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Risk and reward

Risk and reward

risk reward

I was going to write a post about risk and reward today. About executive pay, and how it relates to responsibility in business. The news have been abuzz these days with managers and executive officers raking up the millions in bonuses, even if their companies don’t function very well. Which is another way of saying “bankrupt”.

I was going to write it – in fact I got most of the way through, but I got stopped in my tracks. What have I got to do with all this? I don’t even know what a million dollars looks like. Most of us don’t, and most likely never will.

It’s an alien world, the one I was going to write about. What I learned of it are disparate, small, loose pieces of a puzzle I never got to see before it broke down. What do I know about how these people take decisions? They’re flipping coins in their penthouse offices, for all we know. Or maybe they rent time on SETI@home and fire up huge, complicated social simulations that model market behaviour for the next 5 to 10 years.

We hear the stories of CEO excess, the unbelievable nerve of some early-pensioned bankers, the huge stock incentives that compensate for those symbolic one-dollar salaries. The private jets. The yachts. The lifestyle. The news would boil them alive, just. And we still know nothing about them.

Footballers, we can understand. They too rake millions, but we know why. They can hit a ball. We can hit a ball. We can relate. CEOs, they don’t even speak the same language. They gather thousands upon thousands of air miles a year – the closest any living human ever got to be Superman, with the notable exception of skydivers. They choose, and the companies follow. Like the clans of old, we follow, while at the same time asking for their blood. Metaphorically, of course – that’s what the tabloids are for. Maybe we’re envious. Maybe. Maybe we just want to prove they’re human.

Oh yes we are, don’t pretend otherwise. Those celebrities, they got talent. They got a chance to use it. We don’t grudge them that. These managers, they’ve just been working hard. You could have done that too, if you had a vision of that future. They made it, that’s reason enough to hate. Isn’t it, my dear lynch mob?

The thing is, we have it easy. Eight, nine hours of work, then our work is done, we get to go home and relax. A good manager gets to go home and worry some more. Was that the good decision just now? Was that the good strategy? Where are we going? Where are we going to be in five years’ time? Am I letting my people down?

Yes. They mean us. The good ones always do.

The value of money

The value of money

moneyMy money’s worthless. But that’s ok, because so are yours. Or rather, they have exactly the value you think they have. Which is a pretty neat trick to pull for a piece of paper.

The main purpose of any commercial enterprise in this world is to make money. Or, to translate in marketspeak, to create value for their customers, and thus create value for themselves. This value is created by you, me, and anybody else who works for a living, by converting our time and skills into products that are useful for other companies and/or other human beings. This has always been so. In the past it was worth knowing how to plow a field, how to shoot a bow, how to distinguish the really bad mushrooms from the merely poisoned ones. These were all skills one could turn into profit.

Enter the banks. Banks do not create value directly, by themselves, but rather help create value, by lending money to active companies and individuals that need money to exercise their skills in order to create value. In return, a portion of this value returns to the bank. Banks also help people save money, and pay interest for the right to use those money for lending. In effect, banks are vast meeting places, where the people that need money meet the people that have money to the mutual benefit of both parties.

Or at least, that’s the theory. In reality banks are no longer safeguarding and managing other people’s money. Banks have and produce value in themselves, above and beyond what is needed to function as a bank. They use their guarantees and deposits as assets, which can themselves become guarantees if the bank itself needs to borrow money. And past events teach us that this reality is quite prone to abuse, often with catastrophic results.

It all boils right back down to value. Since value is a subjective property, driven by the marketplace’s two opposing forces, Fear and respectively Greed, there is always a risk factor involved when evaluating the value of an asset or investment. Take salt, for example.

Salt is now by and large a commodity, to be picked up once a month at the grocer’s and passed around at the dinner table. But it wasn’t always so. Before we discovered how to extract salt from the sea, the only way to acquire salt was to dig deep in the earth an pray for a salt vein. Salt was expensive, treasured. Wars were fought for control over salt mines. And to spill the salt was to invite serious trouble upon oneself.

Now imagine that you would buy a salt mine mere days before the sea salt extraction process came into power. Your rock-solid investment, 100% guaranteed profitable by a thousand years of history will become a loser overnight. Your net worth would plummet accordingly. Any loans that may have been available to you against that mine are now a pipe dream, and if you’re really unlucky you have your creditors knocking at your door.

Those were the salt bubble days. We’re now in the housing bubble days. There also were a dot com bubble, an Asian market bubble, an African lending bubble and lots and lots of other smaller bubbles, distanced about 10 years apart. Each of these bubbles was new and unexpected. Each of these bubbles taught us absolutely nothing about risk management in the marketplace. And if you disagree, get in touch; I can tell you all about some really hot opportunities – biotech startups, gene sequencing, next-gen targeted viruses… the way of the future, man! You can’t afford to miss it!