other schools in places like Americus and Warner-Robbins, Georgia. This was a sardonic: "Well, ain't we privileged to have you Atlanta private school kids with us here today."
The beneficial effect of walking outside one's village, for the person capable of acquiring perspective, is the rapid realization that "who" you think you were, back wherever it is you are from, has absolutely zero meaning to the locals "here."
Yesterday, was our court hearing in the affair of the neighbor's noise complaints against our children. As it turns out--in the exactly 12 units in the building, the only people who have had an issue with us are the (now departed) Germans (by way of Argentina) in the unit across from us and the bat-shit crazy people in the unit below us. Rather ironic, considering the former are one generation removed from The Reich and the latter's example of triumphant child-rearing is the single adult daughter who lives with her parents, works for her father, and doesn't look a day younger than forty (to be fair, this could be the perma-mask of bitterness etched on her face).
It was both less than I was expecting from a legal point of view--all that went on was that our lawyer told the judge that we deny the accusations they make against us (like our kids make noise at all hours of the day and night--not exactly possible since they're in school all day and in bed from 9pm to 7am). From an emotional point of view it was worse. Most of you have better things to do than waste time on Facebook, but this pretty much sums it up.
Me: "Nathalie Mason-Fleury experienced the disgust of having the 80-yr old president of our building association tell his lawyer and my lawyer (AS IF I WASN'T THERE 3 meters away) that it is "not normal" for a 2-yr old to wake up at 4 am in the morning and cry."
Cristina: "ask him to come to my house yesterday night... 2-yr and 9 months crying. At 3.32. And the three were hungry and 1 with fever. drinking bottles and eating biscuits."
Karen: My 17 month old made it to 5:30am before the molar coming out of his gums got the best of him yesterday. No, crying there...
Fiona: like he would have any idea. My two year old was hollering at 5:30 am today before I bounded to his room, gave him the pacifier, and he went back to sleep.
Abigail: What alternate reality is he living in? The one where the babies are silent and the old farts make all the whining? And even if it wasn't 'normal' wtf are you supposed to do about it? It's not like you can tell your doctor 'I'd like a peaceful sleeper' and then get pregnant, can you? can you? did I miss something here?
Heather: If his own mother were still alive, she'd straighten him out. "Oh yeah, you used to wake me up at 4 am all the time," etc.
In 8 months, the first time I saw my elderly neighbor was yesterday--I imagine him, mummified in his apartment, remembering a better world, when Franco was still alive and running things, children knew their place and foreigners weren't your neighbor.
I remember, the kind of reception I got in the 80's when I traveled with the debate team from my private preppy (we send 20 kids a year to The Ivy League!) Atlanta high school (see The John Knox Institute) to compete against other schools in places like Americus and Warner-Robbins, Georgia. This was a sardonic: "Well, ain't we privileged to have you Atlanta private school kids with us here today."
The beneficial effect of walking outside one's village, for the person capable of acquiring perspective, is the rapid realization that "who" you think you were, back wherever it is you are from, has absolutely zero meaning to the locals "here."
Yesterday, was our court hearing in the affair of the neighbor's noise complaints against our children. As it turns out--in the exactly 12 units in the building, the only people who have had an issue with us are the (now departed) Germans (by way of Argentina) in the unit across from us and the bat-shit crazy people in the unit below us. Rather ironic, considering the former are one generation removed from The Reich and the latter's example of triumphant child-rearing is the single adult daughter who lives with her parents, works for her father, and doesn't look a day younger than forty (to be fair, this could be the perma-mask of bitterness etched on her face).
It was both less than I was expecting from a legal point of view--all that went on was that our lawyer told the judge that we deny the accusations they make against us (like our kids make noise at all hours of the day and night--not exactly possible since they're in school all day and in bed from 9pm to 7am). From an emotional point of view it was worse. Most of you have better things to do than waste time on Facebook, but this pretty much sums it up.
Me: "Nathalie Mason-Fleury experienced the disgust of having the 80-yr old president of our building association tell his lawyer and my lawyer (AS IF I WASN'T THERE 3 meters away) that it is "not normal" for a 2-yr old to wake up at 4 am in the morning and cry."
Cristina: "ask him to come to my house yesterday night... 2-yr and 9 months crying. At 3.32. And the three were hungry and 1 with fever. drinking bottles and eating biscuits."
Karen: My 17 month old made it to 5:30am before the molar coming out of his gums got the best of him yesterday. No, crying there...
Fiona: like he would have any idea. My two year old was hollering at 5:30 am today before I bounded to his room, gave him the pacifier, and he went back to sleep.
Abigail: What alternate reality is he living in? The one where the babies are silent and the old farts make all the whining? And even if it wasn't 'normal' wtf are you supposed to do about it? It's not like you can tell your doctor 'I'd like a peaceful sleeper' and then get pregnant, can you? can you? did I miss something here?
Heather: If his own mother were still alive, she'd straighten him out. "Oh yeah, you used to wake me up at 4 am all the time," etc.
In 8 months, the first time I saw my elderly neighbor was yesterday--I imagine him, mummified in his apartment, remembering a better world, when Franco was still alive and running things, children knew their place and foreigners weren't your neighbor.
Monday, May 25, 2009
China caught up in a Dollar trap
If you want to get a primer from the chinese primer on imbalances read this. If you need some background on imbalances read the dummies entry here.
It describes a dollar trap. Where China is kinda stuck with its savings and it cannot fuck the dollar up or it will fuck up 70% of its own reserves. So they need to support the dollar bubble. They do so by buying US treasuries. This makes the US Treasuries market one of the most liquid on the planet. Which is a good thing, from a peace on earth standpoint, because everyone is sort of in the same boat.
However the Chinese seem to have found a protectionist way to resolve imbalances. By having state owned monopolies spending their dollars to acquire competitors abroad. Unfair competition I say!
From the FT:
Got it? Can they be clearer in their intentions? Economic war has been going on for years it seems. The paper money that was accumulating were claims on produce and capital. When the produce is not enough to settle claims, e.g. when we consume at 103 and produce at 100 over a sustained period of time, then we got to settle with capital and that means selling bits of corporate america. On the cheap.
Keep in mind that america inc produces 14T per year. If that is growth of 3% which means the mass is at 500T. 2T per year for 5 years (end of crisis?) means 10T means 2% of america, max, has changed hands. Over 5 years. So there it is, why do we care?
It describes a dollar trap. Where China is kinda stuck with its savings and it cannot fuck the dollar up or it will fuck up 70% of its own reserves. So they need to support the dollar bubble. They do so by buying US treasuries. This makes the US Treasuries market one of the most liquid on the planet. Which is a good thing, from a peace on earth standpoint, because everyone is sort of in the same boat.
However the Chinese seem to have found a protectionist way to resolve imbalances. By having state owned monopolies spending their dollars to acquire competitors abroad. Unfair competition I say!
From the FT:
Over the long term, Beijing hopes to reduce the size of its enormous reserves and cut exposure to US Treasury bonds by encouraging state-owned enterprises to use foreign exchange to acquire competitors abroad.
Got it? Can they be clearer in their intentions? Economic war has been going on for years it seems. The paper money that was accumulating were claims on produce and capital. When the produce is not enough to settle claims, e.g. when we consume at 103 and produce at 100 over a sustained period of time, then we got to settle with capital and that means selling bits of corporate america. On the cheap.
Keep in mind that america inc produces 14T per year. If that is growth of 3% which means the mass is at 500T. 2T per year for 5 years (end of crisis?) means 10T means 2% of america, max, has changed hands. Over 5 years. So there it is, why do we care?
Sunday, May 24, 2009
Matt Asay on OpenRemote, building communities.
Matt Asay recently gave us some coverage on OpenRemote. We are approaching with a Developer Release of OR 1.0 and Matt wanted to be briefed on what this industry (automation) was about.
Matt concludes:
Matt wanted to know about the history of the project and how one goes about recruiting a community in the automation industry. Getting to OR 1.0 was no mean feat. Juha Lindfors (yes JMX lead from the JBoss days) is managing the project full time. A traveling dutchman is helping with business aspects. We have 3 developers in china. And a growing community of good friends with good will. So we lever up with services from the outside, be it hosting, development, consulting. We are a modern cloud community, fully funded and functional.
This narrative, that the initial development is funded seems counter intuitive to some people. Even heresy. I mean afterall isn't open source supposed to be about peace and love. Won't the good lord provide free software? It is a fallacy, one that is not hard to debunk, think about it 2 seconds, no one helps you because you have no product, and you have no product because... you are alone? And even if you get a product, getting to a succesful OSS project is not assured, it will require a lot of passion and perseverance to put an OSS project on the map. Anyone with a project that has achieved more than 1000 downloads in its lifetime will tell you so.
JBoss was no exception, by the way, it was funded in the beginning. Most of the work was done by a small team. The community formed around this codebase and was quick to grow. The community of users and the community of consultants and the community of partners. It became hundreds of thousands. It is not uncommon for end-user project in Linux to achieve millions of users (think Firefox).
Of course outside contributions started coming in, just like contributions are coming to OR. In the case of JBoss I started recruiting those community members that stood out. As a result, at no time was JBoss the codebase with less than 80% contributions from JBoss inc. I have no idea where it stands today but I wouldn't be surprised if it was the same. Community meant users, partners, consultants.
In the case of OpenRemote, we are reaching a 1.0 product stage and we have been lucky on coverage and visibility so far. With 250 visitors a day on average and some days at 1000, OpenRemote is lucky to have a good team, good software and a good dose of coverage (thanks Matt). Those are necessary ingredients for a succesful OSS project.
Matt concludes:
And, like JBoss with Java application servers, the time for OpenRemote may be ripe. Despite the morass of nonstandard technologies and bit players in the automation market, OpenRemote's open-source approach just might have a chance to unify the market. It's now possible to put a $200 computer in the wall, which suggests it just might be feasible for OpenRemote to open source a deeply proprietary and fragmented industry.
Matt wanted to know about the history of the project and how one goes about recruiting a community in the automation industry. Getting to OR 1.0 was no mean feat. Juha Lindfors (yes JMX lead from the JBoss days) is managing the project full time. A traveling dutchman is helping with business aspects. We have 3 developers in china. And a growing community of good friends with good will. So we lever up with services from the outside, be it hosting, development, consulting. We are a modern cloud community, fully funded and functional.
This narrative, that the initial development is funded seems counter intuitive to some people. Even heresy. I mean afterall isn't open source supposed to be about peace and love. Won't the good lord provide free software? It is a fallacy, one that is not hard to debunk, think about it 2 seconds, no one helps you because you have no product, and you have no product because... you are alone? And even if you get a product, getting to a succesful OSS project is not assured, it will require a lot of passion and perseverance to put an OSS project on the map. Anyone with a project that has achieved more than 1000 downloads in its lifetime will tell you so.
JBoss was no exception, by the way, it was funded in the beginning. Most of the work was done by a small team. The community formed around this codebase and was quick to grow. The community of users and the community of consultants and the community of partners. It became hundreds of thousands. It is not uncommon for end-user project in Linux to achieve millions of users (think Firefox).
Of course outside contributions started coming in, just like contributions are coming to OR. In the case of JBoss I started recruiting those community members that stood out. As a result, at no time was JBoss the codebase with less than 80% contributions from JBoss inc. I have no idea where it stands today but I wouldn't be surprised if it was the same. Community meant users, partners, consultants.
In the case of OpenRemote, we are reaching a 1.0 product stage and we have been lucky on coverage and visibility so far. With 250 visitors a day on average and some days at 1000, OpenRemote is lucky to have a good team, good software and a good dose of coverage (thanks Matt). Those are necessary ingredients for a succesful OSS project.
Friday, May 22, 2009
Live from the Trenches of Motherhood
Ce n'est pas aujourd'hui que le ciel me tombera sur la tête...
Today, the bus monitor called me because I forgot to pick up my daughter.
It was one of those Friday half-days, which are darned hard to keep up with, what with all Spanish holidays commemorating obscure Saints and glorious Apparitions, Assumptions, Ascensions and Immaculate Conceptions of our Our Blessed Virgin...not to mention the vagaries of the French Education Nationale labor calendar, with its various strikes and half-days (to plan how they will do less work in the next calendar year). Not that I'm going to spit on Education Nationale because my husband is a product of that and my daughter has a bona-fide, CERN-trained Ph.D. particle physicist as her fourth grade teacher, who's young, cool and lets the kids call him by his first name. Plus, did I mention that French public education abroad is a real bargain compared to anything you would pay in the US. Oh, and the school year lasts through the end of June, joy!
You may be a better parent than we are
I suppose this is an improvement over last year. That was the year my daughter's school teachers called a conference with us to discuss her "organizational issues"-- how she was turning in her homework crumpled up and forgetting to bring the appropriate red, blue and black color-coded ink pens.
My husband and I both, independently, forgot this meeting and showed up 1/2 an hour late. By this time the "educational specialist" they have sit in on these meetings had another appointment. All we could do was grin sheepishly and suggest that "Perhaps the apple doesn't fall far from the tree." "Organizational skills?" The child gets good grades, is sociable with her peers and respectful toward her teachers...give me a break, private school.
Today, my "independent-minded," au naturel (our latest idea for "shock and awe" potty training by the September 3-yr. old preschool deadline) 2 year-old shited all over our white leather living room couch. Soon after that, the latest issue of the "Potty Training Concepts" newsletter appeared in my in-box. Coincidence? I think not.
This inspired my "creative" 6 1/2 year old twin boys to use Mac Photobooth to start producing "poop films" (don't ask). I expect great things from these two.
Is in imminent danger of becoming a Twitterwhore/future Facebook updates
"Try for (fuller-figured) Lisa Cuddy look"
"What would Jack Bauer do?" Vis-a-vis the fact, Marc has "lost" 3 iPods in 7 months and need to look up iPhone app with bad-ass tracing software.
"Said no to the gym and yes to carbs!"
"Is so hep and desirable that hep and desirable people--more so than you, my dear 'friends!'--fight over the privilege taking me to hep and desirable places."
"Top 5 things my 'friends' resent about me"
1) My classic good looks?
2) My stunning figure?
3) My plastic, fantastic life?
4) My H.I.P. (Higher Ivy Potential) children!
"Luv ya'all too. Air kisses. Mwah, mwah."
Madrid Blog--La Señora que Sabe
Adventures in the Workplace and with El Servicio
This one is going to make me wildly unpopular... I will preface the entry by saying that I have limited experience in management. This experience has been "when it's great, it's great," but, in those cases where you may be managing the "lesser motivated" worker, management is highly over-rated.
In my brief professional career, I worked with an outside PR agency team that was very competent. In general, they knew more about what they were doing, than I did. They made me look good. In my house, in the US, I employed a nanny for my children (live-out, hourly wages). In the seven years she worked for me, I don't think she was sick once and I can count on less than ten fingers the number of times she was late to work.
Recently, though, in Spain, I have not had such good luck in the house-hold help category. I wonder if this is not due to different cultural/personal expectations about the workplace. This is exemplified by a conversation I had one day with my "interna" about the fact that the children were consistently late for the school bus. I approached this from a very American HR workplace bias:
"We have a problem. How can we work together (as a team!) to solve our problem?"
I was shocked by the interna's response, which (paraphrased) was:
"Well, Señora, you can do my job for me."
The American weakness: Need to be liked/loved.
Wonder if this comes from the joy that is the American high school experience, where popularity is generally valued above and beyond any sort of academic achievement?
In the JBoss years, it truly was inconceivable to some people that my French-raised husband lacked any concern for what people thought of him. "Not giving a damn" is a good quality to have if you are an entrepreneur. Why? Because if you are doing something truly novel and different (with no money and connections in your chosen industry) expect to be called crazy. "Crazy" is a good thing. Nobody fucks with crazy. When you are in tight situations, acting like a completely unpredictable motherfucker who would rather self-implode than let the other guy win, increases your chances of survival and coming out ahead. If you succeed, you can always console yourself with the Southern (US) dictum: "When you're poor, you're crazy; when you're rich, you're eccentric."
If you are on to something, you will spend the second half of your start-up's life fending off people trying to kill you. This includes insignificant pissants as well as the powerful Personnages/Corporations of this world. Why do they abuse their position? Because they can. Concentrate on out-witting them and extracting revenge, or acting more morally if you ever get near their industry position.
I see "needing to be liked" in the work world as a particular American weakness. Nothing is more ridiculous than the company that thinks they can under-compensate their employees because they they are such a "cool" place to work. Note: employers who think this way are probably so far from cool the light from cool would take a million years to reach them. This is on par with the housewife who thinks she can pay "Edwina" less because Edwina "loves" her children. If Edwina won the lottery, would she be working for you? It's a job, people are there because they need the money or expect a liquidity event.
As for what other people think of us, not just employees, but friends and family, we probably are better off not knowing :) In a work relationship, I see fair compensation and establishing a relationship of mutual respect as more important.
American optimism: You are responsible for the ultimate outcome of your career
OK, I just read Malcolm Gladwell's "Outliers" like everybody else, and he makes some good points de-bunking the individual's responsibility for her own ultimate success. However, if you don't start from this basic assumption, you will not be able to benefit from whatever Gladwellian experiential, cultural, chance advantages that come your way.
Religious bias and Social Values
I am the product of a Protestant/Catholic marriage, and was raised in, and, am comfortable with, both traditions. This is not a discussion of religion or theology, but a thought about Protestantism and the American cultural bias regarding individual self-determination. My experience with Catholicism was very laced with the "look at the birds of the air and the flowers of the field--the good Lord will provide" outlook. The Protestant outlook, on the other hand (which is nowhere to be found in the Bible): tended toward "God helps those who help themselves." The Calvinist predestination doctrine--where it is assumed that God rewards the "predestined" with material success and that material success reflects moral character--is even more pernicious...The two traditions also have different outlooks on the individual's ability/responsibility for interpreting his faith. My experience with Catholicism emphasized dependence on the clerical hierarchy to achieve an understanding of theological tenets; whereas the Protestant tradition (of course both traditions have their dogmatic sects) generally emphasized Biblical textual scholarship and the individual's responsibility to work out his own faith--an approach that has understandably led to endless dissent and schisms...
Them that has 'gits
All this is speculative divergence from what I see as two fundamentally different outlooks in the workplace. One approach is that "the world has always been divided into "jefes" and "empleados". As it was in the beginning, is now and will be forever, world without end, Amen. Fuck them, I am going to do the minimum I can get away with in my job. My misery/poverty is virtue in and of itself. I'll get my reward in Heaven.
Self-determination
The second approach is that "I can impact my ultimate outcome in life" and, by my hard work, I could become a "jefe". This involves taking responsibility for and pride in one's work. It especially comes into play in dealing with how people handle mistakes.
Everybody makes mistakes. This does not distinguish the former or latter category of employees, but how they handle them does. Employee A will 1) acknowledge no responsibility for his role in the mistake 2) expend endless amounts of energy telling me why it's not his fault and how he could not have done anything differently. Employee B, on the other hand, will 1) acknowledge her role in the mistake 2) spend her energy telling me what she is going to do in the future so that this never happens again.
This one is going to make me wildly unpopular... I will preface the entry by saying that I have limited experience in management. This experience has been "when it's great, it's great," but, in those cases where you may be managing the "lesser motivated" worker, management is highly over-rated.
In my brief professional career, I worked with an outside PR agency team that was very competent. In general, they knew more about what they were doing, than I did. They made me look good. In my house, in the US, I employed a nanny for my children (live-out, hourly wages). In the seven years she worked for me, I don't think she was sick once and I can count on less than ten fingers the number of times she was late to work.
Recently, though, in Spain, I have not had such good luck in the house-hold help category. I wonder if this is not due to different cultural/personal expectations about the workplace. This is exemplified by a conversation I had one day with my "interna" about the fact that the children were consistently late for the school bus. I approached this from a very American HR workplace bias:
"We have a problem. How can we work together (as a team!) to solve our problem?"
I was shocked by the interna's response, which (paraphrased) was:
"Well, Señora, you can do my job for me."
The American weakness: Need to be liked/loved.
Wonder if this comes from the joy that is the American high school experience, where popularity is generally valued above and beyond any sort of academic achievement?
In the JBoss years, it truly was inconceivable to some people that my French-raised husband lacked any concern for what people thought of him. "Not giving a damn" is a good quality to have if you are an entrepreneur. Why? Because if you are doing something truly novel and different (with no money and connections in your chosen industry) expect to be called crazy. "Crazy" is a good thing. Nobody fucks with crazy. When you are in tight situations, acting like a completely unpredictable motherfucker who would rather self-implode than let the other guy win, increases your chances of survival and coming out ahead. If you succeed, you can always console yourself with the Southern (US) dictum: "When you're poor, you're crazy; when you're rich, you're eccentric."
If you are on to something, you will spend the second half of your start-up's life fending off people trying to kill you. This includes insignificant pissants as well as the powerful Personnages/Corporations of this world. Why do they abuse their position? Because they can. Concentrate on out-witting them and extracting revenge, or acting more morally if you ever get near their industry position.
I see "needing to be liked" in the work world as a particular American weakness. Nothing is more ridiculous than the company that thinks they can under-compensate their employees because they they are such a "cool" place to work. Note: employers who think this way are probably so far from cool the light from cool would take a million years to reach them. This is on par with the housewife who thinks she can pay "Edwina" less because Edwina "loves" her children. If Edwina won the lottery, would she be working for you? It's a job, people are there because they need the money or expect a liquidity event.
As for what other people think of us, not just employees, but friends and family, we probably are better off not knowing :) In a work relationship, I see fair compensation and establishing a relationship of mutual respect as more important.
American optimism: You are responsible for the ultimate outcome of your career
OK, I just read Malcolm Gladwell's "Outliers" like everybody else, and he makes some good points de-bunking the individual's responsibility for her own ultimate success. However, if you don't start from this basic assumption, you will not be able to benefit from whatever Gladwellian experiential, cultural, chance advantages that come your way.
Religious bias and Social Values
I am the product of a Protestant/Catholic marriage, and was raised in, and, am comfortable with, both traditions. This is not a discussion of religion or theology, but a thought about Protestantism and the American cultural bias regarding individual self-determination. My experience with Catholicism was very laced with the "look at the birds of the air and the flowers of the field--the good Lord will provide" outlook. The Protestant outlook, on the other hand (which is nowhere to be found in the Bible): tended toward "God helps those who help themselves." The Calvinist predestination doctrine--where it is assumed that God rewards the "predestined" with material success and that material success reflects moral character--is even more pernicious...The two traditions also have different outlooks on the individual's ability/responsibility for interpreting his faith. My experience with Catholicism emphasized dependence on the clerical hierarchy to achieve an understanding of theological tenets; whereas the Protestant tradition (of course both traditions have their dogmatic sects) generally emphasized Biblical textual scholarship and the individual's responsibility to work out his own faith--an approach that has understandably led to endless dissent and schisms...
Them that has 'gits
All this is speculative divergence from what I see as two fundamentally different outlooks in the workplace. One approach is that "the world has always been divided into "jefes" and "empleados". As it was in the beginning, is now and will be forever, world without end, Amen. Fuck them, I am going to do the minimum I can get away with in my job. My misery/poverty is virtue in and of itself. I'll get my reward in Heaven.
Self-determination
The second approach is that "I can impact my ultimate outcome in life" and, by my hard work, I could become a "jefe". This involves taking responsibility for and pride in one's work. It especially comes into play in dealing with how people handle mistakes.
Everybody makes mistakes. This does not distinguish the former or latter category of employees, but how they handle them does. Employee A will 1) acknowledge no responsibility for his role in the mistake 2) expend endless amounts of energy telling me why it's not his fault and how he could not have done anything differently. Employee B, on the other hand, will 1) acknowledge her role in the mistake 2) spend her energy telling me what she is going to do in the future so that this never happens again.
Thursday, May 21, 2009
The crisis for dummies: Incentives
Incentives in the financial industries have been out of whack for a long time it seems. There is a lot of grand standing around the pay of CEOs but the rot goes much deeper. I also believe that it is in the nature of the beast by definition of managing "OPM" (Other People's Money).
Asymmetry of payouts
An investor is paid out at exit, when he gets his money back. But when the payout for the manager is yearly he has an interest in front-loading risk. What that means is that he takes on a bunch of risk that he knows will blow up but meanwhile will pay handsomely. When you think about it, the yearly yield payout is there to compensate for that future blowup. So that on a "risk-adjusted" you are making not that much. A bond may pay 20% yearly because it has such a high chance of default.
The manager knows that, buys it anyway and generates 20%/year in the first years. It looks great, you are getting 20 a year! But on a risk adjusted basis, accounting for the rate of default of the investment, he may only be bringing in 1% and costing you 20% of "cash flow profit" or 20x20=4%.
Get it? It is a bit of a scam. If your bonus is yearly then you juice yearly returns at the expense of loading up on tail-end risk.
Loading up on debt
One way to juice up the yearly returns is in fact to take on a bunch of debt. If every dollar brings 20c a year and it cost you 5c a year to get $1, you are bringing an extra 15c for every dollar you load up. Leverage 10x and you are bringing in $1,50 a year for every $1 invested. That is right boys and girls, 150% a year! now doesn't that look good? It pays to leverage. But then again, and even more violently than in the previous scenario, your capital will get wiped out quickly (before debt). This has the effect of blowing credit bubbles.
Payout on exit is fairer
Not all pools of capital are managed the same. Venture capital pay at liquidation of the fund for its limited partners. This means that the investor AND the manager are paid mainly on exit. This minimizes the asymmetry. This is fine for funds that are highly illiquid and where "liquidity" is in fact such an event (the sale of a company) that it triggers distribution.
Socialize losses, privatize gains
Perhaps the most disturbing asymmetry is the one we are validating right now. The machine sets up incentives to keep on growing and growing, isn't it what real companies do anyway? It has a tendency to rig itself so that the capital will blow up long term to generate short term juice. So they grow huge. But when it blows up, the company is so big, it is considered "Too Big to Fail" (TBF) and so the blowup hits the public treasury. Trillions of dollars have been thrown at the problem in the name of stability of our financial system. When the too big to fail are indeed failing, bail it out. This underlying assumption, the TBF-put, sets up all kinds of incentives that go the wrong way.
Asymmetry of payouts
An investor is paid out at exit, when he gets his money back. But when the payout for the manager is yearly he has an interest in front-loading risk. What that means is that he takes on a bunch of risk that he knows will blow up but meanwhile will pay handsomely. When you think about it, the yearly yield payout is there to compensate for that future blowup. So that on a "risk-adjusted" you are making not that much. A bond may pay 20% yearly because it has such a high chance of default.
The manager knows that, buys it anyway and generates 20%/year in the first years. It looks great, you are getting 20 a year! But on a risk adjusted basis, accounting for the rate of default of the investment, he may only be bringing in 1% and costing you 20% of "cash flow profit" or 20x20=4%.
Get it? It is a bit of a scam. If your bonus is yearly then you juice yearly returns at the expense of loading up on tail-end risk.
Loading up on debt
One way to juice up the yearly returns is in fact to take on a bunch of debt. If every dollar brings 20c a year and it cost you 5c a year to get $1, you are bringing an extra 15c for every dollar you load up. Leverage 10x and you are bringing in $1,50 a year for every $1 invested. That is right boys and girls, 150% a year! now doesn't that look good? It pays to leverage. But then again, and even more violently than in the previous scenario, your capital will get wiped out quickly (before debt). This has the effect of blowing credit bubbles.
Payout on exit is fairer
Not all pools of capital are managed the same. Venture capital pay at liquidation of the fund for its limited partners. This means that the investor AND the manager are paid mainly on exit. This minimizes the asymmetry. This is fine for funds that are highly illiquid and where "liquidity" is in fact such an event (the sale of a company) that it triggers distribution.
Socialize losses, privatize gains
Perhaps the most disturbing asymmetry is the one we are validating right now. The machine sets up incentives to keep on growing and growing, isn't it what real companies do anyway? It has a tendency to rig itself so that the capital will blow up long term to generate short term juice. So they grow huge. But when it blows up, the company is so big, it is considered "Too Big to Fail" (TBF) and so the blowup hits the public treasury. Trillions of dollars have been thrown at the problem in the name of stability of our financial system. When the too big to fail are indeed failing, bail it out. This underlying assumption, the TBF-put, sets up all kinds of incentives that go the wrong way.
Wednesday, May 13, 2009
Madrid blog: Jamon Joselito
In case you wonder, the main reason I came to Spain is for the ham. Period.
Love actually
So a couple of weeks ago I manned up and went and got myself a leg. Out I come with a Joselito. This being the district of Salamanca, Javier, the store attendant, prepares it like it came from Prada. Check it out in the picture. Nathalie was called "a brand new leg of jabugo ham" in the street the other day by construction workers. She didn't know what to make of it, I assured her it was the ultimate in spanish piropo. The picture proves it!
Gran reserva
The way it is prepared is that the front bone plate is removed. This allows for a continuous cut. As seen in the picture.
Hams vary in quality greatly amongst themselves. This particular one was absolutely superb. I think I shed a tear when I first tried it. There was emotion in the house for about 2 weeks. We devoured it.
Tuesday, May 12, 2009
Crisis for Dummies: Global Imbalances.
Trade in commerce assumes we are exchanging things of equal economic value. What happens when a country consumes more than it produces?
Global imbalances
When americans consume at 103% or their own production for a sustained period of time, they need to borrow the extra 3%. Americans have pretty much eaten their savings so that extra 3% must be funded by savings from elsewhere. This is where the global kicks in. Enter China, saving countries of Europe and petro-dollars all too happy to buy treasuries to re-invest their dollar denominated debts.
Wall-E
The US govt has such a low cost of financing, even in this crisis, that this has worked for a long-long time. See also the entry on Securitization on how the machine kept producing debt backed products to sell to foreigners. When real products are going extinct and there is only debt, no worries! repackage that debt and sell it as a product.
Impact on economy, crisis
What it creates is a trickle of principal and interest payments that drag on the real economy. They impact cash flow, and now instead of having 100 available for consumption you may have only 97. To keep up with 103 you need to borrow 6 now. And so on and so forth until you cannot borrow the next layer. Then "naked consumption" appears and it has been chewed up by debt repayments. By the time you are done, you may be at 90% available for consumption and it starts to look like a serious recession (-13% GDP fall).
The way out
Default. All of the sudden defaulting on debt becomes fashionable through QE (see inflation/deflation entry). Foreigners are facing a potential fall in GDP combined with an increase in monetary volume.
Equilibrium: imbalances cannot exist long term
But imbalances need to resolve themselves. The RMB needs to appreciate (making goods from China more expensive) or dollar denominated debt will need to default through inflation and equivalent dollar depreciation. The point being that at the end of the day, equilibrium says that over a period of time on average what was consumed is what was produced. There is no free lunch is the principle sustaining equilibrium in global exchange. You don't mock about with that principle. The last time large imbalances appeared was WW1 when old Europe was in debt up to its eyeballs, not producing but rather over consuming. America was too happy to oblige.
Sustainable imbalances can be politic
But, what if, in the globalized version of Cheney's "deficits don't matter", imbalances do not matter? Afterall the Chinese are happy growing at a brisk pace, they probably consider buying treasuries a Keynesian action of some sort whereby they sustain their own growth by financing the american consumer. They know they are going to take a cut. Each time they take a cut, they can write it off as as a 'stimulus package' subsidizing the US to subsidize themselves.
The death of the US super-consumer
A readjustment of global imbalances is already under way. Consumption is down and driven by the US. The US has been consuming at 103 for a sustained period of time. I, for one, believe that the financial flash we just witnessed woke up the american public in a cold sweat. Already savings are shooting through the roof and your average citizen is adjusting his standard of living faster than you can say "nationalize the banks". And this is a good thing (c).
Blame the saviors
It really baffles me when officialdom blames the saviors for saving money. It is almost as if there was a moral flaw in doing so. I really cannot connect to that argument. So they don't consume enough? is that it? True, america has pulled the world out of misery by consuming until they got obese. You know it is hard being a super-consumer. But maybe I am missing something...
A dollar run?
Armageddon in finance goes something like this: unfriendly central banks coordinate a run on the dollar. Europe would stick with the US, it would become Occident vs the rest of the world, finance edition. I do not believe it will come to that.
Global imbalances
When americans consume at 103% or their own production for a sustained period of time, they need to borrow the extra 3%. Americans have pretty much eaten their savings so that extra 3% must be funded by savings from elsewhere. This is where the global kicks in. Enter China, saving countries of Europe and petro-dollars all too happy to buy treasuries to re-invest their dollar denominated debts.
Wall-E
The US govt has such a low cost of financing, even in this crisis, that this has worked for a long-long time. See also the entry on Securitization on how the machine kept producing debt backed products to sell to foreigners. When real products are going extinct and there is only debt, no worries! repackage that debt and sell it as a product.
Impact on economy, crisis
What it creates is a trickle of principal and interest payments that drag on the real economy. They impact cash flow, and now instead of having 100 available for consumption you may have only 97. To keep up with 103 you need to borrow 6 now. And so on and so forth until you cannot borrow the next layer. Then "naked consumption" appears and it has been chewed up by debt repayments. By the time you are done, you may be at 90% available for consumption and it starts to look like a serious recession (-13% GDP fall).
The way out
Default. All of the sudden defaulting on debt becomes fashionable through QE (see inflation/deflation entry). Foreigners are facing a potential fall in GDP combined with an increase in monetary volume.
Equilibrium: imbalances cannot exist long term
But imbalances need to resolve themselves. The RMB needs to appreciate (making goods from China more expensive) or dollar denominated debt will need to default through inflation and equivalent dollar depreciation. The point being that at the end of the day, equilibrium says that over a period of time on average what was consumed is what was produced. There is no free lunch is the principle sustaining equilibrium in global exchange. You don't mock about with that principle. The last time large imbalances appeared was WW1 when old Europe was in debt up to its eyeballs, not producing but rather over consuming. America was too happy to oblige.
Sustainable imbalances can be politic
But, what if, in the globalized version of Cheney's "deficits don't matter", imbalances do not matter? Afterall the Chinese are happy growing at a brisk pace, they probably consider buying treasuries a Keynesian action of some sort whereby they sustain their own growth by financing the american consumer. They know they are going to take a cut. Each time they take a cut, they can write it off as as a 'stimulus package' subsidizing the US to subsidize themselves.
The death of the US super-consumer
A readjustment of global imbalances is already under way. Consumption is down and driven by the US. The US has been consuming at 103 for a sustained period of time. I, for one, believe that the financial flash we just witnessed woke up the american public in a cold sweat. Already savings are shooting through the roof and your average citizen is adjusting his standard of living faster than you can say "nationalize the banks". And this is a good thing (c).
Blame the saviors
It really baffles me when officialdom blames the saviors for saving money. It is almost as if there was a moral flaw in doing so. I really cannot connect to that argument. So they don't consume enough? is that it? True, america has pulled the world out of misery by consuming until they got obese. You know it is hard being a super-consumer. But maybe I am missing something...
A dollar run?
Armageddon in finance goes something like this: unfriendly central banks coordinate a run on the dollar. Europe would stick with the US, it would become Occident vs the rest of the world, finance edition. I do not believe it will come to that.
Monday, May 4, 2009
Crisis for Dummies: Fractional Reserve Banking, the money multiplier
Fractional reserve banking is not directly part of the crisis narrative but it is a constituent feature of system. It is important because it's breakdown mode is the dreaded "bank run". This is how monetary levels were supposed to be controlled.
What it is
Fractional reserve banking is the habit of NOT keeping all deposits in kind but just a fraction of them. You invest the rest make a profit and return it when you are done. If the good is fungible then you can in fact return it at any time since you can put equivalent things in place of the original, even if the original is working somewhere else. Romans would sometimes treat this then emerging banking practice as criminal, today it is enshrined in our laws and institutions. The FED maintains the system, prevents bank runs etc.
Say you deposit a art collection for safe keeping. The bank cannot engage in "fractional banking" and has to keep your good whole. But with fungible goods, such as oil, grains, gold or indeed cash money, and many clients, your average banker can lend out a big portion of it, keep what is needed to cover average daily demands (a fraction of it).
Legal shenanigans
From a legal standpoint, it was debated in the past whether a fungible good deposited and whose redemption was "at any time" was the sole property of the legal owner. Or could a bank invest that capital instead of letting it sit idle in a corner. Today the matter has been legislated. A bank, by virtue of the federal reserve banking act, can in fact invest a large proportion of the deposits entrusted to it (up to 90%).
Monetary levels
This is the mechanism that the FED uses to control the money levels, at least in principle. They do so by controlling the monetary reserves of the banks and imposing ratios of deposits to reserves or investments to reserves.
When people talk about the "money multiplier" model this is also what they refer to but seen from another angle. If you give 100 to a bank and they lend 90 then you have 190 monetary units in circulation. From 90 you lend the corresponding fraction etc. If you do so recursively, you find that you have created 10x the money that was deposited. This is the chief way the FED controls the monetary levels. Fractional reserve banking is an inflationary practice. See Securitization for how the banks innovated their way out of the limits imposed by our forefathers and monetary control by the FED may have been in fact limited, the main culprit being that M2 proceeds M0 these days (debt creation happens first, FED adjusts M0).
How much money? A: Not too little and not too much
So the ratios of deposits to reserves are legislated. At any time banks should have around 1/10th of the deposit money in reserves. Those reserves are monitored by the FED. By legislation we limit what the balance sheets of those banks should support. Not too much or you buckle, not to little or you are under-investing in your economy. If the ratio of 1/10, put in place during the depression proved too limiting for the go-go years, it turns out that 1/40 is a sure fire way to kill equity capital as a 2.5% variation on assets will void the most junior member of the capital table: equity capital. So the number must be legislated somewhere in between.
Legislating Securitization
The new legislation must account for Securitization as after all it was the total amount of debt generated and distributed by the system that was important, not just what the banks held onto.
Greenspan argues in his defense that the FED had effectively lost control of the monetary levels. It is an admission that the combination of M0 levels and M0/M2 ratios were insufficient. The debt dog was wagging the fiat money tail after all.
PS: to test your understanding of the above, read this poem, by Macro-Man one of my favorite hedgy reads
What it is
Fractional reserve banking is the habit of NOT keeping all deposits in kind but just a fraction of them. You invest the rest make a profit and return it when you are done. If the good is fungible then you can in fact return it at any time since you can put equivalent things in place of the original, even if the original is working somewhere else. Romans would sometimes treat this then emerging banking practice as criminal, today it is enshrined in our laws and institutions. The FED maintains the system, prevents bank runs etc.
Say you deposit a art collection for safe keeping. The bank cannot engage in "fractional banking" and has to keep your good whole. But with fungible goods, such as oil, grains, gold or indeed cash money, and many clients, your average banker can lend out a big portion of it, keep what is needed to cover average daily demands (a fraction of it).
Legal shenanigans
From a legal standpoint, it was debated in the past whether a fungible good deposited and whose redemption was "at any time" was the sole property of the legal owner. Or could a bank invest that capital instead of letting it sit idle in a corner. Today the matter has been legislated. A bank, by virtue of the federal reserve banking act, can in fact invest a large proportion of the deposits entrusted to it (up to 90%).
Monetary levels
This is the mechanism that the FED uses to control the money levels, at least in principle. They do so by controlling the monetary reserves of the banks and imposing ratios of deposits to reserves or investments to reserves.
When people talk about the "money multiplier" model this is also what they refer to but seen from another angle. If you give 100 to a bank and they lend 90 then you have 190 monetary units in circulation. From 90 you lend the corresponding fraction etc. If you do so recursively, you find that you have created 10x the money that was deposited. This is the chief way the FED controls the monetary levels. Fractional reserve banking is an inflationary practice. See Securitization for how the banks innovated their way out of the limits imposed by our forefathers and monetary control by the FED may have been in fact limited, the main culprit being that M2 proceeds M0 these days (debt creation happens first, FED adjusts M0).
How much money? A: Not too little and not too much
So the ratios of deposits to reserves are legislated. At any time banks should have around 1/10th of the deposit money in reserves. Those reserves are monitored by the FED. By legislation we limit what the balance sheets of those banks should support. Not too much or you buckle, not to little or you are under-investing in your economy. If the ratio of 1/10, put in place during the depression proved too limiting for the go-go years, it turns out that 1/40 is a sure fire way to kill equity capital as a 2.5% variation on assets will void the most junior member of the capital table: equity capital. So the number must be legislated somewhere in between.
Legislating Securitization
The new legislation must account for Securitization as after all it was the total amount of debt generated and distributed by the system that was important, not just what the banks held onto.
Greenspan argues in his defense that the FED had effectively lost control of the monetary levels. It is an admission that the combination of M0 levels and M0/M2 ratios were insufficient. The debt dog was wagging the fiat money tail after all.
PS: to test your understanding of the above, read this poem, by Macro-Man one of my favorite hedgy reads
Saturday, May 2, 2009
TF 19: Prince, Black Mix
Download new version here.
This is my take on Kiss. A prince classic. Last time I heard this was in a club setting in Berlin at around 5AM. I think it was a JBoss World.
In the background there are bits of "Black Strategy" from DJ Dex. The original is a hot track from early 00's and I played it at around 140BPM at the end of TF3, just like in the original underground techno compilation from Detroit's UR of early 2000. For those that still have TF3 laying around and are so inclined do spot the difference between the 2 tracks at 20BPM difference (20%) they are two different tracks.
Here it is slowed down to its original tempo, playing here at 124BPM... this was a house track when you lend an ear to it.
The result is a lot more sluggish, in a good way, in a hypnotic way. The sounds from DEX take on a edgy and alien-ish dimension. They also have this uncanny ability to distort the original melody, they complement Prince in a new way.
This is a bit of a rough-cut, it has something like 6 hours of work into it. Little sound work was needed. Mostly it is structured as a "long-drink" version of the Prince original with a few repeats and a couple of extensions. I have only used cuts from DEX's first movement, from no melody to wouiiiiiiiiiiouuuuuuuuuuaaaaaa. I think the sound is addictive and just wanted to release it ASAP.
This is my take on Kiss. A prince classic. Last time I heard this was in a club setting in Berlin at around 5AM. I think it was a JBoss World.
In the background there are bits of "Black Strategy" from DJ Dex. The original is a hot track from early 00's and I played it at around 140BPM at the end of TF3, just like in the original underground techno compilation from Detroit's UR of early 2000. For those that still have TF3 laying around and are so inclined do spot the difference between the 2 tracks at 20BPM difference (20%) they are two different tracks.
Here it is slowed down to its original tempo, playing here at 124BPM... this was a house track when you lend an ear to it.
The result is a lot more sluggish, in a good way, in a hypnotic way. The sounds from DEX take on a edgy and alien-ish dimension. They also have this uncanny ability to distort the original melody, they complement Prince in a new way.
This is a bit of a rough-cut, it has something like 6 hours of work into it. Little sound work was needed. Mostly it is structured as a "long-drink" version of the Prince original with a few repeats and a couple of extensions. I have only used cuts from DEX's first movement, from no melody to wouiiiiiiiiiiouuuuuuuuuuaaaaaa. I think the sound is addictive and just wanted to release it ASAP.
Friday, May 1, 2009
Crisis for dummies: Credit Default Swaps
Credit Default Swaps or CDS have played an important role in the current financial crisis. Some blame them for the initial outbreak of summer 2007.
Imagine you lend $10,000 to a friend. You may want to take insurance against default of payment from this friend. For about $300 a year, someone will reimburse you the entire $10k if your friend defaults. This is a CDS, a "credit default swap", think of it as you would car insurance. In the event of a default you "swap" the liability with your counterparty. You get cash (or sometimes equivalent security), he gets the bond. CDS then are taken on bonds. You can buy a CDS on a bond from a company on a bond from a government, on an obscure tranche of a securitized loan. You can buy a CDS on pretty much anything.
Economic function
The economic function is pretty straight-forward, it moves the burden of default to a willing and able party. If loosing 10k is a devastating effect for you then you may want to swap the default. If it isn't then you may want to sell the CDS and get the premium. On first analysis CDS are a good thing as they move the risk around.
AIG and the concentration of risk
In practice however CDS have ended building up on one balance sheet, that of AIG, the large insurer. Consider for a second that debt usually constitute a large part of the capital of a company. Here a company is selling insurance that puts it on the hook for the debt of many other companies. When you factor in naked CDS (see below) that multiply this amount, the balance sheet that takes it on better be a large balance sheet.
Imagine a local salesman sells insurance against default from your friend's debt, and he sells many of them, say 10. He is on the hook for 100,000 but in practice it is unlikely everyone defaults together. But there is a bout of swine flu and everyone dies. In practice AIG had sold CDS they could not possibly honor when the context changed. AIG being so big makes it a juicy target for government intervention and bailout.
Pushing for default
President Obama just spoke out against hedge-funds resisting Chrysler restructuring. The main reason for this behavior was probably CDS. If you hold a CDS, in the event of bankruptcy, you want to see the company default since it will trigger the swap. In other words, why settle for a payment of 60c on the dollar when you can get 100c on the dollar. This of course creates members of your capital table that are better off seeing you either completely healthy or completely dead, but not at the capital restructuring table. It makes the system less flexible.
Naked CDS
A further abuse of the CDS is the naked CDS, whereby the buyer of the CDS does not hold the underlying bond. Imagine your neighborhood insurance guy sells naked insurance, many people can bet against your debtor. They didn't lend 10,000 they just pay the premium (say 300/year) and if there is default then they get 10,000. There are several problems with this a/ the local mafia guy will take naked CDS and proceed to snuff off your neighbor for maximum gain (see point above). b/ Where there was really 10,000 changing hands there is now n times 10,000 (say 50,000) of liability. The bad debt has been multiplied.
In practice naked CDS to covered CDS was 4 to 1. This means we have 4 times more liability than real debt out there, it is obvious, given the size of the numbers, that eventually there would not be enough money to reimburse 4 times the size of an economy that is ... defaulting.
Payment of banks
It has been pointed out that since traders are paid on the flow of deals they had an incentive to just write and write CDS. One problem was that they showed premium income which should have been set aside as a liability and paid themselves bonuses on this flow. Put simply, imagine a security that defaults at 40% in 10 year. You sell security at 43% over 10 years (to reimburse the 40 and pocket 3). But from an income standpoint, we get 4.3 coming in per year, when 4 should be reserves. Of course the full income was the basis for senior management bonuses and dividends.
Liquidity crunch and the spread of default
Many CDS are settled in cash. This means that at a time when liquidity is hard to come by and people default, the issuer of CDS needs to come up with a LOT of liquidity, a lot of cash, further compounding the problem of liquidity. When a company defaults it would normally sit there, but with CDS, someone has to sell assets to cover this hole. This is liquidity drained from healthy parts and so the liquidity problem spreads.
Contribution of Aug 07
CDS were the main contributing factor to the very early Aug 07 liquidity crisis which led to a solvency crisis. Many CDS including naked were taken on the tranches of securitized products. When the subprime markets began to dive CDS began to trigger. Many hedge funds (including the famous Paulson fund) had bet AGAINST the markets. Someone needed to come up with the liquidity needed to repay this. So the implosion of the subprime markets started to spread via CDS liquidity needs to other parts of the economy. Note that the liquidity need was multiplied by the ratio of naked CDS. The liquidity needs may have triggered forced liquidation in certain parts of the shadow financial system. This is how the subprime virus quickly spread and mutated, via naked CDS.
Imagine you lend $10,000 to a friend. You may want to take insurance against default of payment from this friend. For about $300 a year, someone will reimburse you the entire $10k if your friend defaults. This is a CDS, a "credit default swap", think of it as you would car insurance. In the event of a default you "swap" the liability with your counterparty. You get cash (or sometimes equivalent security), he gets the bond. CDS then are taken on bonds. You can buy a CDS on a bond from a company on a bond from a government, on an obscure tranche of a securitized loan. You can buy a CDS on pretty much anything.
Economic function
The economic function is pretty straight-forward, it moves the burden of default to a willing and able party. If loosing 10k is a devastating effect for you then you may want to swap the default. If it isn't then you may want to sell the CDS and get the premium. On first analysis CDS are a good thing as they move the risk around.
AIG and the concentration of risk
In practice however CDS have ended building up on one balance sheet, that of AIG, the large insurer. Consider for a second that debt usually constitute a large part of the capital of a company. Here a company is selling insurance that puts it on the hook for the debt of many other companies. When you factor in naked CDS (see below) that multiply this amount, the balance sheet that takes it on better be a large balance sheet.
Imagine a local salesman sells insurance against default from your friend's debt, and he sells many of them, say 10. He is on the hook for 100,000 but in practice it is unlikely everyone defaults together. But there is a bout of swine flu and everyone dies. In practice AIG had sold CDS they could not possibly honor when the context changed. AIG being so big makes it a juicy target for government intervention and bailout.
Pushing for default
President Obama just spoke out against hedge-funds resisting Chrysler restructuring. The main reason for this behavior was probably CDS. If you hold a CDS, in the event of bankruptcy, you want to see the company default since it will trigger the swap. In other words, why settle for a payment of 60c on the dollar when you can get 100c on the dollar. This of course creates members of your capital table that are better off seeing you either completely healthy or completely dead, but not at the capital restructuring table. It makes the system less flexible.
Naked CDS
A further abuse of the CDS is the naked CDS, whereby the buyer of the CDS does not hold the underlying bond. Imagine your neighborhood insurance guy sells naked insurance, many people can bet against your debtor. They didn't lend 10,000 they just pay the premium (say 300/year) and if there is default then they get 10,000. There are several problems with this a/ the local mafia guy will take naked CDS and proceed to snuff off your neighbor for maximum gain (see point above). b/ Where there was really 10,000 changing hands there is now n times 10,000 (say 50,000) of liability. The bad debt has been multiplied.
In practice naked CDS to covered CDS was 4 to 1. This means we have 4 times more liability than real debt out there, it is obvious, given the size of the numbers, that eventually there would not be enough money to reimburse 4 times the size of an economy that is ... defaulting.
Payment of banks
It has been pointed out that since traders are paid on the flow of deals they had an incentive to just write and write CDS. One problem was that they showed premium income which should have been set aside as a liability and paid themselves bonuses on this flow. Put simply, imagine a security that defaults at 40% in 10 year. You sell security at 43% over 10 years (to reimburse the 40 and pocket 3). But from an income standpoint, we get 4.3 coming in per year, when 4 should be reserves. Of course the full income was the basis for senior management bonuses and dividends.
Liquidity crunch and the spread of default
Many CDS are settled in cash. This means that at a time when liquidity is hard to come by and people default, the issuer of CDS needs to come up with a LOT of liquidity, a lot of cash, further compounding the problem of liquidity. When a company defaults it would normally sit there, but with CDS, someone has to sell assets to cover this hole. This is liquidity drained from healthy parts and so the liquidity problem spreads.
Contribution of Aug 07
CDS were the main contributing factor to the very early Aug 07 liquidity crisis which led to a solvency crisis. Many CDS including naked were taken on the tranches of securitized products. When the subprime markets began to dive CDS began to trigger. Many hedge funds (including the famous Paulson fund) had bet AGAINST the markets. Someone needed to come up with the liquidity needed to repay this. So the implosion of the subprime markets started to spread via CDS liquidity needs to other parts of the economy. Note that the liquidity need was multiplied by the ratio of naked CDS. The liquidity needs may have triggered forced liquidation in certain parts of the shadow financial system. This is how the subprime virus quickly spread and mutated, via naked CDS.
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