Janet Tavakoli’s live interview with Financial Times:

http://ftalphaville.ft.com/blog/2009/01/09/50980/bailing-out-the-bad-guys/

Another Dear Mr. Buffett reviewer’s comments:

http://seekingalpha.com/article/113943-no-mere-buffett-a-14-course-menu

Watch Warren Buffett’s interview on The Charlie Rose Show in October 2008.

Drinking Kool-Aid?

by K. Graham

Warren Buffett, the legendary “Oracle of Omaha,” started communicating in 2005 with Janet Tavakoli, author of the book Structured Finance & Collateralized Debt Obligations (yes, that book was the subject of the featured review article in the last edition of HQ Financial Views).  The gist of those conversations as they relate to the financial and world events unfolding through 2008 are intermingled with Tavakoli’s insights in a thought-provoking easy to read narrative in this just released book, Dear Mr. Buffett: What An Investor Learns 1,269 Miles from Wall Street.  Of course as usual, the different topics covered probably will appeal relative to each reader’s perspective, which is fine because once again Tavakoli has written a book that offers much to ponder.  “Drinking the Kool-Aid,” human nature, and marketing are the subjects reading Dear Mr. Buffett made me contemplate.

According to Wikipedia, “drinking the Kool-Aid” is a term first used by The Washington Post in 1987 in a quote about former Washington, D.C. mayor Marion Barry.  That usage was derived from the 1978 slaying of over 800 people in Guyana by cult leader Jim Jones who put potassium cyanide in his followers’ Kool-Aid.  These individuals knew that the sweetened water contained poison but they drank it anyway because Jones ordered them to do so.  Tavakoli provides a phenomenal amount of evidence and quotes from the regulators, financial leaders, and other individuals directly involved in the current global financial meltdown. The comments and actions given as examples lead me to think that if these people were not stupid, ignorant, or gaining some sort of payoff, they must have been drinking the Kool-Aid that either trapped them in an increasingly onerous situation or blinded them to reality.

For example, Tavakoli quotes SEC Chair Cox about a week before Bear Stearns blew up. He assured the public that all the major investment banks including Bear Stearns had plenty of capital so there was nothing to be concerned about.  Now if I sitting here in Chicago knew at that time that those banks were likely to falter, how could someone in Cox’s position not know, especially if he had reviewed their books?  If ignorance, stupidity, or a payoff are not the culprit for his blunder, could belonging to a culture that would penalize him personally for doing his job and reward him for accepting the prevailing dogma been enough of a trap to bind him?  Could being part of the “in crowd” play a role in blinding him to reality?

There’s a lot of Kool-Aid drinking in the world and it’s not all poisonous.  For instance, as a retained executive search recruiter, the most important quality my candidates must have outside of the requisite skill sets is that they “fit” the corporate culture.  In other words, they naturally like the flavor of the Kool-Aid of that organization’s culture.  One of the key ingredients for being promoted is a person’s personal commitment to the values that the firm’s upper management holds.  Can you imagine someone working for Buffett who doesn’t conduct independent fundamental analysis, doesn’t evaluate the underlying collateral’s probability of default and recovery worth, and loves leverage?  There are many successful financiers and business owners with such non-Buffett approaches but if they’re not drinking Buffett’s Kool-Aid, they shouldn’t be a Berkshire Hathaway investor or employee. These value distinctions expressed in different corporate approaches create the profit and loss opportunities in open financial markets. These value disparities are what create the opportunities for Buffett to repeatedly profit from others’ practices, which Tavakoli provides numerous accounts of in Dear Mr. Buffett.

How does one individual, such as Warren Buffett, continually keep producing such positive returns?  In Structured Finance & Collateralized Debt Obligations, Tavakoli explains the unusually large number of purported financial geniuses present in the modern world using probabilities of a coin toss: “If you have 64 people in a room, each tossing a coin,…the law of probabilities being what it is, one person will flip heads six times in a row.  This person will be dubbed a genius.  What genius?  What cockamamie twaddle!  The next thing you know, another firm has signed the lucky person to a two-year contract at a minimum of $1 million per year.”  In Dear Mr. Buffett, Tavakoli focuses on the outlier, the person who truly is a genius.  Reading this book, reviewing the volumes of material written on Buffett, watching Buffett’s interview with Charlie Rose from October 2008, and thinking of other true geniuses, I realized that these outliers share at least three common characteristics.

The first two are a profound comprehension of their subject matter and a deep understanding of human nature.  Buffett attended Wharton for several years before transferring to the University of Nebraska where he earned his BS in Economics followed by a MS in Economics from Columbia University where he studied under the famous Benjamin Graham.  Graham gave Buffett an A in his classes, which was something very uncommon for Graham to do according to Tavakoli’s book.  At 24 years old, Buffett started working at Graham’s firm, Graham-Newman, as a securities analyst.  Two years later he had amassed personal savings of over $140,000, which was a lot of money in 1956.  Obviously, from early on, Buffett demonstrated great investing comprehension, a talent that he refined into a philosophy of investing that Tavakoli explains with frequent stories in Dear Mr. Buffett.

As for a deep understanding of human nature, Tavakoli begins in her preface by saying that Buffett “has a genuine affection for the human race, and a generous desire for everyone to get as much from life as he does.”  This regard and knowledge of how people work is also clearly displayed in Charlie Rose’s interview of Buffett.  When asked about who created the current financial fiasco, some of Buffett’s comments were: 

· “Everyone behaved foolishly.”

· “People should always know better.”

· “You’re not going to change human nature…It’s the basics of greed…you see others making money and you want to do the same…it pays off for awhile.”

His three market phases were also very illuminating: Buffett calls them “the three I’s”:  Innovators followed by Imitators followed by Idiots.  The comment he made that most embedded in my musings, however, was when Buffett said, “It’s a big mistake to mislead people.”

The third characteristic that true geniuses have is their innate knack for marketing, themselves as well as their companies.  There are over one million Google entries regarding Buffett and his marketing genius.  There’s a whole section at each of the major bookstores dedicated just to books written about Buffett.  That’s a lot of free advertising Buffett is gaining.  So what is Buffett doing different than other investors who have to pay for their brand marketing?  What has he done different than Wall Street? 

In Tavakoli’s book she mentions that: Buffett is top tier school educated; he’s a “highly intelligent polymath;” Buffett uses derivatives to make money; he takes directional bets; he hedges his portfolio in multiple ways including buying only assets at bargain prices and eschewing debt; and although an advocate of transparency, much of his firm’s earnings are hidden because Buffett’s company “prefers to purchase companies that generate earnings that do not have to be reported.”

The Wall Street “Black Barts” that Tavakoli mentions by name and quote in Dear Mr. Buffett are also generally top tier school educated; highly intelligent polymaths or geeks; use derivatives; take directional bets; hedge their portfolios although not using all of Buffet’s methods; and prefer a lack of transparency.  Outside of the facts that their use of derivatives, their directional bets, and their hedging portfolio techniques of using leverage and buying pricey assets have not resulted in the success that Buffet’s approach has garnered, is there any other difference between Buffett and some of the Wall Street crowd?

“It’s a big mistake to mislead people.”  Hmmm.

Reading Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street provided me with some great insights.  Other reviewers of this book focused on other aspects.  What I and all of her other reviewers to date have agreed on is that Janet Tavakoli’s newest book is yet another “must read.”  After reading Dear Mr. Buffett, why don’t you visit HQ Script’s blog at www.hqsearch.com/blog to read the other reviewers’ insights, watch the Charlie Rose interview of Warren Buffett, and add your own perspective?

In July 2005 for the first time all commodity prices rose in the same period, Goldman Sachs outlandishly forecasted oil prices rising to $105/barrel, Goldman and Citigroup stated that these oil highs wouldn’t last with Citigroup saying that declining demand would be the restoring factor.  Commodities expert Jodie M. Gunzberg, who is Marco Consulting Group’s Chief Investment Strategist, reviews Kathy Graham’s article that covered these factors as they occurred.  She then continues commenting on where commodities have gone since and what are likely scenarios for tomorrow.

 Commodities: They’re not boring anymore

by Kathy Graham

FIRST PUBLISHED JULY 2005 IN HQ FINANCIAL VIEWS

A first has occurred - all commodity prices are up at the same time.  Most understand that this demand for commodities, i.e., all agricultural products au natural and refined (like cocoa and sugar, which are called “soft” commodities), metals, and energy - is due in part to China’s growth coupled with the U.S.’s hunger for such products in an environment where global resources are more readily and affordably accessible.  What isn’t commonly understood is how pervasive commodities financing and investment decisions wrap round all of our lives and some of our careers.

The producers’ impacts

Economics 101 says that when demand increases to the point that the current supply cannot cover it on a short-term basis, prices rise and, in response to the increased prices, supply swells to meet the demand, thus recreating equilibrium again.

The problem with commodities is that supply can’t easily be increased until a new crop is grown, a new mine and/or refinery is built once new ore or oil/gas/etc… is discovered … and then more railways, roads, and ships to handle the extra loads need to be added.  Time, for most commodity supply increases to occur, is minimally a year and often as long as five to ten years.

Further exacerbating the time issue is the fact that most commodities are not items that store well because, as discussed in Hilary Till and Josepth Eagleeye’s chapter “Commodities - Active Strategies for Enhanced Return,” in the forthcoming book The Handbook of Inflation Hedging Investments, the storage costs are too high so commodities lack the inventory safety net.  Therefore, when supply/demand imbalances occur, prices of commodities tend to rise for longer time periods than experienced by other products.

The producers, most all but one notable exception, are racing to fulfill their expected role of increasing supply.  According to Rebecca Bream, Christopher Brown-Humes, and Keving Morrison in their Financial Times article on 4/11/05, “On the climb: a natural resources boom is unearthing both profits and perils,” mining is up, heavy machinery for agribusiness are having record sales year, plus port operations and ship owners are examing their capacities so over time supply will again meet demand.

To meet these new goals, producers are cautiously adding staff, especially in the risk management areas as commodity firms, quite familiar with the volatile “boom or bust” nature of their business, want to ensure that they don’t expand themselves into a downdraft.

The one notable exception to producers increasing supply in response to higher prices are the oil companies.  With their increased profits they don’t appear to be increasing exploration or ways to grow supply.  Instead it seems that they’re mostly buying back their own shares and acquiring other companies.  Neither of these activities incrase supply so the question remains: Given increasing prices, why aren’t oil companies investing more in exploration and growing supply?

One final thought:  a nice feature not often mentioned is that because many of these commodity producers are in third world or emerging market companies, all this building, mining, and growing is creating jobs.  The jobs are moving people from the country to the cities and providing those individuals with the resources to buy new goods and services they couldn’t afford before, thus strengthening the virtuous circle towards better living conditions slowly on a global basis.

The financiers’ impacts

Already consumer banking systems where none or only primitive facilities existed are being established in these countries according to international monetary standards proven to increase liquidity via creating structures that people can trust with their funds.  Stronger local banks built on regional monies are now vying for business that the major international banks once owned.  The cost of capital is falling in these areas due to the increased competition, again fortifying that virtuous circle.

The international banks’ original supplying of capital to these regions at rates lower than their country’s rate helped set the stage for corporate development.  This type of financing is called structured financing because it’s based not on the quality of the firm’s balance sheet (which, in many countries where their accounting standards aren’t up to acceptable levels, is questionable to begin with) but on the profitability of the transaction.  Because these banks are global, they have the resources to minimize the multiple risks inherent in such deals via the way they structure the contracts.

Structured commodity trade finance and traditional commodity trade finance are the financing tools that primarily a handful of international banks offer to commodity producers and the commodity trading houses worldwide.   These tools are the vehicles that enable potential locked in the form of oil or gold in the

ground or plantations capable of growing coffee or oranges to be transformed into ready capital. 

The price increases that are driving producers to supply more product are also driving bankers to provide more credit lines and innovative structures to meet the producers’ demands.

Because much of commodity trade finance is in illiquid higher risk countries dispersed over a wide geographic region, there is a significant reputation and commitment barrier to entry for new financiers interested in entering this lucrative field.  Commodity trade finance consists of a small group of professionals - a much smaller niche than even hedge funds - working for banks that have been in this niche for a long time.  In fact, some of these banks have been doing this type of financing going back to the first trading ships that went to India and China.

Commodity trade finance professionals are smart and creative because they need to be able to structure financing around unique company and country conditions.  They are adept at managing all sorts of risk for commodities are one of the most volatile product lines (i.e., think just about agricultural products: slight variations in weather can result in bumper crops that send prices crashing with oversupply or wipe out an entire season’s productions…and we’re not even considering country risk, delivery risk, etc.).

The demand for commodity trade financiers’ services is creating the need to hire more credit, risk managers, and marketing professionals.  Because the supply pool of qualified individuals is small and widely dispersed globally, this demand is escalating base and bonus compensations.

The investors’ impacts

In addition to the usual producers and some financiers who use the commodity futures markets to manage their forward price risk, big money investment funds, pension funds and insurance firms are all increasing their stake in commodities.  Some are even actually taking physical delivery of goods!

Trade & Forfaiting Review’s 4/22/05 article entited “Pushing beyound the lines’ says that about $1 trillion commodities futures contracts are trading each month, making them more attractive to investors than private equity or hedge funds because of the ease of purchase and sale.  Many of the top performing mutual funds are in the commodity sectors.  Macro hedge funds are gearing their portfolios towards more of an energy-related emphasis.

Hedge funds are one of the largest holders of energy debt and are major players in the emerging field of the “green” products, which are organic agriculture and renewable energy sources.

 The “greens” could also stand for green as in money.  Consider organic agriculture; although not a large segment, it’s one of the most profitable sectors for its producers and retailers.

Although the renewable energy sources aren’t yet as profitable, they are attracting a lot of money.  Goldman Sachs, with its recent purchase of a wind power projects developer, is now one of the U.S. major wind developers.  Morgan Stanley is one of the largest emissions traders in the global sulfur dioxide market.  BP, formerly known as British Petroleum but today refers to itself as Beyond Petroleum, is one of the largest alternative energy producers.  There are now many dedicated “green” hedge funds, mutual funds, money management , and private equity firms.

Who knows - perhaps the “greens” will be the soft landing to the current commodities demand/supply imbalance?  Goldman Sachs, in its 3/30/05 controversial U.S. energy oil research report where it mentioned $105/bbl oil prices, says that oil demand in China and India plus U.S. gasoline consumption are the two major components fueling demand in this sector.  They continue by saying that they expect steel prices and drilling rig rate hikes to increase in the short run but in the long run they forecast return to equilibrium as either demand is destroyed or “material new investments” are made.  Citigroup in its 3/31/05 equity research global commodities report concurs that equilibrium will be restored by declining demand.

Declining demand can come from a recession, a shock to the system like a disease epidemic or terrorist attack, or through innovation.  Let’s hope it’s an innovative equilibrium restoration.

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BLOG STAR

 Jodie M. Gunzberg, CFA

Jodie is the Chief Investment Strategist for The Marco Consulting Group (MCG).  She joined MCG in 2007 as their Director of Research.  In October 2008, Jodie was promoted to her current role with the responsibility of working with the Fiduciary Services (FS) Management Committee to establish the asset allocation and structure of FS portfolios.

Prior to joining MCG, Jodie was Vice President of Hedge Fund Investments at Morningstar/Ibbotson.  Additionally, she has numerous years of investment management experience across all asset classes including: equities, fixed income and alternatives (hedge funds, real estate, commodities, etc.). 

Jodie has published many articles on commodity investing and hedge funds including:  “The Long and Short of Commodity Index Investing” with Paul Kaplan in the 2007 book Intelligent Commodity Investing by Hilary Till and Joe Eagleeye and ”Chapter 3: Absolute Returns in Commodity Futures Investments” with lead author Hilary Till in the 2005 book Hedge Fund Investment Management by Izzy Nelken.

Jodie is a Chartered Financial Analyst charterholder, a member of the CFA Institute, and serves on the Board of Directors of The CFA Society of Chicago.  She holds a BS in Mathematics from Emory University and an MBA from The University of Chicago.

ABSTRACT

In a year of transformation, communication skills can make or break your efforts.  Business Communications Trainer and Coach Cathy Emma gives sage advice on how to keep yourself and your team motivated while managing the emotions and anxiety that poor economic periods inflict on most individuals.  Immediately following this article is HQ Companies’ founder Kathy Graham’s first career advice column, Dear Kathy^©, which debuts answering questions regarding topics that

Cathy Emma covers in this article.

Staying Professional in Troubled Times

by Cathy Emma 

THE ENVIRONMENT

Wall Street bailouts, mortgage failures, volatile markets and unemployment are having dramatic impacts on the business world. The current financial crisis with economic downslides is hard on everyone. Frustration, anxiety and fatigue are widespread.  Companies, organizations and individual business professionals are finding it difficult to maintain stability and productivity. There is also serious concern about the loss of professional presence and good judgment in doing business. Performance levels and morale is low, and customer service is diminishing. That’s the bad news. The good news is that we are in a new era of CHANGE, and recovery is on the way, but you must be willing to take full responsibility for your own rescue plan and focus on building for the long term.

Effective communication is the key. Everything in life boils down to one’s ability to communicate well. The most successful business professionals and leaders typically are also the best communicators. This is especially relevant in a slow economy, but it applies in good times as well as bad. The way you look, speak, write, act and work defines YOU and your level of professionalism. Staying professional has never been more challenging. You need every tool, technique and strategy to keep that winning edge and maintain business success. Now is the time to invest in you by honing and reinforcing your communication and interpersonal skills. Your self confidence will be bolstered, your stress levels reduced, and you will be taken to a more vital level of professional presence in spite of what is going on in the environment.

Use it or lose it. Communication skills diminish when they are not practiced and polished. We need to take extra care in tough times when emotions run high and anxiety exists. Whether it’s face to face, speaking on the phone, writing or communicating electronically, you need to get your messages across in the most effective way. Client and customer loyalty increases when we keep our professional attitudes and integrity at a high level during a down economy. Business credibility is restored and a sense of security and mutual support and trust is felt by everyone.  Whatever mode of communication you use, being professional never goes out of style!   

A Few Tips for Communicating Professionally in Troubled Times

· Understand that attitude plays an important role in getting you through any crisis. Keeping a positive attitude will favor your personal welfare.

· Focus on excellent customer service by displaying a high level of professionalism in all your business communications with clients, customers and colleagues.

· Dress appropriately for your work environment and pay close attention to your appearance and body language. Both are powerful non-verbal communicators. Think “company image.”

· Speak clearly with energy and enthusiasm. Your voice and speech are important parts of your professional image. Keep them aligned with your credentials. Your speaking style is your “verbal” business card.

· Use excellent telephone and voice mail skills. Listen attentively to your caller to receive complete and accurate messages. This will add to your productivity and business success. Return all calls in a timely manner. Courtesy counts!

· Keep your email communications professional. Review the basic guidelines of good written communication and follow them. Check spelling, grammar and typos, and keep your messages brief and clear. Email is business correspondence. Hold it in high regard.

· Participate in professional development classes and training programs to reinforce your skills. Leaders can give their teams a boost by offering training sessions to help maintain productivity levels and business stability.

Maintaining professional attitudes in troubled times puts you head and shoulders above the competition and differentiates you from the pack. Confident communication produces business in any economy. Professionalism is a personal commitment that you make to yourself. Harness all of your energies and commit to creating your own recovery plan by investing in YOU. Stay professional and you will profit!

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Cathy Emma is a Business Communications Trainer/Coach and Professional Speaker. She is the president of VOICE POWER IN BUSINESS and a professional member of the National Speakers Association and the American Society for Training and Development. For more information on Cathy Emma, visit www.cathyemma.com , email  cathy@cathyemma.com or phone 630-513-5145.

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 DEAR KATHY

In a year of transformation for many finance professionals, we at HQ Search, Inc. want to provide the most of what finance professionals need.  Hence, the introduction of this feature that focuses on the soft skills.

Another new addition is a career advice column on our blog where you can write in confidentially with your question, which will be answered by HQs’ owner, Kathy Graham.

Graham will start her new column right here with a question that pertains to some topics that Cathy Emma just addressed.

Dear Kathy,

I’m behind in answering my emails and phone calls.  What should I do?

– Tardy in Chicago

Dear Tardy:

Cathy Emma says that you should first look at how to simplify what you’re doing so that you can stay on top of answering phone calls and emails.  Letting them build up is not good for your long term success.  If you can’t do it all yourself, is there some way to outsource some of your work to free you up?

Graham adds:  While you’re getting caught up, remember to sincerely apologize to those you’ve inconvenienced.

ABSTRACT:  Kathy Graham is back at it again:  read her 2009 Financial Services Job Forecast.  Will it be as accurate as her preceding six forecasts have turned out to be?  Find out what sectors and jobs will be growing…and what won’t.  Listen to her 11/14/08 interview with First Business discussing her 2009 Financial Services Job Forecast below, then read her article.

2009 Financial Services Job Forecast^©

by Kathy Graham

SUMMARY

For individuals in the financial services field, the entire year 2009 will be a year of transformation:  a year in which many financial services professionals change from one configuration into another one more suitable to the new set of variables that will be shaping their industry.  Hence, an opening picture of windmills in motion, transforming one form of energy—wind—into another more useful to us type of energy—electricity—using new technologies that free us from the negative effects of previous energy sources, seems quite fitting.

My 2008 Financial Services Job Forecast was correct, which makes all six of my annual predictions to date completely accurate.  The 2008 theme was “Winter can be a lovely season…but watch the weather for storm warnings.”  As forecasted, the year 2008 was a downturn all year with some really big storms blowing in.  Thankfully, the global economies managed—although barely—to escape a humongous blizzard. 

Unfortunately, some industries and individuals were close enough to that blizzard to suffer frostbite.  They will emerge in 2009 in a different form than what their appearance was previously.  As for the rest of us, well, we became very cold, even those of us who were dressed for the season.  Shaking off that cold by finding ways to warm up via transforming their skill sets into new activities is probably going to take many finance professionals all of 2009 to accomplish. 

This article begins by reviewing the history and process that enables me to reach this conclusion, then provides the positive and negative factors that are creating this condition.  It finishes by stating what financial services sectors and jobs will be growing and which ones won’t, and then offers advice as to how to enhance your

career based upon what sector your current skill set resides in.

The volume of negative factors far outweighed the few positive indicators this time.  White knights, i.e., sources of rescue in troubled times, are few as many hedge funds, ultra high net worth individuals, private equity, investment banks, sovereign funds, and banks have taken serious hits to their resources.  The size of the 2007—2008 financial fallouts have left governments as the likely option to resuscitate the industry where financial services professionals work.

When governments are involved, politics enter, processes lengthen, regulations increase, and unintended consequences occur.  Thankfully, thus far, the politicians globally are moving quickly and with a depth of financial understanding.  New systems, lower compensation, higher cost of capital, larger operating expenses, new regulatory requirements, and more stability and transparency are likely outcomes for the financial industry and corporations.

The year 2009 will be a phenomenally exciting time but still full of ups and downs as the new global financial infrastructure emerges and its professionals identify and settle into their roles.  For those who are prepared, this period offers great possibilities to exponentially grow their careers as change creates opportunity.

HISTORY & PROCESS:

Since 2002 I’ve been presenting an annual financial services job forecast, which to date has been completely accurate each year.  Now it’s time to use the same process once again to create my 2009 Financial Services Job Forecast. 

The forecast is produced by making a list of all the economic indicators in the current year that are relevant to predicting the next year’s job status in the financial services field, i.e., the asset management, banking, corporate, hedge funds, investment banking, private equity, real estate, research, and turnaround/workout sectors. 

The leading economic indicators used are: fiscal and industry statistics; senior financial management’s outlook; status of retained search recruiters; and personal perceptions of people in the different sectors (what I call “word on the street”).

Then this list of economic indicators is divided into two categories:

·        ones that are likely to have a negative effect on financial services job creation

·        ones that are likely to have a positive effect on financial services job creation. 

The last step is easy:  those job holders with more negative economic impacts than positive ones probably have a no growth to slow growth next year job forecast while those whose fields are affected by more positive than negative economic impacts will benefit from some job growth to really hot demand for their skills.

Analyzing the current year’s economic indicators to forecast financial services job demand works because both a person’s career and job are second derivatives.  You see, what first determines the value of a person’s skill set is the supply and demand level for the expertise stage the person whose career or job is being considered is at… BUT this first factor’s value is dependent upon the status of the underlying economy, which makes a person’s career and job second derivatives. 

People routinely forget that much more than their own performance and education determines their pay level, the availability of positions, and even the speed of their career progression.  Remembering that jobs and careers are dependent upon what happens in the underlying economy makes career decisions—and annual financial services job forecasts—more effective.

THE LEADING INDICATORS SAY:

What’s negative:

µ STATISTICS: The OECD Economic Outlook keeps trending downward for the US and the world with each semiannual update because of continuing financial turmoil, the global housing cycle, and soaring energy and food prices.  Cascading from 3.9% US GDP forecasted for 2004, the latest forecast for 2009 is now 1.1%, which is still more optimistic than the IMF’s forecast for 2009 US GDP.  Unfortunately, the OECD’s latest outlook also states that “the distribution of risk around the projections is wide,” which means that the possibility of a worse or better outlook than forecasted is greater than usual.

µ STATISTICS: The Chicago Fed National Activity Index CFNAI-MA3’s latest (10/21/08) 3-month moving average declined further to “-1.78 in September from -1.18 in the previous month.  This negative value…marks the tenth consecutive month that the CFNAI-MA3 has indicated an increasing likelihood that a recession has begun.”

The Anxious Index, which is what Table Four’s Estimated Probability of Decline in Real GDP in The Federal Reserve Bank of Philadelphia’s quarterly Survey of Professional Forecasters has been dubbed because that number is known for rising as recessions begin, peaking during them, and then declining when recovery is imminent.  With first quarter 2008’s number a 43, the second quarter 2008’s number a 29 and the third quarter 2008’s number a 47, the entire 2008 has had percentages around or above 30%, which is the starting point  indicator of a recession having begun. 

µ STATISTICS:  October 2008 US Non-Manufacturing Index plunged into recessionary territory numbers  in all four of its components.

µ STATISTICS:  Conference Board’s US Employment Trends Index “continued its decline in September 2008, suggesting even more losses to come in the labor market…The persistent slackening in labor market conditions, worsened by the financial crisis, has reached a level that in the past led to significantly slower wage growth across most industries.”  Confirming these results were the unrelated US Labor Department’s report stating that the jobless rate in October 2008 rose to the highest since March 1994.

µ STATISTICS:  Conference Board’s US Leading Index “has been falling since July 2007…(with) the weaknesses among the leading indicators remaining widespread over the past six months.”

µ STATISTICS:  Euro-area Economic Indicators such as the purchasing managers’ index and Ifo’s business expectations gauge fell to their lowest levels ever while the European Commission’s October 2008 measure of economic sentiment dropped to a fifteen year low.

µ STATISTICS: World Trade Organization’s estimates for world trade volumes fell in the second half of 2008 and appear to be continuing their decline until at least the middle of 2009.  “The financial crisis has not completely unfolded and the impact on the real economy may only just have started.”

µ STATISTICS: Standard & Poor’s Distress Ratio has risen to its highest level with nearly two-thirds of all distressed issues falling into the lowest ratings.

µ STATISTICS: The Usual 21^st Century Risks such as terrorism, energy, pan-epidemics, healthcare costs, and operational risks (key person, fraud, settlement, judge track record, claim liability, disputed/contingent claims, holding period, liquidation, tax issues, compliance, IT, legal, infrastructure, etc…) are again economic growth derailment possibilities if they impact sizeable areas.

µ SENIOR MANAGEMENT: Conference Board’s Measure of US CEO Confidence has remained at levels of pessimism associated with recession all of 2008. 

µ SENIOR MANAGEMENT: US CEO Confidence Index plummeted to a record low in October 2008.  Since it began in October 2002, never has there been such a sharp decline in all five indices (current confidence, future confidence, business condition, investment confidence, and employment confidence) simultaneously. 

µ SENIOR MANAGEMENT: PNC Economic Outlook among US Small Business Owners, who are the core of the US economy, are at an all-time high in pessimism, forecasting weaker sales, profits, and hiring; growing cost pressures; and tighter credit availability according to this survey taken in July 2008 – before the September and October shocks. 

µ STATUS OF RETAINED RECRUITERS: In three words:  hit hard globally, for obvious reasons.

µ WORD ON THE STREET: Banking, which now includes the major investment banks, on top of being more risk averse will also be more highly regulated, which means that the cost of capital will increase, dragging down GDP growth.

µ WORD ON THE STREET:  Unemployment in most sectors and countries is beginning to rise even more than the high numbers already racked up in 2008.  With profits, debt, and equity all providing diminishing returns coupled with weakening demand, the overall number of workers employed will most likely continue to drop.  Not even upper management is immune as more CEOs in 2008 than previous years have been “asked to quit” according to Chief Executive magazine.

µ WORD ON THE STREET: Consumer Cuts are beginning to impact overall economy as unemployment rises and significant investment  losses prompt consumers to minimize healthcare, consumption purchases, etc.  Car and appliance repair shops, Wal-Mart, and low cost fast food firms are some of the few industries showing an increase in business.

µ WORD ON THE STREET: Commodity prices are dropping, which are hurting in varying degrees emerging markets and sovereign wealth funds whose economies are dependent upon high demand for those products from foreign investors.

µ WORD ON THE STREET: High Net Worth individuals have had their overall monetary value negatively impacted as diversification failed to protect their portfolios.

µ WORD ON THE STREET: Countries ranging from the USA, UK, South America, Russia, India, Europe, China, the Baltics, Australia, Asia—just about everywhere except maybe Canada—are showing signs of slowing growth, rising unemployment, rising costs of capital, etc.

µ WORD ON THE STREET: Private Equity, including venture capital, is being rocked by large debt, a significant amount of previous years’ deals currently not worth much, growing mistrust between investors and managers, and a concern that these factors might seriously and negatively impact public and private pension systems, charitable foundations, etc., who are major investors in this asset class.  Three other potential issues have yet to surface: namely, negotiating lines of credit in 2009 for deals that can’t be sold because of market conditions, changing tax and regulatory rules, and the inability of investors to honor their future commitments because of negative changes in their own situations.

µ WORD ON THE STREET: Sovereign Wealth Funds—many of whom invested in private equity and financial institutions plus many of whom gain their wealth from commodity sales—are thought to have lost up to 25% in their investments this year.

µ WORD ON THE STREET: Traditional Asset Management of all types (mutual funds, active management, etc.) mostly saw their assets under management dwindle as diversification and modern financial management techniques failed to produce returns investors were anticipating.

µ WORD ON THE STREET: Investment Banks that remain are smaller than the former bulge bracket firms that are now banks, are more middle market focused, and yet are still impacted negatively by market conditions.  No large bulge brackets means less syndication fees while their equity shops are feeling the same effects as the other money managers, and the middle market firms that are their clients aren’t immune this time (see small business owners).

µ WORD ON THE STREET:  Hedge Funds, battered by poor performance, client redemptions, increasing government regulations, and a squeeze on funding are being forced in falling markets to sell more liquid assets—even ones that are more profitable—to cover margins on more illiquid holdings.  Service providers to hedge funds will see their business impacted by fewer hedge funds and lower total assets under management.  Hedge funds are expected to move their expertise into other niches such as exchanges, securitizations, private equity, long only funds, etc.

µ WORD ON THE STREET:  Bankruptcies, Turn Arounds, and WorkOuts are picking up speed with Chapter 11 bankruptcy M&A-related activity increasing for the first time in the last six years.  Although New York City is already busy with many engagements, most other areas of the US and abroad are just starting to encounter significant amounts of this type of work.

What’s positive:

µ SENIOR MANAGEMENT:  The Speed and Coordination of Government Intervention brought the response to a potential global meltdown to a level not encountered before.  Working virtually and in face-to-face meetings, together and independently, governments across the world took—and appear willing to continue to take—concerted and innovative actions to stem the liquidity and credit crunch creating this crisis all in a matter of days and weeks—not months and years.

µ SENIOR MANAGEMENT: Surviving so far the gravest financial crisis since the Great Depression is no mean feat.  The robustness of the global financial system even under great duress is a definite positive.

µ WORD ON THE STREET: Banking systems globally are showing tentative signs of recovery.

Non-Growth

Financial Services

Jobs/Careers

IN GENERAL:

â  Most financial niches and positions because overall available capital is likely to be pinched, which means new hires will be a slower longer process plus less frequent and raises smaller.

ASSET MANAGEMENT:

â  Minimal job growth and layoffs likely where assets under management lessen.

BANKING:

â  Minimal job growth here as cutting costs and minimizing write offs are the major focus.

CONSULTING:

â  Minimal new positions outside of accounting, compliance, government financed areas, legal, workout/turnaround or risk management and layoffs likely as many of the industries that consultants serve shrink and minimize expenses.

CORPORATE:

â  Most positions that are not government financed as the higher cost of capital makes more projects less feasible and demand less vibrant.

HEDGE FUNDS:

â  Most positions at a larger number of hedge funds.

INVESTMENT BANKING:

â  Most positions at most investment banks.

PRIVATE EQUITY:

â  Most positions, especially ones with larger deals.

REAL ESTATE:

â  Most residential and commercial positions.

RESEARCH:

â  Cut backs here, too.

Growth Job Areas:

IN GENERAL:

The usual downturn growth positions: 

• legal in the unemployment, turnaround, bankruptcy, and securities lawsuits sectors
• turnaround/workout/valuations. 

THE HOTTEST NEW JOB GROWTH AREAS:

á Clearinghouses, exchanges, and dark pools.

á Government financed sectors—likely candidates appear to be working for banks and consulting firms awarded the work of tracking and disseminating bailout monies; infrastructure rebuilding; energy sustainability; real estate renewal programs, etc.

á Financial institutions and corporations that are doing well (note:  “well” is defined as currently achieving near flat or positive revenue or investment growth) for these are the future colossally successful firms.

á Entrepreneurs who can invent and successfully market financial products and systems that actually work.  Some possibilities:

• portfolio level risk management systems
• asset management products that continue to deliver positive returns under all market conditions, including liquidity and credit crunches
• systems of tracking asset purchases and sales that provide transparency without revealing enough information that other parties can utilize that data for their own profit.

2009 Financial Services Job Forecast:

Wow!  In the six years that I’ve been doing this calculation, never have I seen data as nasty as these factors are.  From a human capital perspective, we’re not even at the bottom of this business cycle because many of the layoffs, restructurings, and workouts have not yet occurred…and there doesn’t seem to be any reasons that will surface to prevent those outcomes from happening in the financial services sectors. 

So, am I advocating that you consider all that effort you’ve invested into your financial career—which is looking quite like a frog with warts right now—as sunk opportunity cost?  Is tumbling to the bottom of the job pond and enveloping yourself in the slime of oblivion your only option?  No, not at all. 

In change, there’s opportunity.  Even in the Great Depression, there were many people and companies who exited that storm in a better condition.  The common actions that their stories share are that they:

o    cut costs, paid down debt, and made cash “king”

o    diversified

o    innovated possibilities that utilized and developed core competencies.

If others have done so, you can, too. 

Talk is cheap unless it is followed by actions.  I took quite seriously my 2008 forecast so my company, HQ Search, Inc., has re-emerged as four fully functioning firms—HQ Services, HQ Scripts, HQ Search, and HQ Seminars, Inc.—ready to connect financial services professionals with what you need to be successful in the coming year.  Visit our websites at www.hqsearch.com  to view our new product offerings.  Call us at anytime—we’re here to help in myriad ways transform your career and company into the best ever.

Your 2009 Transformation Goal:                         

ABSTRACT

Janet Tavakoli was one of the first and few voices speaking up about the risks of structured finance, including derivatives. The 2003 first edition of this book was a beacon warning of the dangers that this product line would play in creating the current global financial crisis.  Her new book, Structured Finance & Collateralized Debt Obligations: New Developments in Cash and Synthetic Securitization, Second Edition (Wiley, 2008), provides a clear understanding of these products including their  proper structures and valuations. This book is a great desktop reference, a fascinating chronological story, a marvelous unveiling of the quagmires to avoid, and a balanced commentary on the major relevant issues encompassing these instruments.

Derivatives Detox^©

by Kathy Graham

DESKTOP REFERENCE

The scope of products under the generic umbrella of “structured finance” is huge and still growing.  For anyone that encounters these instruments as an investor, banker, financial services provider, money manager, or even a reader of the daily news, Tavakoli’s book offers thorough explanations of all of the following products, their definition and uses, pros and cons, and any moral hazards, topped with good advice:

· Collateralized debt obligation (CDO)

· Collateralized fund obligation (CFO)

· Collateralized mortgage obligation (CMO)

· Asset-backed securities (ABSs)

· Residential mortgage-backed securities (RMBS)

· Commercial mortgage-backed securities (CMBS)

· Mortgage-backed CDO

· Credit derivative, Credit default swap

· Total return swap aka Total rate of return swap

· Special purpose entities (SPEs) aka Special purpose vehicle (SPV) aka Special purpose corporation (SPC) with/without capitives

· Master trusts, Owner trusts, Grantor trusts

· Real estate mortgage investment conduits (REMICs)

· Financial asset securitization investment trusts (FASITs)

· Multiseller conduits, Single-seller conduits

· Certain domestically domiciled corporations

· Convertible bonds and asset swaps

· Marquee deals

· Credit enhancement

· Monoline and multiline insurance

…and that’s just the first six chapters.

“Super Senior Sophistry” is a chapter describing how the “Frankensteins of Wall Street,” as The Economist dubbed them, created the super senior tranches that are a key driver of a synthetic CDO arbitrage. Others, including The Economist, have wondered how such sophisticated financiers thought that they were holding onto to the safest slices of CDOs by keeping the super seniors for themselves.  Tavakoli explains their rationale and then hits the reader with two even more shocking facts:  rating agencies don’t rate supers and there’s “no market standard definition of super senior risk” nor is there a standard means of pricing super senior risk.

THE CHRONOLOGICAL CHAIN

Structured Finance & Collateralized Debt Obligations is filled with stories such as the senior super situation.  As a historical account of the development of structured finance products, her narrative is entertaining while being extremely informative.    

One tale explains the unusually large number  of financial geniuses present in the modern world using probabilities of a coin toss.  Tavakoli states, “If you have 64 people in a room, each tossing a coin, …the law of probabilities being what it is, one person will flip heads six times in a row.  This person will be dubbed a genius.  What genius?  What cockamamie twaddle! The next thing you know, another firm has signed the lucky person to a two-year contract at a minimum of $1 million per year.”

The Vatican, money laundering, the major investment banks, hedge funds—all play their parts as Tavakoli  weaves through the history of structured finance from its roots to  now. 

Her description of the current great unravel is illuminating.  After detailing the subprime mortgage scenario play by play, Tavakoli mentions that though many of the predatory lending practices that contributed to the subprime problem are not illegal, they do employ “truthiness in lending”, which is a term that Comedy Central’s Stephen Colbert defines as “what you want the facts to be, as opposed to what the facts are; what feels like the right answer as opposed to what reality will support.”  She concludes by saying, “…if one defines a classic Ponzi scheme as using money from new investors to pay obligations to existing investors, the lending relationship between investment banks and failing mortgage lenders has devolved into just that.  In fact, it had devolved into the largest Ponzi scheme in the history of the capital markets.”

From remarks such as these, some might be thinking that Tavakoli is perhaps not understanding the nuances of these products or situations because she is not qualified or perhaps she is just a cynic, seeing negatives where none exist.  Those individuals would be wrong on both accounts.

                   JANET M. TAVAKOLI

Tavakoli has her MBA in Finance from the University of Chicago’s Graduate School of Business.  She taught Derivatives there as an Adjunct Associate Professor of Finance for several years.

Her past work experience is equally illustrious, including stints as: 

· Executive Director, Head of Financial Engineering, Global Financial Markets Division, Westdeutsche Landesbank, London

· Head, Market Risk Management, Capital Markets Group, Bank One, Chicago

· Head, Asset Swap Trading Desk, Merrill Lynch, NYC

· Head, Mortgage Backed Securities Marketing to Japanese clients, PaineWebber, NYC

· Head, Quantitative Research Marketing, Bear Stearns.

Additionally she’s provided expert reports on many major litigations involving financial institutions to the tune of over $1.2 billion in consolidated litigation total claims.

Tavakoli answers the second concern of some herself, “Despite the caveats, I’m an enthusiastic proponent of structured financial products and welcome the growth of new products in the market.” As for the future, she’s unclear what its composition will be, but does note that “what is needed is effective regulation.  Until that occurs, investors will have to fend for themselves.”

QUAGMIRES

Ineffective Guardians:  According to Tavakoli, senior management, the regulators, Basel II, and the rating agencies have all contributed to the abuse of these new structured finance products. 

Because of “poor understanding of the basic mechanics” of these products combined with market pressures to rapidly grow departments to satisfy client needs, management often has a difficult time assessing what the dynamics behind their group making or losing money truly is.  Adding to the fog, investors don’t have the ability to check the accuracy of performance reports given to them by managers, who are paid their bonuses based upon that performance.

As for regulators, Tavakoli wonders why the SEC, the Fed, and others were so missing in action when they should have been questioning a number of glaring oddities that were pointed out by concerned professionals from the beginning.  She says that “Basel II is part of a series of failure by various financial regulators” because it “has been ineffective in heading off problems such as the global securitization crisis due to securitizing risky product that was improperly rated.”

Tavakoli’s critique of the rating agencies responsible for improperly rating those products is comprehensive.  In fact, it’s well worth buying this book if you are an investor just to understand how thoroughly rating agencies were and appear still to be bungling the basics.  Her critique offers ways that investors can protect themselves until effective regulation surfaces.

Fraud:  One of the reasons Tavakoli mentions effective regulation as necessary is because it helps break the fraud triangle, which is need, opportunity, and the ability to rationalize one’s behavior.  Her approach is common sense based:  financial systems need to be systems that people can trust to manage their money wisely but, on the other hand, there are and probably will always be people who try to help themselves to more of other people’s money than is due them.  Given the complexities of modern finance and how smart financiers are, effective regulation to decrease opportunity combined with vigilance by all parties is required to keep the system trustworthy.

Gray-area Opportunities:  Another area that Tavakoli tackles are those gray-area opportunities, the ones that sometimes are legal and sometimes—and in other places—are illegal.  Acknowledging that ethics are a slippery slope because they’re impacted by location and era, she still strives to point out where they occur, even when only ignorance—not intent—causes the possible opportunity to defraud.

BALANCED COMMENTARY

Even though Structured Finance & Collateralized Debt Obligations is a valuable purchase solely because it provides all of the aforementioned attributes,  there is yet one more reason to read this book.  Tavakoli’s commentary on various money management related topics is extremely insightful because it’s presented in an easy to comprehend manner by someone who understands human nature and complex financial matters.

The limitations and uses of models are one such topic covered.  “The irony of the complex CDO market is that the basic principles of sound finance are often violated in ways that models cannot capture,” states Tavakoli.  Throughout the book, she constantly explains how the models miss the pertinent facts and what can be done instead to capture the true dynamics of these products.

Portfolio diversification myths and many other subjects are also analyzed, so many that HQ Financial Views has assembled a panel of financial experts (their bios and topics follow) to share their insights - and hear yours - on this book at www.hqsearch.com/blog.  See you there!

****************************************************************************

Read these four financier’s insights from perusing Janet Tavakoli’s book Structured Finance & Collateralized Debt Obligations at http://www.hqsearch.com/blog…then join in to share your thoughts.

BLOG STAR PEG SWANTON

Fraud:  Is it or Isn’t It?

Margaret M. (Peg) Swanton is the president and owner of  Tactics, Inc.—a  management consulting firm established in 1995.  Peg, who has more than 25 years of professional experience, is a University of Chicago MBA and a CPA .  She began her professional career by successfully implementing and operating an ERP system at a manufacturing firm.  She observed that good information systems combined with good business processes made it possible to quickly identify and stop fraud, waste and errors in the normal course of business. 

In the 1990’s, she began working as a management consultant, found fraud on her first project and decided to focus on fighting fraud.  Already a CPA, she became a Certified Fraud Examiner.  Some of her projects still involve designing accounting and financial reporting systems; others are investigations of fraud allegations or business disputes. 

Peg has excellent business analysis and reasoning skills, is able to rapidly identify critical business issues and determine how to resolve them whether the project is the design of a new accounting system or a fraud investigation.  She and Tactics, Inc. have a solid history of successfully completed projects – on-time and on-budget. Peg can be reached at 312-987-1800.

Peg’s blog concentrates on the fraud aspects of this current economic situation.

BLOG STAR TIMUR GÖK

The Mother of All Derivatives

Timur Gök is on the faculty of the Department of Finance at Northern Illinois University where he teaches courses in corporate finance, international finance and business economics in the undergraduate, the MBA and the Executive MBA programs.  Before joining NIU, he was Director, Domestic Finance at Deere & Company.  He began his professional career at the University of Florida, where he taught economics.   

He is a former Fulbright Scholar and holds a M.A. degree in Economics from Washington University in St. Louis and an Advanced Professional Certificate in Finance from New York University.  He is a member of the American Finance Association and Financial Executives International (FEI) and is the Regional Director of the Chicago Chapter of the Professional Risk Managers’ International Association (PRMIA).

Timur has chosen as his blog topics the history of the “mother of all bombs,” the issue of regulation, bubbles, and bail outs.

BLOG STAR LISA A. GARLING

Musings from a Corporate Banker…

Lisa A. Garling has 15 years of leveraged lending experience with a major international bank in Chicago.  She has held senior roles there in credit risk assessment, cross functional team leadership, loan portfolio and relationship management.  Her MBA is in Finance from the Kellstadt Graduate School of Business at DePaul University and her BA is in Economics from the University of Michigan.  Garling is a member of the Turnaround Management Association and Chicago Financial Women.

 Her blog musings focus on the impact past, present, and future that those sophisticated financiers that created the super seniors have had on the traditional banking industry.

BLOG STAR JIM HOLTZMAN

Jim Holtzman has more than 25 years of entrepreneurial financial and operational experience in the software, outsourcing, manufacturing, procurement and telecommunications industries. Jim is charged with leading the finance and administrative team and is responsible for all financial/admin operations at Fieldglass.

Previously, Jim held senior management roles in the areas of finance, operations and marketing at a variety of successful early stage businesses including iPhotonics, Inc. in Maryland and MFS Communications and Cognitive Concepts, Inc. in the Chicago area. Prior to that, Jim served in various roles within the capital markets, banking and leveraged lending sectors. As a founding member of Household Commercial’s leveraged lending unit in Chicago, Jim helped grow their portfolio of leveraged loans to more than $2 billion of outstanding assets.

Jim holds a master’s degree in business administration, with concentrations in finance and accounting from the University of Illinois at Champaign-Urbana. He holds a bachelor’s degree in microbiology from Indiana University at Bloomington, as well as a secondary concentration in chemistry.