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Archive for November 18th, 2008

The Historic Link Between Tulips and The Sub-Prime Mortgage Debacle

Tuesday, November 18th, 2008

by: Geoff Ficke

Almost every living individual is being effected adversely in some way by the international economic meltdown we are experiencing today. The genesis of this severe financial downturn is attributed to the United States government encouraging the expansion of homeownership to people who would have historically been deemed unworthy of obtaining credit. The banking systems participation and eagerness to leverage credit risks by extending loans to people with poor credit histories is the principal cause of the current sub-prime mortgage crisis.

Historically, the bursting of the credit bubble follows a long and dubious line of similar scandals. Greed, hubris and suspension of common sense and disbelief are always present before the hen comes home to roost after the gravy time has ended. The panic of 1908 in the United States, the worldwide Great Depression and the implosion of the technology stock bubble in the late 1990’s are memorable examples of euphoric periods followed by great loss and assignation of blame as to the causes of these financial busts.

These peaks and troughs in economic fortune are not unique to modern times. One of the earliest documented financial crazes was the Dutch Tulip Mania in the 17th century. The Dutch, being a tiny, mercantile nation, surrounded by larger, stronger empires were the earliest creators of trade policies and sophisticated financial products. One of their most creative vehicles was the introduction of the futures market.

Tulips were introduced into the Dutch economy and agronomy early in the 17th century. They quickly became prized for their beauty and the floral engineering that created many unique, exotic varieties of tulips. An exchange mechanism developed for speculation in the valuations of the various strains of bulbs. By 1637 a full-scale mania had erupted in evaluating future tulip bulb harvests.

Records from that period are sketchy, but it is known that a single Viceroy Tulip bulb was valued under contract for between 3000 and 4200 Dutch florins in 1637. Contrast this with the annual wage of a skilled Dutch craftsman of 150 florins per year. Isn’t this a definitive example of excessive senseless mania?

The Dutch referred to such trading contracts as “wind trade”. This was because no one ever actually took possession of the tulip bulbs. They simply owned a piece of paper, a contract that documented their claim on the tulip bulbs. Does this example of financial engineering ring any bells today in our current distressed situation?

The popularity of the tulip trade, and the amazing returns, mostly paper gains that were realized by the early speculators created a stampede of inexperienced, gullible speculators. Noblemen, farmers, sausage makers, chimney sweeps and day laborers began to speculate hoping to turn a few florins into exponentially huge investment returns. Of course, the last investors in, were the most harshly abused by the implosion of the tulip bulb speculative bubble. This is true in all bubble cycles.

The British economist Charles Mackey wrote a tome in the 18th century cataloguing the history of the Dutch Tulip Mania. His “Extraordinary Popular Delusions and the Madness of Crowds” remains in print to this day. Business schools and economists refer to Mackey’s study of the herd mentality of people during manias. Nevertheless, though Extraordinary Popular Delusions is still studied, its lessons have hardly been taken to heart.

The greed and hubris that are always present in manias too often define the human condition. People tend to see someone profit from an enterprise and try to emulate their perceived success. This engenders ever more people attempting to participate in the affair and the result is a panic, a mania, a bubble, then disaster.

The no money down payment, zero document loans, offered in the last decade created a completely different type of borrower and lender. The borrowers have no skin in the game. They get to possess a home in which they have no equity. As long as their condition is stable they can maintain possession. However, if their fiscal condition recedes, or the value of the property declines, they are in deep trouble. Foreclosure is a reasonable action for them to undertake to simply walk away from a gamble that did not work out for them.

The lenders have suspended proper underwriting standards in order to induce entry into these risky home sales transactions. They have little skin in the game, because they have conceived exotic packaged investment vehicles where mortgages are bundled and sold to investment speculators all over the world. The owner of the mortgage is actually unknown to the mortgagee, or even the originator of the loan. The loan originator collects their fees and offloads the loan obligation from their balance sheet. The risky transaction is now someone else’s responsibility.

As a result we have endured a period of fake prosperity built on credit swaps, personal irresponsibility, corporate irresponsibility and governmental corruption. The mania of our time is cheap credit. This bubble has burst, and every homeowner faces shrinkage in the valuation of their property because of the greed of speculators and the attempt of government to secure homeownership for people who should be renters. Community banks and credit unions that have maintained high lending standards are being hurt because of the recklessness of the giant money center banking institutions. Retirees and prudent investors have seen their savings and investments slaughtered because of the inane greed and corruption of others.

The 1990’s technology stock bust decimated a generation of people who came to believe that investing in the inter-net was the new “Holy Grail” for prosperity. Startup companies with no sales, no balance sheets and inexperienced management were given huge market valuations. Investors were advised that the tech boom was just in the first or second inning of this nine inning game. Brokerage firms provided guidance on equities that they actually made markets for. This bit of double dealing lead to constant buy calls on tech firms stock that insiders knew had no prospects for success.

The Dutch Tulip Mania, the Mississippi Company, the South Seas Company, the South African Milk Culture craze and the many modern crazes, Ponzi schemes and asset bubbles that we continue to experience are testament to man’s inability to control emotions. Greed, power and wealth are aphrodisiacs for many. We are imperfect beings, susceptible to herd mentality, even when we have knowledge of history’s lessons and could apply these to spare ourselves the pain of participating in activity that will assuredly lead to great pain and loss. Discipline, responsibility and thrift are essential to long term success.

How To Assure Failure In a New Venture

Tuesday, November 18th, 2008

by: Geoff Ficke

One of the great benefits we enjoy about the consulting work we do is having the opportunity to review the inventiveness of hundreds of entrepreneurs each year. It truly is amazing how many of these creative talents push the envelope of novelty. There is no such reality as the oft stated: “I have seen it all”. None of us have seen it all, as the volume of freshly executed innovative products and concepts being nurtured, is never ending.

And yet, so few of the projects we review ever make it past our initial critique and pre-product development criteria. They will never become widely distributed products, successfully sold in the contemporary marketplace. There are many reasons for this. One reason seems to occur more than most.

Many entrepreneurs become so enamored of their vision and perceive the markets will have positive acceptance for their item that they suspend rationality. We have a term for this malady: “falling in love with the product”. Love is a wonderful emotion. However, it can blur rational thought. The process of gaining purchase into hyper-competitive markets and successfully commercializing new products requires a steady, realistic, but passionate vision. Total commitment to detail and identifying an unfilled market niche, one with scalability, is essential to successfully selling to retailers and consumers.

Very early in my career as an entrepreneur, I made the mistake of “falling in love with my product”. I had created a unique cosmetic accessory product. I was able to bootstrap distribution into almost all of the major department stores in the United States. Then I expanded and sold the product internationally through country specific distribution agreements. Seeing your novel product creation on store shelves in the world’s finest emporiums, such as Marshall Field’s, Bloomingdale’s, Macy’s, Nordstrom, Preciados, Harrod’s and Selfridges was more gratifying than can be described.

However, I did not spend enough time building my Company. I was a single product business. Initially sales were lucrative, re-orders were positive. I was attempting to handle sales, marketing, product development, operations and logistics. I was too close to my product to recognize my shortcomings and the limit of my resources.

Nevertheless, I had penetrated a difficult, sophisticated market. I was a real entrepreneur. I had achieved a modicum of success and had gained the knowledge necessary to launch more companies and products in the future. I learned from my mistakes.

Most of the new product submissions we receive come from first time inventors. Every entrepreneur is a novice at least once. They believe they have identified a need, created an answer to that need and are prepared to sell their item for millions of dollars to big box retailers or investors. It almost never works out that way. Here are a few anecdotal examples that prove this point.

Items like the “arm mitten” are too narrowly positioned to ever achieve mass- market scale. The “arm mitten” is a patented product that is a simple sleeve the driver of a car places over their left arm, to protect the arm from sunburn. Air conditioning, high speed driving with windows closed for wind noise mitigation and safety glass treated with UV inhibitors all posed massive hurdles to the potential for “arm mitten” success.

Consider the “beach boot” for negotiating sandy terrain. This boot, equipped with tank-like tracks attached to the sole and a miniaturized motor roll the wearer over the sandy beach surface. Why walk over sand when you can roll? Why walk barefoot when you can ensconce your feet in hot, sweaty boots at the seashore? Not much upside here!

The “insomniac helmet” was a sleep aid, sort of. There is a small battery powered motor humming in the helmet and the unit massages your head with rubber fingers until you fall asleep. The straps utilized to attach the “insomniac helmet” to the users head look like preparation for capital punishment. Now I like a neck massage as well as the next guy, but this Rube Goldberg contraption would make falling to sleep a nightmare.

The “cup o golf” was the proposed answer to every duffer’s hope for improving the golf swing. A steady head is crucial to a fine golf swing.

The “cup o golf” was a little cup, attached to the bill of the cap. The cup contained a little ball tethered to a string. When the head dropped or moved the ball rolls out of the cup, and dangles annoyingly in front of the golfer eyes, thus conveying that the swing was imperfect. Some players, using the “cup o golf”, could take nine hours to play a round, and they wouldn’t be good company in the clubhouse bar after the experience.

Another example of an inventor’s blind love in their product was the “dad saddle”. This item took the papoose pouch that parents use to carry infants on their backs to new heights, or lows. The “dad saddle” was invented to enable dad’s to carry 10 or 12 year olds on their back without perpetrating excessive lumbar damage. The “dad saddle” is a leather waist strap that the bigger pre-teen can stand on and hold onto padre’s neck. Cool! Bonding forever!

Each of these items is patented. Each of these inventors, and thousands more, spent considerable time, energy and some capital on their ideas. They had really “fallen in love with their invention”. Unfortunately, the inventor’s view of their product is irrelevant in the long run. The marketplace is the final and only arbiter that counts in measuring whether offerings are truly novel, commercial products. Sales equal confirmation of entrepreneurial assumptions about products.

Successful entrepreneurs must treat their inventions as if they are always works in progress, because they are. They will know what the product’s strengths are. These are usually obvious. Aggressively seeking out the flaws in the concept and addressing and improving these weak spots are essential to achieving success. If you are “in love with your product” you will find it much more difficult to edit, redesign or change direction as needed. If this is so, you will fail.