The Fein Line

Focus on what really matters

Sat, 11 Oct 2008 10:19:05 -0500

My political biases may be clear to those who read this blog, but I have to admire John McCain for resisting the temptation to roll in the muck with many of his supporters. "I have to tell you he is a decent person and a person that you do not have to be scared of as president of the United States," McCain said of Obama, much to the consternation of some of his supporters.

I can understand people who want to vote for McCain because they think he will be more fiscally responsible than Barack Obama, or who feel he will do a better job in foreign policy. I don't necessarily agree, but those are principled positions. However, when Republican supporters are whipped into a frenzy because they think Obama is an 'Arab', or commits 'treason' or is a 'terrorist', they're just stupid. I don't like McCain's positions, but I acknowledge that he is patriotic and is advocating what he thinks is the right path. I'm glad that he's willing to acknowledge the same about Obama.

I think that most Americans are exhausted from the partisan rancor. We need legitimate discussions of how to deal with all the big issues we face, including the loss of the world's confidence in America. I think that the best solutions are those that include elements from both sides of the aisle. With the hatred of the opponent so high, it makes compromise difficult.

When McCain's supporters exhort him to 'take off the gloves', why does that have to be character assassination? Why can't he rally support around his own proposals and discredit Obama's (without lying, of course)? If his proposals can't win on their merits, then McCain doesn't deserve to win, either. And, I feel exactly the same way about Obama.

Our 'Sponsors'

Fri, 10 Oct 2008 13:28:10 -0500

I don't have or need sponsors for this blog. I don't have any ads or generate any revenue. And, I don't have any real costs, either.

Nevertheless, while starting up a new firm, it's great to get help from others. I want to recognize three of our partners who have been incredibly helpful. All of them would be great for any new business to work with.

Our office is at the Emerging Enterprise Center of Foley Hoag. Foley Hoag is our law firm, and we've had incredible support from Bruce Kinn on fund formation, Dave Broadwin as our 'landlord' and expert on small public companies, and John Patterson as our overall sponsor. In addition, the whole team at the Emerging Enterprise Center has been very supportive, treating us as part of the company. If you are an entrepreneur and can convince Foley Hoag to host you at the EEC in Waltham, you'll be well taken care of.

Our firm is investigating opportunities in the public markets. As you can imagine, we do a lot of research on public companies. Although you can find a lot of this information in free public sources, you can't be productive in this endeavor without a real tool that automates and organizes this research. CapitalIQ is a fantastic tool for mining data on public companies. And, our account team has been very supportive during our start-up phase. In addition, Capital IQ has incredible support -- fast, helpful, and willing to do some custom work on our behalf. If you have a company that needs to research public companies, you need Capital IQ.

If you clicked through to our sparse website, you got a glimpse of the design work done by Rebecca Fagan of Fagan Design. We love the work that Rebecca has done on our logo, web site design, business cards, letterhead, and marketing materials. She's been very easy to work with, gets things done quickly, and meets her commitments. If you need design projects done, you can't go wrong with Rebecca.

Thanks to all of you for your support of Sempre Management!

All In A Day's Work

Fri, 10 Oct 2008 13:21:44 -0500

My friend Angelo Santinelli has started a new blog called All In A Day's Work. He's focusing on issues that entrepreneurs and small businesses face in today's challenging business environment.

Angelo has always been someone to focus on the reality of the situation and not on the emotion. Read some of his recent posts for his thoughts on what entrepreneurs should be doing in light of the current economic crisis.

Please make this ride stop

Wed, 08 Oct 2008 15:02:42 -0500

This is like one of the roller coasters I love.

Slippery Slope

Wed, 08 Oct 2008 14:31:44 -0500

At last night's Presidential Debate, John McCain said that he would order the Treasury Department to purchase up to $300B of consumer mortgages at the original value of the mortgage and renegotiate them down to the new diminished value of the home. The idea is to get people into a loan they can afford so they don't lose their house. It sounds like a nice idea to help out homeowners, but I think that it is an incredibly slippery and expensive slope.

First of all, the taxpayer will be taking the loss on all of these mortgages. That seems like one of the biggest government handouts ever. Secondly, this loan will bail out banks who overextended credit, falsified appraisals to inflate home values, or engaged in other practices to over-mortgage properties. These banks will be made whole.

However, the most complicated part is bailout out the homeowners who over-mortgaged their property and spent the money on something else. There are plenty of people who mortgage their homes to the hilt and spent the money on new cars, vacations, etc. This was encouraged by banks. Now, the taxpayer is going to pay for this profligate spending. And, McCain calls Obama a liberal!

The worst is that this rewards all the people who took advantage of the easy credit at the expense of those people who lived conservatively and didn't end up in trouble.

I'd prefer a program where the level of debt that the homeowner owes isn't reduced. Perhaps some level of debt has to be moved to a soft second mortgage that is only paid out when the property is sold (or is possibly forgiven if the homeowner stays in their home and pays their mortgage for 10 years). Mortgages will be restructured so that homeowners are given 'prime' terms even if they are subprime borrowers (30 year fixed rate mortgages only). The banks will have to take a write-down for the diminished value of the loan, but that will be cheaper than doing a foreclosure. And, perhaps, the government can provide some sort of tax credit proportional to the value of the writedown that a bank does to encourage this and soften the blow.

Homeowners who can't afford their mortgage even with the terms above should be required to pay whatever they can towards a restructured 'prime' mortage in order to get a six-month moratorium on foreclosure. This gives them time to move to something they can afford. It keeps some cash flowing to the lender during the foreclosure process, softening the loss from the foreclosure. A tax credit for restructuring the loan as described above is also a possibility.

I prefer this type of approach because the homeowner doesn't get to wriggle out of their responsibilities. I think that the very large majority of homeowners subjec to foreclosure knew that they were borrowing more money than they could afford. Shame on the banks for making this loan available, but shame on the homeowner for getting in over their head. This approach also limits some of the losses of the banks, but the banks will certainly take some losses (somewhat offset by some tax credits).

Minimizing foreclosures will help the banks financial situations and will help stop the drop in home prices from foreclosed homes flooding the market. There are probably still many challenges with this approach as the restructured loans are securitized and may be difficult to change. Part of the government rule would be allow these changes to happen without making the banks liable for changing the terms of the loans.

We have to do everything we can to make sure the money we spend during this time bails out the economy, not the individuals or companies who took advantage of the easy credit environment. Individuals and companies can survive, but they'll have to give up a lot financially in order to do so. Unfortunately, I don't know how we can reclaim the profits and bonuses that were legally made during the runup before this crisis.

Peace, Love and Understanding

Sat, 04 Oct 2008 10:08:03 -0500

Can't get this song out of my head today. The sentiment is as great now as when the song first came out in the 1970s.

No Matter What, You Gotta Vote

Wed, 01 Oct 2008 14:28:45 -0500

Time is running out to register to vote. In Massachusetts, you have to be registered by October 15. In New Hampshire, you can register on Election Day (great!). With all of the things going on in the world today, this election is certain to be extremely important. No matter where you come out on the issues, please be sure to register and to vote. Google has a nice site with voter information here.

So many people decide not to vote for many reasons (apathy, laziness, busy schedule, etc.). With more and more states offering absentee and early voting options, your schedule on November 4 isn't a viable excuse. Please be sure to register and vote, and get your friends to do so, too!

In the Globe

Mon, 29 Sep 2008 08:12:10 -0500

Scott Kirsner quoted one of my recent posts on the Wall Street meltdown in today's Globe. There seems to be consensus that there are lessons to be learned from the recent Wall Street excesses, but, in the long run, things should settle back down to more normal business.

Be mad, but don't be crazy

Sun, 28 Sep 2008 09:46:33 -0500

Back in May, I wrote about the misguided effort behind Massachusetts ballot question 1 on repealing the state income tax. I just don't see how you can have such a big dislocation of revenue without a plan for figuring out how we would deliver the services through some other means, public or private. If you look at our financial markets right now, you can see how chaos can spiral out of control when we have unsound financial plans.

Today's Boston Globe had an editorial piece on the same subject, recommending a No vote on Question 1. Read the editorial for a list of all the various groups who oppose question 1 -- the Mass Municipal Association, Chambers of Commerce, teachers, school administrators, religious charities, even the Mass Taxpayers Foundation.

Some tidbits from the editorial:

After steady work by fiscal conservatives in the Legislature, Massachusetts has shed its "Taxachusetts" epithet and now ranks 32nd for overall tax burden - that is, all taxes paid as a percentage of personal income. That is below the national average and well below competitor states such as New Jersey, California and Michigan.
The Massachusetts Taxpayers Foundation estimates that some $13 billion in state spending is non-discretionary: required by court order, the constitution, or federal law. The $12 billion cut would have to come out of what is left.
The state could stop spending every dime it now spends on local aid and every dime on human service programs - food banks, domestic violence and homeless shelters, care for autistic children, substance abuse and more - and still not have enough to make up for what is lost to Question 1. The state could fire all 67,000 state employees - every prison guard and college teacher - and still have to find another $7 billion.

And, most amazingly proving the craziness on the part of the backer of Question 1, Carla Howell:

Carla Howell, chairwoman of the committee sponsoring Question 1, says 41 cents of every tax dollar is wasted. How does she know that? It's what people estimated in a survey she took.

That's the kind of sound financial analysis that caused our current Wall Street mess. I am all in favor of cutting taxes, but only with a plan that figures out what we will do in their place. With the lower tax burden in Massachusetts, what is the analysis that shows that we could and should cut our way to the bottom?

As the editorial says:

We hope voters will remember the slogan that helped defeat an earlier tax repeal effort - "I'm mad, but I'm not crazy" - and reject this reckless measure.

If you read the comments to the editorial, it's clear that there is a lot of anger among taxpayers. There is no doubt that there is money to be saved in the state government. But, it's much more effective to do surgery with a scalpel than with a meat cleaver.

Listen to the front-liners

Fri, 26 Sep 2008 07:32:47 -0500

At any company I've been involved with, the front-line people always know what is really going on. Executives have varying degress of knowledge, but no one fools the people on the front-line. When a strategy change is announced or someone is fired, you can usually hear people on the front-line saying "FINALLY!" If people at the company know what should be done, why does it sometimes take the executives so long to figure it out?

The most common reason is that no one listens to the front-line people. Maybe top executives don't spend time with people on the front-lines. Maybe they hear things, but their top managers dismiss this feedback in order to deliver their own message. In any event, if you aren't listening to people on the front-line, you are missing what is really going on.

If you are a CEO, you have to be careful when you try to get this feedback directly. Employees have to feel safe in bringing up issues with you. They can't fear reprisal, from you or anyone else. Also, you have to be careful in how you react. If you say "we shouldn't do that" when you hear about an issue, that becomes a directive. I remember a company I worked at once where the CEO (Frank) did a good job talking to people on the front-line. But, "Frank said" became the way that someone could cut through normal decision-making. And, "Frank said" usually meant that Frank was empathetic, not making a decision on the spot. Instead, try "I'll look into it" (only if you mean it).

Here's a current example of top leaders ignoring feedback from the front-lines. In today's column by Steven Syre in the Boston Globe, he writes about Sheila Bair, head of the FDIC since 2006. She was trying to raise an early alarm on sub-prime mortgages:

Bair was working in Washington as assistant secretary of the Treasury for financial institutions until 2002. She already didn't like what she was seeing in the mortgage market then.
"In 2002, she had tried to get the Federal Reserve to pay attention to subprime loans," says Tom O'Brien, former dean of the Isenberg School of Management at UMass. "She was worried there was fraud being perpetrated, and she was sure this was going to cause tremendous problems for people taking out the loans. But none of us saw the systemic risk and how it mushroomed. But we used to talk about the fact that she couldn't get the Federal Reserve to take that seriously."
Ben Branch, a UMass finance professor and friend of Bair's, recalls similar conversations in Amherst.
"She was way ahead of the curve on all these problems and trying to get people's attention. Unfortunately, people didn't listen to her so much."

I didn't know anything about Bair until this morning, but it sounds like we have the right person in charge of the FDIC, which insures bank deposits. The FDIC will be under alot of pressure as some banks fail, but hopefully she'll make the right calls (and listen to people in her front lines).

At what cost?

Fri, 26 Sep 2008 07:11:36 -0500

It's hard to avoid talking about the big proposed government bailout of the financial markets. As Fred wrote, we need some liquidity in the system where private companies don't feel comfortable providing that to each other. Having a credit gridlock stall the economy isn't in anyone's interest.

But, if the government is going to be the investor of last resort, then the government (us) should get the lion's share of the upside. The AIG deal seems like a good blueprint -- an $85B loan at a higher than market interest rate, secured by $1 trillion in assets with an 80% equity stake in the company to capture the upside. This could turn out to be a pretty good deal for the taxpayers, who could make a profit. In fact, this is probably a good buyer's market for private equity investors with the guts (Warren Buffett investing in Goldman Sachs) or the deep pockets (us, again) to invest now when others won't.

To me, the big challenge is figuring out what these assets are worth. If the government is going to take bad loans and other investments off the balance sheets of financial institutions in order to shore them up, then the government needs to get a great deal on the value of those assets. We're talking cents on the dollar. This may cause the financial institutions to do some further write downs, but will at least let them signal the markets that this write down is the last one. And, it will give the taxpayers some upside potential. I don't know who is going to decide what these assets are worth, but it has to be a VERY conservative estimate. Maybe this is a good job for Mitt Romney?

If you've ever been at a company that has gone through a recap investment round, you know that the terms can get pretty draconian. That's what we need to enforce on Wall Street. That's their punishment for getting in way over their heads and toppling the house of cards.

Start-up Rx

Thu, 18 Sep 2008 12:19:56 -0500

My friend, David Aronoff, has a good set of prescrptions for start-ups to follow during tough financial times. Check it out. Most importantly, in my opinion, are his points on cash. Raise more (if you can). Spend less. And rigorously scrub your sales pipeline.

Maybe I'm Old Fashioned

Thu, 18 Sep 2008 10:55:29 -0500

I've spent some time trying to learn some of the reasons behind the recent Wall Street meltdown. Here are some good things to check out:

Fresh Air interview with Prof. Michael Greenburger 9/17/08

The Giant Pool of Money from This American Life 5/9/08

Definition of Credit Default Swap

My conclusion is that the fundamental problem is that financial institutions were not required to truly represent or report the value of their holdings, the level of risk represented in their holdings, or to ensure that they had sufficient capital behind the leverage they were utilizing. This isn't new news. Excessive leverage and speculation was on of the major reasons for the Wall Street Crash of 1929. In fact, as I was reminded last night when I watched Enron: The Smartest Guys In the Room that complicated financial structures that defy transparancy have led to problems just in the last few years. Enron and their auditors continued to obscure the fact that the company was losing huge amounts of money, right until it collapsed. In many ways, many of the investment banks have done the same thing with credit default swaps.

I think that deregulation has gone too far, but I am not at all in favor of having the government restrict the type business transactions. I think people should be able to do whatever kind of crazy financial structures they like. But, where the government and the SEC can be very helpful is in ensuring that these transactions are accurately reflected on various firms balance sheets in terms of true underlying value, level of risk, concentration of risk, liquidity, and capital reserves. This will make over-leveraged companies stand out and be more fairly valued in the market. As it was, companies were rewarded for taking big risks because they could report higher profits, which led to big bonuses and higher stock prices. And, as in the mortgage crisis, you can't count on independent rating agencies to figure it out. Such a house of cards was erected that we are still seeing it topple long after the subprime mortgage mess first became visible.

An interesting contrast I see -- after Enron, Worldcom, etc., Sarbanes Oxley was passed with the intent of making companies have more accurate and transparent financials. And FASB and the IRS (see 409A) have gotten stricter and stricter with the recommended accounting practices you have to follow to get a clean audit. Where were these guys when the financial institutions were making credit default swap deals to inflate their profits and hide their risks?

I guess I am just an old fashioned guy. As an entrepreneur and VC, many people may have thought that I was a risk taker. But, those risks are nothing compared to these complicated financial transactions. At least I understood the risks I have taken. And, I prefer a transaction where people's interests are aligned -- I buy stock, company grows and performance improves, stock goes up, I sell my stock. It's not as simple as it sounds. But, it's easy to understand and straight-forward to value!

The person makes the job

Tue, 16 Sep 2008 16:47:57 -0500

It's the person who makes the job, not the other way around...

“Jesus was a community organizer. Pontius Pilate was a governor.”

This quote is getting some people upset. The point isn't to compare Obama to Jesus or Sarah Palin to Pontius Pilate, but to remind ourselves that you have to look at the person, not just the job they had.

Taking the Medicine

Tue, 16 Sep 2008 15:38:56 -0500

The difficulties on Wall Street this week are a reminder that from time to time we have to take our medicine. Many entrepreneurs felt this after the Internet bubble burst. We all knew of the excesses of the Internet boom, but very few people were able to resist diving in and trying to capitalize. When things burst, we had to radically change our approach and rationalize our investments. Although incredibly painful, particularly for those who lost their jobs, this is an important part of capitalism.

This type of U-turn is important feedback to remind investors about irrational exuberance in the future. Investors got religion on capital efficiency and more coherent business models. Over time, they will get less disciplined as the sting wears off and, eventually, market strength returns. But, corrections come which reminds people to stick to the fundamentals.

Homeowners who knew that they couldn't afford the loans that they were taking out and investment bankers who knew that they were overextending themselves with excessive leverage are both like crazy Internet entrepreneurs in the bubble. They may have known that what they were trying to do didn't make sense, but the market was letting them do it. It wasn't illegal or unethical (although I am sure that there were unethical dealings in some of each of these types of deals). Maybe things would hold up long enough for them to take advantage of it. But, when it doesn't, I don't have much sympathy. They took a chance, and it didn't pay off. Unless someone lied to them about the risks, they generally have to be responsible for their own actions. That's taking the medicine, and it will make them think twice before they do it again.

I am generally not a big believer in government bailouts in these situations. I guess that some of these situations are so big that the government has to guarantee some aspect of the deal to get it done. But, I would be more in favor of cutting the price to the bone and having no guarantees. If that means that the stocks of the investment banks are worth nothing or that someone loses the house that they couldn't really afford, so be it. If the government helps anyone, it should try to make sure that unknowing customers are protected and that there isn't a run on financial institutions that is unjustified. And, the government should insist on more transparency to limit the risk of this type of thing in the future. I like transparency much more than regulation. Regulators will inevitably get it wrong (see Sarbanes Oxley). But, quantifying the risks of all of a banks holdings is a good thing.

Lessons for all: Don't live beyond your means. Don't over leverage your business. Don't take on much debt. All of these things may feel good in the short term, but the medicine you will inevitably have to take won't taste very good in the end.