Sunday, 8 March 2009


Leverage is the tool of our demise. And the wielders are bankers.

This is the fairly straightforward message that we receive through our media and its not hard to understand why. The diagram below is a 'toy model' of the banking and 'shadow banking' system. It shows the investment process, of $1 in true capital being 'geared' as it goes through the sausage machine of the fund management industry, with banks pumping in debt at every step. By the time you reach the private equity investors on the sharp end there is a lot of cash to play with. The size of the deals these guys were doing was truly mind-boggling. What is important to understand however, is that no bank, at any point would have had to agree to lending at leverage ratios of 64:1. In fact, in this fairly tame example, no credit committee would have seen ratios above 4:1. What they would call responsible lending!

However, what if the masters of the universe wanted in the private equity business wanted even more cash to play with. One thing you could do is ask the banks to lend more, but there is an even easier way to do it. Introduce another layer of fund Managers. Lets call them 'fund of fund' managers.

Wow! Thats really cool. Now what you've got is leverage of 256:1!!! And still not irresponsible lending by the banks. That's what you call financial engineering.
The really difficult problem with this situation is that its not anybody's fault. These transactions happen all over the world. In different domiciles, and in hundreds of different institutions, and every individual transaction feels like a sensible, and low risk proposal.

The reality is of course much more complex than this, but its possible to see through this simple example how cheap money gets sprayed into the world of business. It was Milton Friedman who said

"... if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government."

Hmmmm. Sounds a lot like fund management too.

The problem now is what do we do about it?

Gordon Browns suggestion is to extend regulation to the fund industries. The regulators have failed to oversee banks though, so its hard to see how that will make the system more robust.

I think a more sustainable long term solution is to restrict and regulate the total supply of debt to the fund management industry, but by controlling banks, not funds.

This would require a much more pro-active, data driven approach from the regulators. This is not the same as having banks fill out more reports however.
With the approach of cloud computing and enhanced grid analytics we do now have the technological capability to do this. But it will require a very far sighted and energetic set of regulators to do this. Not least because the implied deleverage is probably a very difficult political pill to swallow.

Especially for Gordon.....

Saturday, 7 March 2009


It is the role of the Venture Capitalist to take a medium term view of the economy and the needs of people and businesses.
So it is fun to read what is commonly called 'futurology' as a way to challenge one's ideas of how our commercial ecosystem will evolve.

An early influence on me was Lyall Watson, who died last year aged 69. He wrote a series of books ('Supernature' being the most famous) that discussed supernatural phenomenon and spent sometime considering the likely future evolution of the human race. One essay I recall reading was comparing the complexity of the global telecommunication network to the complexity of the human brain. It was a kind of enjoyably gentle 'nuttiness' that would provoke good after dinner conversations. Not serious though, only useful in the same way as science fiction might be to a working scientist.

It is into the same camp that I would put Raymond Kurzweil, only perhaps replacing humor with hubris. One of Raymond's books, 'The Singularity is Near' talks at great length on the idea that the constantly accelerating rate of technological change will soon become self sufficient, and human beings will become a passenger to technical evolution rather than a driver. It is not a good read though, combining the dullness of a (selective) technical survey with a poor simulacrum of 'Godel, Escher, Bach'.
In fact, in a 2007 interview, Douglas Hofstadter, the author of GDB compared his ideas to a blend of very good food and "the craziest sort of dog excrement".
Well, he said it, not me!

So it was with some surprise that I read of the creation of The Singularity University.
The role of the singularity university is to take a series of 10 super short modules in 'high technology' such as nanotechnology, specialise, and then do a project, all in the space of 10 weeks.
The faculty has a few Engineers and Scientists on it. It also has Aubrey de Gray, Chairman and Chief Science Officer of the Methuselah Foundation, of less certain acedemic pedigree, and a bunch of 'chief evangelists' and venture capitalists.
So its not really a university.

Then what's it for? The SU website declares its mission as follows:

A number of exponentially growing technologies (bio, nano, AI, info, etc.) will massively increase human intelligence and capability and fundamentally reshape our future. This concept, known as the technological Singularity, as advanced by Ray Kurzweil, warrants the creation of an academic institution whose students and faculty will study these technologies, with an emphasis on their interactions, and help to guide the process for the benefit of humanity and its environment.

Vint Cerf (Google's Chief Evangelist) says:
Creating a network of future world leaders across the range of exponentially growing technologies addressed by Singularity University will have profound implications.

So its more like a mission control for members of the 'Kurtzweil club' sent forth to save man-kind.

There is no doubt that the problems we all face today are verging on the insurmountable, but I do find it strange that such a dubious group of 'free thinkers' should be given credibility in this way, with state backing from the United States Government (they are part funded by NASA).