This was a fascinating book – in that it showed me how little I really know about the complexity of financial markets.  It provides enough history to help you understand how things have come along – from simple roots to the complex financial system we have today.

There were 2 eras mentioned in the book that significantly involved technology:

• Backroom Crisis of 1968
• Complex derivative products

Paperwork Crisis of 1968

In 1968 there was a problem in the financial system- the paperwork involved in a growing number of trades was getting lost.  Back in this era mostof the trades moved by hand – in that a piece of paper had to move from one person to another.   This manual system couldn’t keep up with the volume of trades – therefore a computerized system had to replace this manual paperwork system.  I know today it’s hard to imagine buying a stock or mutual fund and having to mess with paper – but that was where it started.  And computerizing the system made it feasible to handle the large volumes that an expanded financial system brought.

Complex Derivative Products

One of the areas of the recent meltdown had to do with complex derivative products. A derivative product is one where you don’t buy the thing – but something related to it.  For example the most common object of this era was collective mortgage obligations – a package of mortgages together sold for their value.  The value of this package is a function of the underlying assets – or in this case the value of the payments coming from those mortgages (cash flow).

Technology also came into the forefront as these financial objects that can be invested in become more complex.  There was also a lot of financial modeling going on – trying to locate underpriced assets, predict the market, etc.  To support all this a large (and probably still growing) amount of hardware and software had to be developed to support this businesss.

Conclusion

I would recommend this book to others – in that it will help get a sense of what’s going on in the Financial world.  I still don’t understand it all – but I appreciate the complexity of the system much more now.  From a geek perspective it would interesting to know how I would feel now if I had created some of the code that helped sell these complex derivatives that subsequently fell apart.  That said I also can see that as technology evolves it will be easier to understand what the risks and benefits of these packages are -as we continue to gain more information and how to process it better.

I think there are 2 main lessons from this book:

1. Things are not always as you seem – as someone may be misleading intentionally.
2. People don’t act rationally – depending on that can be dangerous.

Misleading Intentionally – things may not be what they seem

One of the major points of this author (a Soviet by birth) was that Stalin intentionally misled the world about the Soviet’s role in WWII.  The typical portrayal of the Soviets in WWII is a weak one – where they are victim of Nazi aggression – of them needing help to stand up against the Nazis.   That the reason the Soviets intially lost to the Nazis was obsolete equipment and poor leadership.

This author paints a strong portrait of how it was actually the Soviets that were prepared to invade Germany – that they were on a strong offensive footing.  Their entire industry and military allocations were designed for this – that they were close to an overwhelming offensive themselves – of the being the aggressor and not the victim.

The author then rationally explains why the Soviets were initially hurt so hard by the German invasion – that they were not prepared in any way for defense.  They were set up so strongly for an offensive operation that they were very susceptible to an attack.  That even the equipment they had was poorly suited for defense – as it was set up for offense.

So why did we have the wrong understanding for so long?  The author believes that it was intentional on Stalin’s part – to avoid portraying the Soviet Union as an aggressor.  It was an intentional deception to minimze how dangerous the Soviet Union really was.  That it was in their best interest to appear weak – when they were actually strong.

What does this have to do with business and technology?  The unfortunate reality is that sometimes another party – a vendor perhaps – may intentionally be distorting the truth.  The higher the stakes the more risk there is that this could be true.  The good news is that the technology today makes it harder in some ways to do this – as so much more information is available – provided we look at it carefully.

People don’t act rationally

One of the more interesting points of this book was that Stalin was surprised by Hitler’s attack – as it was an act of irrationality.  The Soviets knew that opening an eastern front with the Soviets was nearly an act of suicide on the part of the Germans – as they didn’t have the resources to accomplish the attack.  In fact they believe Hitler was doomed from the start – as his country lacked the natural resources to sustain a long war – especially in terms of oil.

It wasn’t that the Soviets weren’t paying attention – they had significant intelligence resources devoted to this – watching coat production, gas conversion, etc. – all items needed in order to successfully wage in winter of Russia.  Germany did not take any of the actions they were looking for.  In fact were very unprepared for a war in Russia – even though they attacked.

So again – the lesson is to not assume that people act rationally.  Maybe technology geeks like me are more susceptible to this – as we work with rational computer systems a lot (they behave predictably for the most part).  People often don’t act rationally – they will do things that they’re unprepared for, nobody expected.  Sometimes this works well – other times it certainly does not.

In my usual style I’m not going to reiterate the book – but draw a few observations from it.  I think this is especially one of those books you need to read for yourself – to soak in the thoughts and perspectives of the authors.  This is not a history book or a how-to book – but an observational book.

One of the major themes of this book, and others, is that the web pushed back the “mass” tendencies of our society – creating more democracy and connecting people in new ways.  That the web gives us the ability to have a voice, to connect directly, to find more information and do so in new ways.   The web is without order – without much control – so it’s more a of free playing field.

I have this blog – but I’ve been putting my thoughts on the web since the mid-90s (that seems like such a long time ago) with a website.  I only needed a website – didn’t have to participate in some group, get some editor’s permission, pay large sums of money (a lot of my initial sites were free in fact).  Am I pretending that they had a large audience – no – but I do remember that one of my original thoughts I published was picked up by someone else for their newsletter (my small claim to fame).

I’m not the only one who can do this – millions of people put their voices out there for us to hear.  And guess what – we like it.  If you’re like me you like to hear what your friends think – not just read authoritative articles.  We smile when we read something that connects us to a person – more than just what they are saying – we do want to hear their voice.  For me my writing is often a brain dump – it’s the closest thing to the thoughts in my head – to the narrative of my mind.  I don’t think I’m the only one that thinks that way – that wants to communicate that way.

What does this mean for business?  That some businesses are in trouble – and others are on a growth path.  One of the dumbest things you can do in business is to try to fight an industry trend – you’re always going to lose.  No business environment is static – the world keeps changing – and so must your business.  Now that’s easier said than done – as who can walk away from a cash flow – from what works today to move to what works tomorrow.

The authors have a good recommendation – treat people like people and let them be people.  Don’t try to fit things into a box that’s convenient for your business – as it doesn’t work like it used to.  Your customers aren’t willing to fit into that box anymore – as they know better.  They want things they way the want – sorry many other competitors are spoiling them by listening to them and meeting their needs (oops – that was a little harsh).

I intentionally wrote this in a rambling style – to give it a very human voice – something the authors of the Cluetrain Manifesto valued…

One of the key points of the book is that the heart of the economic crisis was not derivatives, exotic loans, etc – but a housing bubble.  Real Estate simply became overvalued and when it fell it caused a ripple of consequences to the economy.  Not only was the wealth generated and lost by the housing itself – but it fed a lot of consumption in the economy that was also lost.

The heart of the problem is that no type of asset will endlessly go up – at some point it goes down.  Stocks go up and down – even if over a long time period they go up.  Housing has gone up and down over time – but the general trajectory is up.  Gold, other metals, even bonds, go up and down in value.  To assume anything will forever keep increasing signficantly is just denying reality.  But our society seemed to buy into it - as it was making us money and driving the economy.

Another interesting point the author made was how this affected the baby boomer generation –  in terms of their readiness for retirement.  I can’t back it up but he says that baby boomers that don’t own a house are actually in better shape than those who do – that too many baby boomers made their house their primary wealth vehicle – not retirement funds, stocks, bonds, etc.

One of the interesting measures of whether a housing market is overheated is the ratio of rental prices to real estate prices.  During the “boom” times the cost of buying a house was significantly higher than the cost of renting the same property – to the point it was far higher than historical values.  One of the facts he presents is that from 1996 to 2006 house prices went up by more than 80 percent – vs. rental prices increased by just 4 percent.  One of the suggestions he makes is to tie real estate appraisals to rental prices – to keep a real estate market from becoming overheated.

While exotic mortagages (such as interest only, loans where no documentation was required – which still drives me crazy) helped fuel the crisis – I think they were a symptom of the problem – not the problem itself.  The reason people went after these loans was that houses prices were so expensive it made it much more feasible – as it lowered the initial payments. These loans then became deeply embedded in the financial system – as they were traded and re-traded, etc.

This boom also boosted the economy in general – as many jobs were created to build and maintain houses.  Also, many people took equity out of their homes – which they spent.  So it did juice the economy – it’s now were feeling the cost of this.  It was good then – but not so good now.

Overall I think again the most important point is that we had a bubble – in that we had a type of asset that was significantly over-valued and finally was unsustainable.  What concerns me about economies is that this seems to happen often – such as the dot-com boom, stock booms, etc.  That the fundamentals of the economy are lost in hype and then we all suffer.  I’m not sure how to solve this (the author has his own ideas)  – but it does concern me.

• We need to treat people the way they want to be treated – not the way we want to be treated.  Recognize them as individuals – who have different learning, communication, etc. preferences and view points
• The generations have different viewpoints about reality that can be in conflict if not recognized – they each have their advantages and disadvantages.

Without re-printing the book I’ll summarize here some information about the different generations I found valuable:

Veterans (born before 1946)

• Performance Evalation: Don’t tell me anything if there isn’t a problem
• Training Preference: Learns best in classrooms, lectures, experts
• Likes organized, factual information
• Rewards: tangible symbols of loyalty, commitment, and service including plaques and certificates

Baby Boomers (1946-1964)

• Performance Evaluation: Tell me how I’m doing once a year – especially if it’s tied to a salary increase or a promotion.
• Training Preference: Casual, training with participation
• Communication: Face-to-Face or by phone, agendas are guidelines
• While in the past they rebuffed authority now they respect and expect it.
• Rewards: personal appreciation, promotion, recognition

Generation X (1965-1979)

• Performance Evaluation: Prefer ongoing positive feedback
• Training Preference: prefer immediate feedback, coaching
• Communication: Face-to-Face or by phone, agendas are guidelines
• Doesn’t respect hiearchial authority – wants interaction and participation, respects competency
• Rewards: Free time, upgraded resources, opportunites for development

Generation Y (1980-2000)

• Performance Evaluation: desires frequent and instant feedback
• Training Preference: Participative, more active learning
• Rejects top-down authority – will leave if challenged by authority driven culture
• Rewards: awards, certificates, tangible evidence of credibility

Being a Gen-X-er myself I found reading this interesting – as I sometimes have problems fitting into a corporate culture.  As I read some items it resonated with me – the need for more frequent and actionable feedback, the desire for more work-life balance, the challenge with bureacracy, etc.   I find myself, as I interact with web technologies,  understanding more how the Gen-Y thinks and feels -as concept of checking facebook, twitter, etc. doesn’t seem that much different than taking personal phone calls at work.

One easy way to have conflict is to keep assuming the other person has the same values and expectations as yourself -  and choose not to follow those.  We assume they are in the wrong – and they often assume the same.  We need to step back and verify if we have the same expectations, the same values – to avoid meaningless conflict.  We aren’t the same in all areas – and recognizing that (even if we don’t agree) can help make for a more productive and enjoyable workspace. There is much more to this book than just generational differences- as it brings out personality styles, where we are in a careers, in order to help manage people.  Again I think the point is a one-size-fits all approach doesn’t work anymore – as people are just too different.

The world keeps changing faster and faster – with technology becoming disruptive.  This technology affects how we interact with each other – e-mail vs. phone, IM vs. phone, social networking, text messages, etc. (How many of you are texting far more today than you were before – to the point you don’t call people anymore).  I wonder if the affect of technology has a way of pushing the “older” generations toward the “newer” generations (albiet with some resistance).

I also just realized something fascinating about the generation Y in terms of start up businesses.  There are a raft of “Web 2.0″ companies popping up – many of which don’t seem to have a business model (i.e. how will they ever make money?).  One of the common values of this Generation is wanting to make a difference – not just make money.  So to them (which drives this Gen-X’er crazy) they may not care if they’re making money – as long as they’re making a difference.  Additionally this generation has generous support from their parents (helicopter parents)- so their perceived risk levels are lower (if you’re living at home you don’t have a lot of expenses).

Like other reviews I’m not going to re-iterate the book – but focus on some of the key points of the book. What was most fascinating was how the events of the day looked from the inside of the industry.  To the outside and in hindsight it seems like people were insane but the author gives some reasoning why people felt and acted the way they did.

One interesting point he makes is that the events of 9/11 – the struggle for survival of the company – created a unique culture at Lehman Brothers.  The company struggled many times – but emerged through deft management after many of those struggles.  Those in the firm believed in the firm – believed that any struggle could be overcome with hard work and patience.  I got the hint of a different world that these bankers and traders lived in – one of risk, reward and the thrill of the deal.

The author helped me understand how the whole subprime crisis could have started in the first place.  There were a number of factors:

1. It is fairly common for mortgages to be sold (many of you have gotten a notice saying a different company has bought your loan) in a package by the original lender to a different party.  If you think about it a mortgage- to a creditor –  is a cash flow – each month you send a check to them – so the value of the mortgage is the future cash flows it produces minus risk.
2. The Federal Government, through Fannie Mae and Freddie Mac (wow- those names sound strange), encourage this practice – as they buy up the loans – encouraging more lending as the original lender no longer has this loan on their books.
3. This seemed to work good when borrowers were well qualified – as the default rate (risk) –  was low and well understood.
4. The Federal Government, to boost the economy, lowered interest rates – which both encouraged more lending and reduced investment opportunities.
5. So the housing marked heated up and went crazy with expectations of ever increasing value.  Everyone seemed to buy into the crazy idea that housing prices would never go down – just up and up!
6. As houses got more expensive it was harder to get a loan – so riskier forms of loans became more common – interest only, adjustable rate, etc. – these loans were more risky – but this wasn’t well understood.
7. So these more risky mortgages were also grouped together and sold -but the big problem was that the risk was drastically underestimated.
   • For some reason people seemed to think (irrationally) that grouping together a group of risky loans together somehow make the whole package not very risky.
   • The ratings agencies did not help here – as they valued these packages of loans practically the same as less risky loans.
   • The government did not challenge this practice either
8. Here’s where things get interesting – everyone fell in line with underestimated risk.  Nobody really, at least not effectively, questioned this practice.  Everyone bought into it hook line and sinker – the public, investment bankers, traders, investors, the government, etc.
9. As time went on investments got riskier and more complex – so the returns were higher.
10. An interesting point was that there is a cascade effect with these exotic, risky investments.  As they yielded higher revenues everyone took notice – and wanted to be part of the party.
11. We might think – wait – what are the risks here – is it worth it?  These people didn’t – as they we’re going for the deal – and the subsequent compensation.  Even if they made the safe bet (best for the company and the economy in the future) they may be out of a job – as they weren’t bringing in the same revenue as the riskier bets.
12. Then the companies became even more entangled -as to offset risk they took out hedges and insurance against these investments.  And then these got re-packaged and sold -making the whole thing so complex and difficult to evaluate.
13. So the risk for the economy was growing – but not so obviously – as these companies were slowly entangling themselves together with complex contracts of transferring risk.

So the whole thing fell apart – real estate stopped wildly gaining value – so the house of cards was brought down.  Commercial real estate also went down – causing another ripple through the economy.  Lehman Brothers had slowly took on more and more risk – but most people in the company didn’t realize it – as it was not well known and dissent was stifled.  So, according to this author, he was shocked at what happened – as he “drank the kool-aid” and believed everything was going to be fine – that things would turn around like they always had.  Another example of group-think – of believing things contrary to reality…

The cost was enormous – good, hard-working people lost their jobs at Lehman Brothers.  The economy itself took a major hit -as investor confidence was shaken.  The long-term costs of this era are difficult to estimate – but they will linger for some time…

Overall it’s a book worth reading – but it’s a little dry.  There is a lot of research that the author references to make his points – a lot of sociological research.  While I’m not fully on board with the author – I think it’s worth considering how the world is changing how to market to customers.

Like in some of my other Book Reviews – I will talk less about the book and more about some observations about it.  I see some of what the author sees – as the growth of online communities is large and growing.  I’m on Facebook a lot, read Twitter posts a lot and support a number of online forums (from a technical perspective).  I see trends in TV watching – that people are using the DVR, watching things online – that old days of everyone watching the same thing are over.

One of the fascinating things the book points out is the human need to form groups – to find a sense of community.  One of the things I find fascinating is how much money (hundreds, even thousands of dollars) people will spend on their hobbies.  I can’t imagine spending that much money (probably because I don’t have it) on a hobby – but I see it over and over across many hobbies.  I’ve often wondered why that much money is spent – is it just because they enjoy the hobby that much – or is it about a sense of community?  About how by joining other in that hobby – of that shared passion – they find identify and comfort in that shared community.

Another area that’s interesting is how the business environment has changed – in that the cost of doing business in many ways is drastically lower.  The Internet allows cheap and pervasive advertising – technology allows customization (print on demand), small one-person shops to compete, etc.  You can “broadcast” cheaply, sell stuff on eBay or Amazon, create a “FAN” page on Facebook for free, advertise on Twitter,  craigslist (also all for free!).

If you’re a large established company with a large cost structure your new competitors (especially those overseas) can be a definite challenge.  Look at traditional media companies – especially newspapers – and you have an example in the making.  The future will likely require companies to be more nimble to adapt to the marketplace – to engage with their customers – not just talk at them.  For those companies that adapt and engage- the future will be fascinating - for those that don’t it will be frightening.

This book does a good job going over the facts in detail – to the point I was skipping some source material.  It presents a solid picture of how many casulties – both U.S. and Japanese would be involved in the invasion of Japan.  After reading the book I can easily see the U.S. suffering a million dead and many, many million of Japanese dying.  So for me, while it’s almost a deal with the devil, dropping the bomb was the right decision to attempt to avoid an even worse outcome in terms of death and destruction.

Instead of going over the book in detail (as you can read it) I wanted to comment on the trend I see in society to twist facts to purpose – instead of letting the facts rule.  The casulty estimates for the invasion of Japan has been something debated for many years – without the best scholarship.  It was interesting how the author noted that the claims of many, many WWII veterans of 500,000 deaths for an invasion were treated with derision.  The author’s research, using newly released evidence, underscores and makes this claim almost timid. 

I’m concerned that in society we’ve gotten the point where science and history have become tainted with agendas, politics, belief systems, etc.  The people doing research are humans – they have their own biases, interpretations, etc. – so it’s alway been a risk they will read into things something that’s really not there.  What concerns me is that their peers don’t seem to question like they used to – that everyone just agrees with the expected conclusions.   The debates over Global Warming show a dangerous tendency in those involved to not be willing to allow differing opinions.

Of course one of the dangers is when we mix empirical science (repeatable facts) with historical/predictive science – as if they are the same.  The first one is pretty objective – in that someone else can repeat the experiment – can show the same result.  The others – and this includes some areas of history – is more subjective as interpretations and suppositions have to be made – not all the data is there.  In a good sense this is why things keep changing – as we learn more – but what bugs me is that we weren’t honest in the first place of that it’s our best guess – not an empircal fact.

When we make decisions in our business and personal lives on poor data we often have poor results.  When we discount the nature of the data (say risk evaluation for financial firms) we also make poor decisions.  I think it’s important we stay honest with ourselves and others on what data we have and the quality of it.

The author’s premise is that the nature of the workforce and society is changing rapidly – due to a number of factors:

1. The younger workforce is not interested in “permanent” employment – they’ve much more self-centered, many of their parents have worked from home and technology has changed permanently the way they interact with people (growing up with Facebook, Twitter from a young age?).  They are not likely to want a traditional full-time job nor expect that to be in their future.
2. The world keeps changing faster and faster – and traditional corporations have a hard time adapting. To re-organize hundreds of full-time employees into new organizational structures can be very painful and expensive, much less time consuming.
3. The world is becoming increasingly global -with new consumers coming on board every day across the whole world – in places many of us have never heard of.
4. Therefore the complexity of relationships of the business environment in the world to come will be much more significant.

So the author makes the point that the traditional corporation isn’t flexible enough for the future – but a completely decentralized corporation isn’t good either -as it has no identify – no sense of who it is – which can lead to a lot of trouble. Therefore the author proposes that a new structure be created  - one with a core set of employees (full time with job security) that set the values of the organization – with another set of employees, contractors, vendors, etc. – that have less and less commitment to the organization.  This “cloud” is then the flexible and dynamic part of the organization – whereas the core is the stability.

The core is also a balance against the CEO – even though they can’t set business strategy themselves.  They can actually advise a new CEO against taking a path that would be folly given the corporate culture.  They also will help develop the tools to educate the “cloud” with the corporations values, standards, etc. – to avoid potential problems.  This also then makes the board of directors more important – as they become the arbiter between the CEO (business leadership) and the core (corporate continuity).

The author really doesn’t seem to be trying to promote this corporate structure for it’s own sake – but as a method of handling the changes in society and business that he feels are inevitable.  Interestingly enough the author also indicates that the federal government should consider re-organizing into something other than the monolithic organization that it is – the massive bureaucracy. Instead consider moving toward more of a “cloud” model itself – which is an interesting idea.

The overall writing of the book is good – but it wasn’t spectacular either.  I would recommend reading this book as food for thought – not as a blueprint for how to re-build a corporation.  I do think many corporations  need to start looking at themselves in terms of how they are organized – in order to adapt better for the future.  The economies of scale of old may not be as effective in the future as they are today – which are a specialization of many large corporations today.

One of the challenges for America will be the current coupling of health insurance and retirement with an employer.  If a larger percentage of employees are no longer full-time employees somehow these employees will need to obtain affordable health insurance and plan for retirement.  These may require some structural changes in how our society is organized – I’m just not sure how.  I sometimes wonder though if those items were taken out of the equation if more people would go work for themselves – if that is what is tying them to a full-time job.  It will also require Americans to get off their debt binge – as to work on a contract basis will require individuals to actually have savings – so they can go between contracts.

This book took an interesting approach – constrasting Lincoln with some of his rivals – those who would become part of his cabinet during his presidency.  It was fascinating to understand more the context of the life of Lincoln – in terms of what was normal for a man of his era to experience.  It was an age of America where many men went “West” – to create for themselves a new life – one of economic opportunity.  Lincoln was a complex man – suffering from depression, anger  – but all of those life experiences culminated in a powerful personality as President.

One of the key points of this book was how brilliant that Lincoln was in working with people.  He took offense very rarely, was patient and forgiving – holding few grudges (unlike many others around him). What Lincoln did in bringing these rivals into his Cabinet was a brilliant move – in that it brought unity to his party.  Lincoln clearly saw the need to balance the different elements of the North in order to preserve the union on the eve of war.  He surprised a lot of people in his ability to pick the members of his goverment carefully  – balancing the different interests against each other and picking people of ability.  It was remarkable that many of these “rivals” became his dearest friends and staunchest allies by the end of his Presidency.  He did not leave a trail of hurt and hate like so many of his peers did…

He also had a keen sense of when to move forward on an issue – resisting many of the more radical elements of his party to wait for the right time to move forward on key issues - like slavery.  He seemed almost too patient as he would hold off making decisions – waiting for the right moment – giving people extreme amounts of grace.  Part of this was his nature and part of it was political – for each person that worked for him represented a group of people who would be offended by their dismissal.

He was also quite the storyteller – telling humorous and fascinating stories all of his life.  He started telling these stories as a child and continued through the rest of his life – making him the life of many parties.  I think it was in the story that Lincoln often came alive – and helped him make points with his listeners.  The language of his letters and speeches was calculated and dramatic – yet accessible to even those uneducated.

He was a man of deep convinction – not easily swayed by others – but he was willing to listen - and change if they spoke the truth.  The job of the president will never be easy – as the pressure is immense – but Abraham Lincoln set the bar high for how good of a job a president can do.  He set the bar for how good a person could be in dealing with others.

The other fascinating thing about this book was how it revealed how divisive the issue of slavery and equality was in that time.  What was surprising to me was how even many of those who believed so fervently in ridding the US of slavery didn’t see the African-American as an equal.  In fact Lincoln and his peers believe that returning them to Africa was a feasible solution – as he had a hard time believing they were equals.  Lincoln did believe that the war was, in part, a punishment for the sin of slavery in America.

However during the war itself the Northern population’s opinion changed over time – from one where the war was principally about restoring the union to one where slavery became a equal issue.  Lincoln started the war with a position that slavery was legal in the original Southern states – but not in any new territories/states (Linclon, like others believed that slavery, if confined to the south would die on its own).  As the war progressed he issued the Emancipation Proclamation and then eventually supported a constitutional amendment banning slavery.

One of the sad things about Lincoln’s assassination was how it was not in the South’s best interest.  Lincoln was one the supporters of a gentle, not punitive, approach the South.  Lincoln’s life, like many others of that era, was filled with sorrow.  His death brought sorrow to the many who learned to love and respect the man…