Archive for February, 2011

The Value of Wall Street

A girlfriend sent me an article from last November’s New Yorker (Thanks jonathan for pointing out I mislabeled this as NYT initially) by John Cassidy that I’ve finally gotten around to reading, and as I ctrl+N my fourth email to tell someone about this article I realize it’s time to just blog.  It’s one of those articles that reinvigorates my desire to have a meaningful portion of my portfolio dis-intermediated – IE invested as directly as possible in entrepreneurs and enterprises that generate value and not in the markets.

The article is about capital market dysfunction and how the financial services industry has expanded to absorb more than a quarter of all U.S. profits.  Yeah, that’s pops my eyeballs a bit too.  The article then goes on a tour of how much of that is “rent-seeking” – the official economics term for capturing value rather than generating it.

One longtime financial industry insider is sufficiently concerned about the problem that he endowed the Paul Woolley Center for the Study of Capital Market Dysfunctionality at the London School of Economics in 2007.  The center publishes research like “Trading Frenzies and their Impact on Real Investment”.    The New Yorker article mentions a 10-point manifesto that Dr Woolley released in May of 2010. It is advice to giant pension funds designed to restore efficiency to the public markets and shift investment emphasis away from rent seeking.  Cassidy mentioned Wolley’s recommended cap on annual turnover, but my attention is drawn by his demands for total transparency of underlying investments and a commitment to only investing in publicly trading securities and refusing to make alternative investments.  To ask large funds to do this is essentially trying to drive the private capital markets public.  I think that would be a great thing and it seems likely to me that it would greatly improve market efficiency, but it’s hard to see how it can be a voluntary drive – it only works if a big enough segment of the market does it so it’s hard to be led by a few.   Like the accusation oft made of “socially responsible investing” its goals seem realistically implementable only by regulation.

Two parts of his “manifesto” leapt out at me because they’re points I’ve heard friends locally make:

  1. (Larina) that there’s a fundamental principal/agent problem where agents (the banks & investment agents) have better information than their customers and their interests are not sufficiently aligned.
  2. (Leslie – check this guy out!) “Understand that all tools now used to manage risk and return are based on the discredited theory of efficient markets”.

There are lots of great quotes in Cassidy’s New Yorker article about the scourge of financial innovation: “’But these types of things don’t add to the pie. They redistribute it—often from taxpayers to banks and other financial institutions.’” attributed to Gerald Epstein at the University of Massachusetts.   Citigroup is described as making a shift from trading significantly on their own account to emphasizing relationships with their clients.  The fact that putting their client’s interest ahead of their own is a novel business strategy is a great illustration of how the financial industry has become a product industry instead of a service industry.  And yet, what exactly is the added value of what they make?

It also touches on the shocking quick return to profitability of the Wall Street Banks -something that resonates particularly today with the recent headlines about GM.  I almost need physical therapy for whiplash I feel on the short ride between the WSJ grousings about  oppressive government interference and the triumphant crowing over profits.  There’s also reinforcement for the argument that short-termism is a root problem – in this case because traders get compensated on short-term results despite the risk that the long-term results can destroy their employers. Heck, if the bonuses are big enough, even that’s not the trader’s problem.

Definitely a compelling read, too bad it seems to be cultural news more than policy. http://www.newyorker.com/reporting/2010/11/29/101129fa_fact_cassidy?currentPage=all

Rent-Seeking defined by Wikipedia: https://secure.wikimedia.org/wikipedia/en/wiki/Rent-seeking

The Woolley Center for the Study of Capital Market Dysfunctionality: http://www.lse.ac.uk/collections/paulWoolleyCentre/Paul%20Woolley%20Centre%20in%20the%20News/Default.htm

Paul Woolley’s Manifesto: http://www.lse.ac.uk/collections/paulWoolleyCentre/word/giantfunds.doc

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I’m working with a small coffee shop on profitability and I’ve been working on managing inventory.  At MBA school we learn standard inventory management methods and how important it is to track, but it’s not so easy to implement where the dollar meets the register.   For starters, perpetual inventory with food is really challenging – we’d need a super detailed POS system which is expensive.  I’m starting to see why my banking school instructors said they think 50K is a minimum for starting a successful business.  Without technology your business can’t be very efficient, and you’re competing against businesses that do have technology.  It seems the only other option is to be such a small business that one person can track most of it in their own head and have really good intuition.

That leaves me with periodic inventory, which I don’t mind except that Quickbooks seems to handle it poorly.  So I’m currently in a bit of a chasm between what I’m able to do with Excel pivot tables and what we know how to do in Quickbooks.

I do see a purpose for the oft taught “reorder point” setting even in our small-inventory setting.  It would help us generate the weekly shopping list.  I’m also discovering an inventory challenge I didn’t learn about in business school – how to construct a minimum order.  As a very small business we are challenged to meet vendors minimum orders – in some cases to order at all, in other cases to get at least a first level price break.  For example:  as a coffee shop we order all our flavored syrups and some other products from a single vendor.  We’re running out of our most-used syrup so we need to make an order. Just ordering a case or two of that syrup doesn’t meet their minimum order, so what else should we order, and in what relative quantity?  I’d like to analyze the relative consumption of goods that we order from that vendor and construct an order to the minimum amount that matches our needs.  Anyone know of a quickbooks plugin (or other inventory package) that can do that?

Another challenge – like any good business we work to keep our inventory thin. Well, we don’t have to work too hard at it, we have neither the physical space nor budget to get too fat.  However it seems to be a fairly common occurrence (every other week maybe?) that some item we use is not in stock when we go to purchase it.  I’m learning that Cash & Carry seems to be a sort of discount supplier that will always have some variant of a product available, but it will vary: IE sometimes the napkins will be bleached and sometimes they’ll be recycled.  Ditto for the paper bags of the size we like.  That is a problem I’m sure larger businesses deal with as well, perhaps by padding inventory, or by getting big enough to have better relationships with their suppliers.

Another suffering of the very small business – data entry.  To track all this requires hours of typing in numbers from paper receipts.  Where’s the EDI interface for Cash & Carry or Costco?  No wonder so few business owners do it, but without it you’re missing a key advantage.  I’m beginning to think that broad support for data and analysis for small business owners would be a huge support for economic development.  It amazes me what a lock QuickBooks seems to have on the market.  Small suppliers don’t seem to offer much in the way of Electronic Data Interchange,  but I’m just beginning to look.

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