Bank Recapitalisation ... Pirate Style

After much ado, the European Union seems to have been badgered into emergency action in order to re-capitalise the banking system due to its over exposure to instruments based on sovereign debt and the reliance on the dollar. I'm not a fan of this, this is just another monetarists prayer to the altar of "no sodding evidence whatsoever" and as usual the taxpayer will foot the bill.

Naturally, there will be wormtongues who will claim it was a Keynesian approach when it all goes spectacular wrong ... that is par for the course for economic banter.

So given that we're going to re-capitalise the banks, let us at least try and arrange the situation in the interest of the taxpayer. First, re-capitalisation should be forced and not voluntary and the capital ratio set by Basel should be raised to 30%. Next the banks should be given two options - either raise the money yourself or borrow from us, the nice friendly EU.

Of course, being the lender of last resort, there will be a couple of strings attached to the capital we lend (oh and lend is the operative word). Hence :-

1. The entire capital lent will need to be repaid annually over 5 yrs at EU base interest rates or average EU inflation (whichever is higher) + 10%.
2. The EU takes precedence over all other debtors and the entire banks assets will be used to underwrite the loan
3. A sum of Bank equity equal to capital lent will be paid to EU as our "setting up administration fee"
4. Late payment will incur an APR of 200% plus a penalty of 50% on any remaining capital.
5. No dividends will be paid until the entire loan is repaid
6. Upon final repayment of the loan, another sum of Bank equity equal to the capital + interest + any late payment fees will be paid over to the EU as our "closing administration free"
7. If you don't like the terms then go raise the capital yourself on the open market.

Now, I'm not actually advocating such draconian terms but I'm arguing for the EU and our Gov to stop acting like they're just pawns in this global game and start acting like pirates. The banking system is an essential vehicle for our economic system but like all things, it should be managed in the wider interest of society.

Curiosity ....

I'm curious. What legislation is there to prevent a bank (or any financial entity) with two regional business units (acting as independent entities) from operating identically the same OTC (over the counter) options against each other?

Why would anyone do this?

Well if one of the business units is in a low tax regime and it exercises the options more often in favourable conditions (for example, in the extreme, the other unit exercising the options in all circumstances) then this acts as a mechanism for funneling profits from a high tax to a low tax regime.

It would seem pretty straightforward to create a mass of intra-company trade and algorithms to control this trade that would give the appearance of a legitimate trading activity.

Is OTC intra-bank trading legal? If it does occur, has anyone compared how low tax regime business units fare against their high tax regime counterparts?

What a Lehman ...

According to today's announcement by Barclays Capital, ten thousand Lehman employees plus the business they created is worth $250 million whilst their office and two data centres are worth $1,500 million.

That's going to bruise a few egos. Thanks to Leon for spotting this.

Sound advice ...

I'm a great fan of Dennis Howlett and his no nonsense approach to finance and IT. In his lastest post he talks about a number of practical activities that professionals should offer to tide a business through the current economic strife. One of the activities he mentions is to kill the IT budget and endeavour to move from capex to opex.

Now as Dennis mentions this means considering software as a service offerings, however this shift from capex to opex has some surprisingly complex management issues.

Many years ago, I started using worth based development techniques and utility charging mechanisms for client projects. To demonstrate this and the problems it caused, To explain this, I'll use the example of a web based sales system.

As the provider of the service, I didn't charge for building and delivering the system but instead provided costs for the design, build, maintenance and hosting. Since I had experience of running numerous web properties, some of which were successful and others less so, I was able to create methods for calculating the cost per user and a risk profile for the likely number of users.

Using this information, I could offer to provide the system on a per user basis with no upfront costs. Naturally, I was taking a risk should the system be unsuccessful but this was balanced against the potential upside of a highly successful web service.

However, this information created a problem. I could tell my clients what the service was going to cost per user, but in many cases the clients had little idea of what the user was worth to them. In the past, web projects had tended to be capex rather than opex, so the idea of calculating the actual worth per user had rarely been considered.

If my clients created a marketing plan to grow the system, I could calculate the additional cost due to growth. All my costs were variable and this was light years away from the fixed budget world of large lumped sums and it was this that caused significant management issues.

For example, on one project I helped the client determine the end value (in this case revenue) of the user and showed that this vastly exceeded the cost. For every $100 of calculated sales, I would in essence be charging $10. Whilst the system was growing we were all doing rather well. Unfortunately, whilst the growth in users created more value (the $100 bit), they also created more costs (the $10 bit). A problem then occurred when it was realised that the total cost would exceed the original fixed budget constraint.

Now, amazingly, it is not that unusual for a value generating activity to be terminated because it has been too successful and the cost has exceeded the constraint. This usually occurs because no-one has been able to identify the value. However, you can also find yourself sitting there pointing out that every $10 of cost means $90 more gross income and yet still hear those dreaded lines:-

"we only budgeted a $100K for this project, we can't exceed that."

So I agree with Dennis on the shift from capex to opex, but I'd be curious to see what sorts of problems this then causes.

U.S. vs us ...

In some European technical circles, the U.K. is sometimes considered not relevant to Europe and just a poor cousin of America. This poor cousin attitude is often reinforced by the claims from numerous bandwagon hopping analysts that if you want to make it big then you need to go to Silicon Valley.

Contrary to such blatant stereotypes, the U.K. (and Europe as a whole) has a thriving technical and entrepreneurial community with companies such as Dopplr, Last.FM and Xing to mention but a few.

Despite this, the government body UK Trade & Investment, has provided financial support to web mission 2008 for "20 UK Web 2.0 companies [to] travel to San Francisco to explore new opportunities for growth with key people in Silicon Valley".

As Ryan points out, whilst the intention is good, the whole web mission basically declares that "we don’t have what it takes over here”. The reality is we do, so why not invest in a U.K. based activity and promote the start-up culture here?

Now what have we got here then?

Last night on Question Time, the fracas about the speaker of the house, Michael Martin, was raised.

Michael has been claiming expenses (apparently within the letter of the rules) that are not quite within the spirit of them. It reminds me of the old tax quote:-

"the difference between tax efficiency and tax avoidance is normally a matter of time".

However, there is an accusation that most of the arguments against the speaker are based upon snobbery and class hatred. According to the New Statesman, "Quentin Letts of the Daily Mail and Simon Hoggart of the Guardian" are the main offenders.

Well, this may or may not be the case, however one of the panelist on Question Time thought that this sorry saga could end up damaging the reputation of the Daily Mail. I'm surprised, I didn't think it had one. I've personally thought the Daily Mail was the perfect counter argument to Keen's horror story that the cult of the amateur was destroying our culture. You want to keep the pre-internet culture and its elitism? You want to keep the Mail?

Far from being an equitable society, according to the Sutton Trust, the UK is "very low on the international rankings of social mobility when compared with other advanced nations". It could even be declining.

As Peter Lampl, Chairman of the Sutton Trust, said :

"It is appalling that young people’s life chances are still so tied to the fortunes of their parents, and that this situation has not improved over the last three decades."

If you're born rich, congratulations. If you're born poor, get used to it. Whilst ability is evenly distributed in our society, much of that ability is squandered by the uneven distribution of opportunity. This is an appalling economic and human waste.

Fortunately, there will always be small glimmers of hope and this time it comes from tax reforms. With the non-domicile changes being suggested, some well-heeled individuals are threatening to leave the country. Their leaving should create some new but small opportunities for social mobility.

It's a minor but noble sacrifice those wealthy individuals make. We should cheer them "bon voyage" as they board their jets.

P.S. Check their luggage carefully.

P.P.S. Good job, Brown and Alastair.

Every trough-full helps ...

Over 3 million children live in poverty in the UK. The government plans to cut this by 50% by 2010, however it needs an extra £3.4bn to do so.

Well, on the 3rd March, Tesco runs its annual "computers for school" advertising campaign. Through the scheme, which is now in its 17th year, you can donate to your school a £700 computer if you spend £379,000 at Tesco's.

Well, you know "... every little helps" towards Tesco posting a £2 billion profit this year.

I have a really radical idea for them. Since Tesco likes to play "our part in local communities", why don't they instead pay the £1 billion in tax which allegedly they are trying to reduce through the use of tax efficient off-shore investment vehicles?

Safe as houses

Any chance the Bank of England can loan me £1 million (at five points above EURIBOR) to bet on Chelsea winning the treble (in my book a high risk gamble now Jose has gone ... whoops, sorry ... a high quality investment portfolio).

I'll even give the betting slip as security, so if I don't repay the loan then the bank can keep the slip (whoops, sorry ... investment portfolio).

Of course, I'll be the one taking the real risks as I would stand to lose a £100 million+ in bonus if Chelsea don't win (calculated from the cumulative odds of winning each competition).

The BoE would only lose £1 million - a trifle in comparison - but at least they would keep the portfolio.

Its a shame that good old market economics are dandy as long as things are going up, but when it's on the way down the banks want to be bailed out by good old state intervention.

As for the demands for Mervyn's head ... well it is almost laughable ... he's not the one who has been gambling with other peoples' money.

Still, the buck for this seems to be heading firmly and unfairly in his direction.

I think that's trebles all round in the world of finance ... talking of which, how is my loan going?

How banking works ...

I thought I'd explain the current banking crisis in plain English. It works like this ...

• People (who happen to be tax payers) save money in say bank A.
• Bank A lends this money as loans to other people to buy stuff, say properties.
• Bank A then borrows money from Bank B on guarantee of the loans business.
• Bank A lends this money again as loans to other people.

and so on, and so on.

Obviously this means the original money is lent many times. Many banks have more loans than savings. It works as long as most of those people honour their debt.

But what happens when people start defaulting on their debt?

Well Bank B starts getting nervous about lending money to Bank A on guarantee of defaulting and possibly worthless loans. A credit crunch occurs. Over stretched banks start to have problems etc.

How do you solve this?

Well, one way is for the central bank (funded by tax payers) to lend huge amounts of cash to the banks in return for the dubious (low quality) loans business.

That way the banks keep going, bonuses remain high, Ferraris still get bought and who pays if all goes wrong? Well we all do, as tax payers.

A sort of, I win then I keep the cash, I lose and we all share the cost.

I can certainly understand the "moral hazard" that such action creates and how it can encourage excessive risk taking. It's like borrowing someone else's money, putting it down on laughing boy, 3rd race, Catford dogs and if it doesn't come in - get your money back from the central bank in exchange for the betting slips.

Sounds like a good business to be in. Unless of course in the long run, you're an average joe public tax payer who saves.

Glad to hear that Mervyn didn't change his mind .... damn, he did.

Whooosh ....

Over the last few months there seems to be lots of good news coming through on the VC / Entrepreneurial front in the Hi-Tech market in and around London.

Saul's OpenCoffee is a regular and growing event.

Dopplr receives funding - congratulations.

Seedcamp has kicked off.

dConstruct just seems to get bigger.

Mashup demo is launching in October

Future of Web Apps is coming to town.

Things seem to be taking off.

To boldly go ....

Just heard the great news that Dopplr has received early stage financing.

This is fabulous news - congratulations.

A lunchtime interlude

Before I get stated on a discussion of the stack, I'd like to talk about the pleasant lunch I had today with a friend who is a research analyst. I discovered that something which I thought everyone had known for the last decade may not actually be that widespread.

Most organisations tend to spend more on CODB-like activities than necessary, because it is easier to justify, and less on CA-like activities because worth is such a difficult concept.

Since CODB-like activities are in the majority, then the correlation between investment and worth is generally broken.

I have been operating under the illusion that this was common knowledge. The revelation that maybe it isn't may help to explain some of my frustrations with our IT industry.

The ideas of worth which I discussed in earlier posts are not mine, nor are they new - they are an amalgamation of my "collective experiences" from others and in most cases are at least a decade old.

The main problem appears to be that most organisations do not segregate activities (into for example CA, transitional and CODB) and tend to instead use singular approaches to manage activities (such as cost focused). As discussed in earlier posts, this leads to the perverse situation that we tend to spend more than required on the necessities which don't bring value and less than required on things which might.

Customer: "I have $300 to buy some essentials like food and some books on finance. I'm hoping to improve my understanding of the field and therefore my prospects"

Sales Rep: "Certainly, now food is a necessity, something you really need."

Customer: "Of course"

Sales Rep: "Well, I have lots of studies here to show how much food is important to you. Everyone uses it you know?"

Customer: "Really, wow that's interesting. I can see food is really important."

Sales Rep: "Hmmm ... I don't seem to have any reports on why improving your understanding of finance will help you?"

Customer: "Well, it's just this idea I have. It's just a hunch, a gamble."

Sales Rep: "Sounds expensive especially if you don't know what the return will be?"

Customer: "Well, it was just this idea."

Sales Rep: "Are you sure you just want any old food? You look like a dyanmic, go-getting sort of person surely you want to compete with the best?"

Customer: "Naturally"

Sales Rep: "Well this report says that if you increase your intake of blue coloured food, your performance ... as measured by athletes ... will increase. All the top notch people are using it - here's a client list"

Customer:"Wow, oh look I'm definitely more go-getting than Fred"

Sales Rep: "It's more expensive to buy blue food - quality always is - but it will give you the edge over others. I've got some ROI calculations for you and case studies if you like?"

Customer: "That's impressive it certainly explains the value. I can also see all these other people I know buying blue food. It certainly justifies the expense. Listen forget the books, just give me $300 of the blue food."

Sales Rep: "Not a problem. Would you like me to book you a session with one of our consultants to tailor the shade of blue required to create synergy with your own lifestyle and to maximise your advantage?"

Customer: "Sure."

Now, I'm not knocking the necessity to eat a well balanced and satisfying diet, but assuming you are fortunate enough to do so then food is just a CODB of living. If you want to improve life beyond this, you'll to need to look further up Maslow's hierarchy of needs.

It's a glib and somewhat turgid analogy, but It's no different with an organisation.

So when I first came across Paul Strassman's work in the 1990's that IT spending was not correlated to company value - it wasn't a shock, just empirical evidence showing this effect. I was delighted that someone had taken the time and effort to gather the evidence which showed what was plainly occurring in my day-to-day experience.

When much later Nick Carr published his article, I felt elation that finally we had a spokesperson willing to take on the insanity and the industry around it.

With the growth of open source, I expected as a side effect there would be a greater shift towards commoditisation of CODB-like activities and an acceleration in innovation and hence disruption of existing industries. So I was delighted when Andrew Mcafee published his report showing increased turbulence in the IT industry.

I expect that turbulence to increase as the "X as a Service" industry grows.

I was just part of the huge crowd who appreciated these breakthroughs to "sense and reason", who understood that the singular magic bullet approaches, the over-hyping of ROI and the sweeping broom of cost focus combined with an organisational inability to identify worth was at the heart of the problems.

After the discussion today - I'm starting to feel that crowd is either smaller or more quiet than I realised. Maybe I'm missing some critical point or a lot more discussion is needed?

Well, if I am operating under a delusion - it is probably best to continue ...

36 hours to kick start your new venture.

For all those budding captains of industry out there, you have a mere 36 hours to submit your application to Seedcamp.

Saul has been doing some great things in the UK, but this is a spectacular opportunity for some young entrepreneurs.

Commoditisation and web 2.0 .... Worth Part VI

The process of commoditisation is simply the movement between the novel, rare and new to the common, ubiquitous and necessary. As such the nature of a system changes in the process from for example potential high worth, scarce, risky, non standard and non-essential (source of CA) to low cost, ubiquitous, low risk, standardised and necessity (CODB).

Much of IT is CODB. That is why we are starting to see the first utility like environments for IT appear (whether at the HaaS, FaaS or SaaS level). However such environments whilst they often contain necessary services for any business at a lower cost than the build your own variety, generally they are neither low risk nor standardised.

Low risk in this context would mean multiple providers of the same service which you can swap between, as opposed to the implementation details of any one provider. To be able to swap between services you need not only standardised services but multiple providers and the freedom to move data, application or framework (depending upon which level of the stack you are talking about) between the providers.

In this context open source is a necessity to provide not only the base standards but also an operational means of implementing that standard. It is neither a tactic or a strategy.

However, open source (and in this context I mean ideally GPLv3 over other licenses) is not sufficient, you also need some form of additional information to ensure the users of such services that they aren't being locked-in, or that this provider is really compatible with another or they can run their own installation should they wish to.

This can only be achieved through monitoring and the use of trademarking, by an authoritative group providing assurance to end users that this provider meets the standard, that any primitives have not been modified and that what you run with one provider will work on another.

The idea of utility computing, running on others infrastructure etc are bundled with other concepts into the term web 2.0. However, the importance of the term is not the details but that it describes that there are some fundamental shifts from an old world to a new world.

There are changes occurring between users and companies, ownership of information, producers vs consumers, conversation vs product, virtual vs real business, the spread of the idea of openness into business, hardware and other areas, the commoditisation of sections of IT and in particularly the web 1.0 components of it.

It's all about the new stuff, creative destruction and new sources of CA and worth.

Is it a buzz word? Yes, but it's a timely intervention to enable us to start letting go of the things which matter but we shouldn't be concerned about.

It's all about progress, which is the only true sustainable source of worth.

--- Update April 2013

General notes

Depressingly, almost six years later, we are still talking about the issues of interoperability, trademarks and competition in the compute utility space.

The terms have changed, HaaS has become IaaS, FaaS has become PaaS and compute utility has become "cloud" but the concept remain the same. Progress has been slow in the open source world.

My personal blueprint .... Worth Part V

The general blueprint I use when dealing with such issues is as follows. First, I divide IT projects into three categories - CA, Transition and CODB. Then for each category I take a different approach :-

With CA like projects (i.e those which are novel and new in the industry, few examples in the wild, minimal whitepapers, some percieved value and relevant) then use more of a VC like approach (IT Finance) or Worth based development. Focus on worth and dynamic like processes for development (e.g. SCRUM, XP etc).

With CODB like projects (i.e. those which are common in the industry, necessary, lots of examples, lots of whitepapers, even conferences on the matter) then focus on cost reduction, standardisation and static like processes (e.g. Prince2 etc).

With Transition like projects (i.e. those betwen CA and CODB) then either:-

* If new to the field then calculate potential worth, risk and costs and then it's a judgement call - wait and adopt or disrupt.

* If already in the field then attempt to move your service to become the standard product for the industry and hence reduce cost of migration.

Now this is my method, there are many others ... this is not about which method is better. I used my own blueprint to illustrate what I believe is an important point:-

the type of approach which should be adopted depends upon the nature or the class of the problem you are trying to solve

It's not about one approach, a magic cure to solve all problems.

The ROI syndrome .... Worth Part I

I haven't posted for a bit, so I thought I'd post some personal and somewhat unpolished views on worth, utility, web 2.0 and why it's all connected and why we are entering a major transformation of the IT industry.

To start with I'm going to explore the concept of worth within corporate IT.

Most organisations seem to be shockingly bad at determining the potential worth of an IT service. This is something I've been harping on about for over a decade and it usually starts with the following conversation.

Client: "We'd like to build this internet thingy - how much will it cost?"

Supplier: "Can you give me details on what you want and how many people will use it?"

Client: "Sorry? we want to know how much it will cost?"

Supplier: "I'll tell you once I know the details and how much it will be used?"

Client: "We don't know that, it all depends upon what happens, what people will want and how popular it is. We need to get the cost sorted in order to get the budget"

Supplier: "Ah, the old ROI syndrome"

The old ROI syndrome

Most organisation have ROIs (Return on Investments) that internally they need to achieve, and IT projects need to show an ROI - whether it's value added or cost saving.

Now the ideal way to deal with this, is to calculate the worth that a new service will bring (sales, cost saving, risk etc) and then calculate the maximum you can spend based upon the ROI required and finally determine what your spending focus should be. The problem is that calculating worth of something can sometimes be very difficult, it depends upon popularity, usage, what your are trying to achieve and other factors and hence most ROI calculations tend to be based upon the cost of something.

Now there are three class of problem - CA (competitive advantage), Transitional and CODB (cost of doing business) - I'll deal with each one of those in turn over the next few days.

Oink Oink ...

I was reading this petition on abolishing inheritance tax. It's not one that I agree with, seeing that inheritance tax has an important role to play in a society.

However I did note the following:-

"Inheritance tax is an immoral form of taxation that penalises hard work and thrift."

and

"millions of households have been drawn into the death duty trap by steadily rising property prices"

Steadily rising property prices ... oh, that's the hard work and thrift bit is it? There's me thinking that most property purchases involved speculation ... doh.

As for the "millions of hard-pressed families" - well the threshold is currently £285,000 and you have to really reserve moral outrage for the 2.7 billion people living on about a £1 a day.

I'm trying to feel sympathy ... nah, just not happening.

Less bang for your bucks....

According to the Independent, Peter Ayliffe, CEO of Visa said:-

"by 2012, using credit and debit cards should be cheaper and more convenient than cash".

Cheaper than cash? Yep, apparently:-

"retailers could soon start surcharging customers if they choose to buy products with cash"

Hmmm, well a number of my friends have recently complained that they've been sent a fee for not using their credit card often enough. According to one of them, the apparent "reason" for this is basically they weren't making enough money for the bank.

This is quite concerning, but it seems that there is a growing trend towards imposing such annual fees according to the BBC.

So, soon it'll be cheaper to use your card than cash (because cash will be surcharged) and banks are going to start charging you for the privilege of using their services, especially if you don't use them much.

That's another way of saying - your savings are our financial opportunity. In other words, if you have small amounts of money, low interest rates and you avoid debt by saving then please just go hand your money into your local "money" service with the kind words:-

"there you go, you've earned it".

I can understand that some of them must be a bit strapped for cash, only estimated to earn in profit more than the GDP of Luxembourg. I often find myself feeling the same way ..... if only I had a few more billion.

Hence I do understand what "cashless" society means; it means I'm going to have less cash than I used to or my bucks are going to be worth less.

They have got to be kidding, right?

The net effect would be in the long run to disadvantage those whom use cash, and do not want to or either cannot partake in the debt frenzy or be involved with the financial services for personal or other reasons. We should especially not disadvantage those that save or can least afford.

Now money & banking services are infra-structural (or essential) needs of society, just like power, water, food etc. Now it's reasonable that I should be charged for what I use (utility consumption), and in many case pay a fee for access to the service.

However is it reasonable that the cost of access to such services should vary according to how much I use them?

Maybe I don't buy enough food for the supermarkets liking - would it be reasonable for them to charge me extra for access?

Maybe I don't consume as much electricity as the power company would like - would it be reasonable to therefore increase my access charge because I don't use enough?

No it's not reasonable! It discriminates against thrift and those who can least afford to pay, but must pay.

So here is a petition (I'm waiting for them to approve it, so it may not be there yet) to make it an offence to:-

• financially discriminate against cash customers by providing a service at a lower rate than that which would be charged to a customer paying in cash.
• financially discriminate against savers as opposed to other consumers.
• financially discriminate against consumers for connection or access to an essential service (banking, power, communication, water, food etc) because of a low rate of consumption.

I've called it Wealth-Neutral (as in Net-Neutrality) since it relates to access, but obviously I need to fit within the 16 character limit of E-Petitions

Got a good idea?

Just picked this up from Saul Klein that he is organising an open coffee meetup on the 1st March 2007 for investors & entrepreneurs.

I met Saul at FOWA, he is a smashing bloke and was really promoting the European VC efforts being made to reach out and connect to people.

In his own words the purpose behind OpenCoffee is

"to be very informal, ask questions, get feedback, meet people - no pressure, no plans - just a fixed location and time"

This is great news for London, I hope it kicks off elsewhere as well.

Worth based development

Butler Group's master class was better than I hoped for. Tim Jennings and Martin Butler gave some interesting presentations on IT value, measurement of value and in general what is wrong with our industry - too much focus on cost, with no clear measureable value.

The content was similar to a discussion group I had a Foo camp last year.

Take home messages were

1. No correlation between IT spending and business value.
2. No correlation between IT spending and cost reduction.
3. Strong correlation between knowledge capital and business value.
4. IT in general is focusing on cost and automation, where it should be focusing on knowledge capital.
5. Big gap between Executive and IT in general.
6. In general there are no clear measurement of business value in IT projects.
7. Difference between Competitive advantage, Cost of doing business and Transition of projects.
8. Focus should be on worth first (or as I would say what's important to users).

and much more. Overall great.

Today the duck count was up to 8.