Regulation vs. Retribution

The United States Congress, at the urging of our President, is in the midst of passing a “comprehensive” package of financial reforms in response to the recent financial crisis. Both the Executive Branch and Congressional Majority leaders have specifically stated that these tough regulations should be enacted, bipartisanship be damned. Democratic leaders sense a window of opportunity to play upon public anger and fear in order to roll back the clock on Wall Street and the financial innovations of the past 30 years. The problem is, however, that lost in the discussion is an honest accounting of who and what precipitated the financial crisis, the underlying motivations for the proposed regulations and a reasoned analysis of the structure of Wall Street by people who actually know what they are talking about. And because of this opacity and dishonesty, the desire to leverage populist rhetoric into votes and a fundamental lack of understanding of how Wall Street and capital formation works, we will likely get a package of regulations that will hurt the US and the global economy fall more than they will help. And this would be a shame, because it will reflect the loss of a golden opportunity to do something truly positive.

The financial crisis was merely the tail-end of a daisy-chain of events seeded by two policy disasters: (1) the Greenspan-led credit bubble; and (2) Congressional approval of a multi-trillion dollar expansion of Fannie Mae and Freddie Mac’s balance sheets (GSEs) and the resulting diminution of underwriting standards. This was neither caused by CDOs and other derivative securities nor the existence of Wall Street proprietary trading desks. As all manner of entities lined up to take advantage of the Federal Reserve’s and Congress’s largess - mortgage brokers, borrowers, banks, structured finance operations, derivatives desks and rating agencies - fraud, deceit and poor risk management emerged in its wake. A breakdown of conduct on this scale and associated conflicts-of-interest were enabled by poor rules and regulations as promulgated by the Financial Accounting Standard Board (FASB), the SEC and Congress. I would posit that this was due to a lack of understanding of the forces at work coupled with the influence of lobbyists, greed and self-interest. Nobody looks good coming out of the crisis and hundreds of billions of dollars were lost, so in our media and PR-driven society somebody has to pay - now. But the last thing Congress and the President should be doing is agitating for change without truly understanding its impacts, and focusing on payback instead of fundamentally reforming elements of the system that are truly broken. I am deeply concerned that this is exactly what they are doing.

Given the severe flaws in macroeconomic policy underpinning the crisis, the outcome was not surprising. But as we look at th subsequent chain of events what might have dampened the magnitude of the crisis? I see four core principles that, if they had been in place prior to the crisis, could have materially altered the outcome: (1) financial markets transparency; (2) enhanced accounting disclosures; (3) clear and punitive rules against conflicts-of-interest and (4) elimination of the US Government as a perceived back-stop for creditors.

Transparency should be the cornerstone of any discussion around legislation. Proposals agitating for banks to shut down or spin-off their swap operations are nonsensical and destructive. When used properly and with adequate collateral to handle changes in mark-to-market value, they are powerful tools for risk management and speculation to support efficient, two-sided markets. Moving the lion’s share of over-the-counter derivatives volume to exchanges will substantially enhance the transparency around market pricing, how derivatives desks make money and reduce risk of inadequate capital provision. Accounting disclosures have recently been tightened to better address off-balance sheet exposures, but still fall woefully short in areas such as fair value accounting. Conflicts-of-interest are still embedded in many aspects of our system; it is incomprehensible that rating agencies still retain their position considering their pivotal role in the credit markets crisis. Not smart enough to understand the possible impacts of highly structured instruments? Then they shouldn’t slap on a rating. The excuses provided for their miserable performance are divorced from reality: they were greedy, and they did what they had to in order to maximize short-term profits. Case closed. Open-sourcing credit ratings is likely the right avenue for dealing with this particular conflict, but many other conflicts remain. And until the US Government is no longer perceived as 100% certain to bail out the creditors of complex financial institutions, we will see a repeat of 2008 again and again. Could the answer be a tax based upon the complexity, scale and risk of a bank’s operations, rather than an open checkbook provided by the US taxpayer? Perhaps, provided that such rules were applied globally and in conjunction with regulators of the other major financial centers. This would also help address the “Too Big To Fail” issue, as super-sized institutions would pay out-sized taxes because of the risk they pose to the global financial system.  But one thing is certain: without elimination of the implicit US Government guarantee, private and public/private (GSEs) institutions will revisit the sins of the past decade without adopting fundamental change.

I penned a little-read post back in November 2007 where I touched on certain of these issues; my fundamental views have not changed much over the past two and a half years. It is almost as if the aftermath of the crisis has turned into a soap opera; painfully slow-moving and not particularly entertaining. And the way things are looking, the outcome might be of similar quality to what is being served on daytime TV.

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U.S. Congress: Mandatory Training Required

This has been a week full of cloudy events: Icelandic ash, the Greek bail-out and the Goldman CDO lawsuit, to name a few. Notwithstanding the “transparency imperative” in the wake of the financial markets meltdown, we are still mired in opacity. Gillian Tett of the FT shared similar sentiments in today’s column. Readers of this blog are well aware of my views on transparency in every aspect of the financial markets: financial reporting, risk management and trading. Yet transparency remains a stubborn and seemingly unattainable goal, even with the knowledge that the social and financial costs of opacity are stunningly high.

Why the trouble? Easy - lobbying, money and ignorance. While transparency is couched as super-sophisticated Wall Street issue, it is fundamentally a Main Street issue. Opacity is what leads to “unexpected” crisis, the price tag of which is invariably picked up by Main Street. Fundamental reform stuck in Congress? Tell your Congresspeople to get on the stick and to represent their constituencies - not their lobbyists. Moving the lion’s share of OTC derivatives to exchanges is both an academic and pragmatic no-brainer, yet this shift is consistently stonewalled by those with huge checkbooks and contacts in Congress. I have written about fair-value accounting and how it should be used in all situations where there is neither the intent nor the ability to hold an asset to term. Not surprisingly, there has been huge push-back on this issue from the same people who want continued opacity in the OTC derivatives markets. And more complete accounting disclosures with “plain english” footnotes would also be a thrilling development, yet many corporations are none too keen to have to display all their laundry, dirty and otherwise. Common sense has not prevailed, largely because of our system of lobbying, privilege and fear of reduced campaign contributions if a powerful business interest is angered.

The costs of friction in everything from complying with our arcane tax code to complex documentation for non-standard financial transactions to extra time spent analyzing byzantine financial statements has to exceed $100 billion - per year. And this says nothing about the reduced investment due to fears over the high costs of growing businesses. Consider the recent proposal to cause venture funds with over $30 million in AUM to have to register with the SEC because of fears over systemic risk. This is nothing more than a publicity stunt by an ill-informed Congressman, but it is simply a microcosm of the bias towards posturing and grandstanding instead of substantive, common sense reform. We are in the midst of a jobless recovery, yet a Congressman is wasting time and money talking about idiotic regulation of the venture capital industry whose very lifeblood is creating the high-value jobs we need to resume a healthy growth trajectory. Why isn’t he talking about tax reform, financial transparency, or something else that really matters? Because those issues don’t make for good headlines and he probably lacks the knowledge to propose something intelligent.

Perhaps the issue is that our Congresspeople are simply ill-equipped for the job. Based upon their decision-making, it is fairly clear to me that many lack even basic knowledge of economics and finance, yet have a hand in making legislation that requires real understanding of the issues. My guess is that the lobbyists and special interests, who have a very keen understanding of the issues and what’s at stake, have a large hand in how legislation is worded. This does those of us who pay our Congresspeople and put them in office a great disservice, and it is hard to see how this will change unless people get really angry. At a minimum, incoming Congresspeople need to go to school, a finance and economics “boot camp” for starters. Classes on micro and macroeconomics. International trade. Financial markets. Corporate finance. Basic yet important stuff. Should a Congressperson really be able to cede their vote to someone more knowledgeable (e.g., that lobbyist or special interest making a campaign contribution) than they are? Clearly not.

So much of what needs to be done is just so simple. None of this is rocket science, but it does require a basic level of understanding (and a good heart, common sense and a conscience). Naysayers will mutter “What you are saying is stupid - your suggestions are unrealistic.” My response: Why?

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Are Derivatives the Real Problem?

This piece was published in FT.com earlier today…

Regulators, Congress, and
the media generally focus on the crisis at hand. The Enron scandal gave us
Sarbox. The market crash has created a PR flurry against “sponsored access” and
proprietary trading. AIG generated a firestorm surrounding the use of credit
derivatives. The common thread is that policy-makers are reactive and missing
the big picture, leading to short-termism and a host of poorly constructed
rules and policies. And invariably the word “derivatives” is used as a
lightening rod for why new regulations should be promulgated. The problem,
however, isn’t exclusive to derivatives; it’s the underlying “business purpose”
of transactions. Hedging has a legitimate business purpose. Making markets,
speculation, and financing projects have solid business foundations as well.
But entering into transactions that serve to hide or obfuscate economic reality
work against this principle. And this lack of business purpose is not confined
to the derivatives markets, but frequently takes place in the cash markets as
well.

Consider leasing, a transaction
that has been popular for over 50 years. As the industry has evolved,
transactions such as sale/leasebacks and “asset defeasance” have been used to
synthetically borrow money without the obligation being reflected as debt on
the balance sheet. The form of the transaction: a lease. The substance of the
transaction: a borrowing.  The
multi-trillion dollar securitization industry has the same motivation: moving assets
(and liabilities) off the balance sheet, while economic recourse still exists
should asset values and/or debt ratings drop. This is what the market
discovered when Citigroup’s multi-billion structured investment vehicles (SIVs)
began to fail and the assets and liabilities came back onto its financial
statements. What is the proper characterization of a contractually obligated
stream of payments? Debt. How should a portfolio of assets and associated
liabilities be treated if the risks and rewards of ownership haven’t been
completely transferred? As never having left the balance sheet. Yet the
accounting profession, with the SEC’s support, has enabled this charade to
continue.

Derivatives have also been
used to achieve similar ends. Structured transactions have been designed to
generate upfront cash without a corresponding obligation being recorded on the
financial statements. The recent discovery of Greece’s use of these instruments
has shined a light on the dangers of hidden borrowings. Municipalities have
mortgaged their futures by selling strips of participations in cash flow
generating assets (roads, bridges, airports, etc.) in order to generate
liquidity today (at a steep cost to financial solvency tomorrow). The virtually
unbounded rise of the credit derivatives industry is partly due to the mismatch
between the notional value of derivatives being written and the actual value of
underlying instruments. This mismatch can be 5x or more of the bonds being
“hedged,” leading to market failures when physical delivery is demanded from
counterparties lacking actual ownership (or the ability to borrow the
position). Neither of these examples embody true business purpose.

Both cash-market and
derivative instruments should be put to the “business purpose” test. Accounting
rule-makers, with support of the SEC, should move towards a “principles-based”
system where common sense, and not black-and-white rules around which myriad
loopholes can be found, should become the new paradigm. But let’s be clear. The
issue isn’t derivatives; it’s all financial transactions whose objective is to
deceive or to weaken financial transparency.

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Three from the NYT: On Strategy, Culture and Boredom

It has been quite some time since I’ve published a “3 from the NYT” piece - but the time has come.

1. Andrew Ross Sorkin on “When Unequals Try to Merge as Equals” - the Sirius/XM merger

My punch line: Mel Karmazin is a smart, logical guy focused on the big picture, for the benefit of Sirius shareholders. And Mr. Sorkin’s questions concerning the economics and timing of the merger announcement miss the boat from my perspective, only serving to reinforce a myopic and cynical view that obscures the big picture: that this merger is both necessary and value-creating for both Sirius and XM shareholders, especially in light of questions over the long-term viability of satellite radio as a value-added distribution platform. The merger at least gives these two companies a fighting chance to find out, and in the most efficient and shareholder-friendly manner possible.

Andrew’s lead, to set the stage:

HERE’S a tip about deal-making: When companies start talking about a “merger of equals,” someone is usually getting the better deal. It is especially true in the proposed merger of XM Satellite Radio and Sirius Satellite Radio.

It is being billed as a merger of equals, with each company getting exactly half of the new entity.

But here’s the unequal part: The stock market thinks that Sirius is worth almost $1 billion more than XM. To get the numbers to work, Sirius offered to pay a handsome 22 percent premium to shareholders of XM. (The premium is actually almost a whopping 30 percent if you account for the run-up in XM’s shares the Friday before the deal was announced, as word began to leak.)

And then, a little more color to make the point:

And then Mr. Parsons played his ace: If Mr. Karmazin wanted to create the enormous savings they both projected would result from a deal — worth more than $5 billion, more than the value of either company — they needed each other.

********************

“I can’t do the deal without them,’ he said. “I thought it was more important for our shareholders that we do the deal.”

Even by giving the 22 percent premium, Sirius stands to save billions of dollars a year if the deal goes through.

These are facts. And the fact is that Mel is a big picture guy, and Mel wants to run a successful and viable entity. Is paying a premium for XM when the deal is billed as a “merger of equals” either irrational or untrue? I don’t think so. Both hold valuable and necessary keys to unlock the value of the combined enterprise. I think it is quite clear what is going on here and I’m not sure why this point warrants much discussion. The cost savings alone, even if one assumes savings on the low end of the projected range, are worth well north of $10 billion. So 22% on XM’s stock price to get the deal done and to get busy? A small price to pay.

The Andrew goes on to discuss the other possible motive for “rushing” into things now instead of waiting until their stock price somehow magically align in order for a “true” merger-of-equals to organically take place:

Still, it seems as if Mr. Karmazin may be paying a premium to do the deal now so that it can be rushed through the regulatory maze while the Bush administration is still in power. Many partners in mergers of equals wait around — often for years — until their stocks align.

Mr. Karmazin disputes that view, contending that he wants a deal as soon as possible so that the savings can start. His view is that there “is no regulatory window.”

In fact, he believes that the longer the companies, both now money losers, wait to merge, the better their chances would be in Washington. That’s because new technologies will continue to emerge that may prove to be competitive with satellite radio.

So Andrew puts forth the “ulterior motive” theory, and I’ve got to say Mel gives the right answer. Besides which, Sirius and XM have been tap dancing together for quite some time; it’s not as if this is a shotgun marriage. Much thought, analysis, pondering and negotiating went into last week’s announcement, so I find Mr. Sorkin’s line of argument more consistent with conspiracy theory than one grounded in fact or logic. Regardless of Administration, this is going to be a challenging merger to get through the Justice Department (not that it should, but it will). But those cost savings are real - and pressing - and they are both spending prodigious sums to win in the marketplace, dollars that could be spent together in a more efficient manner developing better consolidated programming and reaching its target audience.

So Mr. Sorkin, I don’t think it requires much thinking to answer the “why, when and how” this merger got announced - and it is far more simple and logical than you are making it. It is driven by the need to extract value - now. To stop the bleeding. And I hope Mel is able to get this deal done - and fast.

2. Leslie Wayne on “Starbucks Chairman Fears Tradition is Fading”

My punch line: Howard Schultz, Chairman of Starbucks, is the one guy that can help bring it back to its roots, even in the face of pressure to continue its global expansion drive. And he has the passion, vision and credibility necessary to do the job. I wrote about some worrying signs at Starbucks some months back, in a 11/26/2006 post about a little coffee shop in my Greenwich Village neighborhood called Joe. I cited five reasons why Joe was successful in a crowded field with much larger, more powerful competitors:

1. Unbridled Confidence



2. Obsessive Attention to Detail



3. In Touch with the Market



4. Condescending Competitors (read: Starbucks)



5. Ruthless Focus on Quality

I went on to conclude the following:

At this phase of Joe’s existence Jonathan is right. Better to focus on refining and perfecting the model than expanding rapidly. Get the model right, learn how to scale and do so - deliberately. This will drive a stake into the heart of the marginal Starbucks, Cosi and other crappy-experience stores. Why would anyone in their right mind go to one of the mega-chains that have lost touch with their customers versus a place like Joe? Answer: they wouldn’t.

This is classic Schumpeter creative destruction in action, admittedly on a micro-scale as we speak. I’ve written a lot about this and believe strongly that creative destruction is a healthy, and unavoidable, fixture of economic development and a natural part of the company life cycle. Success, without question, sows the seeds of failure, as rapid growth has diluted the Starbucks culture and experience and rendered them vulnerable to a down-home, grass roots entrant like Joe. Further, times change, value propositions shift, and the $5 for a consistent venti skim latte just doesn’t exist any more. Yeah, people are now spending $5 for this when they don’t have many good alternatives, but what about when more Joe’s (or places like them) spring up around town? Invariably, they will. I’ll tell you one thing - I’d sooner spend my $5 at Joe or even at a Dean and Deluca than I would a Starbucks any day. Better preparation, better experience, and I feel better giving a smaller establishment my money than the Seattle behemoth.

Well, it seems as if my concerns were not without merit, given Mr. Schultz’s recent note to Company executives:

The last thing that Starbucks wants is watered-down coffee.

It may not have that. But in a passionate internal memorandum to Starbucks executives, the company chairman said that a drive for efficiency has led to a “watering down of the Starbucks experience.”

Rapid expansion, the chairman, Howard Schultz, said, has led to a “commoditization of our brand” that makes the company more vulnerable to competitors. Specifically, he cited several decisions that, he said, may have been right at the time, but which, in retrospect, have led to a “dilution” of the coffeehouse experience that he wanted to foster.

The memorandum was sent on Feb. 14, and first appeared on the Web site starbucksgossip.com. It also reflects one issue that Mr. Schultz has identified over the years — the delicate balance between expanding into a global brand while maintaining the intimate communal experience that led to success.

A Starbucks spokeswoman, Valerie O’Neil, confirmed the memorandum and said yesterday that it reflected “that we are mindful of our responsibility to do better.”

Do Howard’s concerns sound familiar? He clearly gets it; something I could casually observe in my own little world is something being perceived by him on a much broader scale. I give him tremendous credit by wanting to shake things up a little for the good of the brand, the Company and its shareholders. By the way, this Valerie O’Neil is the same one who said the following back in November when speaking about successful upstart coffeehouses like Joe:

Starbucks said it welcomed the competition. “There is room for many coffeehouses in the marketplace that can meet different customers’ needs,” said a spokeswoman, Valerie O’Neil.

I’ll say now what I said then: that was a stupid thing to say. As a shareholder, do I want to hear this? No. I want my company to crush the competition. But the way to do this is by working to constantly improve the product and the experience and, in the case of Starbucks, to build and preserve the value of the brand that has been so carefully cultivated throughout its existence. This can’t be done by implying “We’re big, we’re successful, let other competitors come in and chip away at our brand,” which is effectively what has happened with a small shop like Joe, which started at one location and how has three. And I’m sure before long it will be five, then seven, then…

Good thing Howard is weighing in. He gets the issue of culture and brand, which is really what has made Starbucks one of the great American success stories of the past 20 years. Hopefully his words will fall upon open ears; otherwise, creative destruction may take hold sooner than you think.

3. Ben Stein on “Of Tax Cuts and Those $10 Million Bat Mitzvahs”

My punch line: Readers of this blog know that I respect Ben Stein and his intellect a great deal and, while not always agreeing with him feel that his heart is always in the right place. But this little rant in today’s NYT appears to the culmination of years of frustration that we, the dopes reading the NYT, just don’t seem to get it. Or he may just be getting bored with us and needed to write something for today’s column. Ben’s far-ranging complaints begin at crappy customer service, wind around to conspicuous consumption fueled by conservative tax policy,  make a visit to the ills of Management Buy-Outs and finish at the lack of competitiveness of the U.S. financial markets.

Clearly somebody spiked Ben’s Wheaties this morning. Usually he is more focused in his criticism and irritation, but today he pretty much covered the landscape. Customer service? Sure, Ben, I feel your pain. Nothing pisses me off more than when I pay good money for an experience, a key component of which is service, and I am let down. Ok, this sucks. My advice to you: provide feedback; don’t patronize that particular establishment; write a letter to HQ; sell the stock; offer your services as a consultant. I don’t think this quite rates a Sunday column in the NYT.

Conspicuous consumption? If this consumption, which itself creates jobs and opportunity, is motivation to work hard and create value, which, in turn, generates rewards with which you can consicuously consume, then what is the big deal? Is your argument economics or utility? I can certainly appreaciate that your utility function may look different than someone who throws a $10 million Bat Mitzvah, but is that really your business? The spending associated with a $10 million Bat Mitzvah ripples through the economy, in a positive way. Further, the ability to spend $10 million on a party might itself be motivating to the party-thrower, who is incentivized to work hard to be able to throw more such soirees. This isn’t a bad thing, Ben. The money is being pumped into the economy. Sorry if you don’t like the way people spend their tax breaks. Those tax breaks are motivating and ultimately do lead people to invest in businesses, whether directly or through consumption that incentivizes others to invest in their businesses. 

MBOs? We’ve talked about that. Sure, there are problems with how they are handled. I’m with you there. But didn’t you just write about this less than two months ago? Are you running out of good material? And, finally, the U.S. financial markets? You have a point, particularly as it relates to listing fees (and SarBox, I’d argue). But again, old news.

Love you, Ben. But please, make sure you are taking those Wheaties straight. Because this morning there clearly was a problem.

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The Wall Street Series Part IV: From Wall Street to Main Street - Making the Break

Overview

Some time has passed since my last installment, as I’ve been wondering: what else is there to say? But then it hit me - likely the hardest thing I’ve dealt with in my career is the transition from Wall Street to Main Street. And yes, the difficulty extends far beyond money and the knowledge of a sizable year-end bonus. The range of emotions brought to the surface by such a dramatic career shift is hard to describe, and it led to a bunch of interesting behaviors that, in retrospect, make me feel like a BF Skinner experiment. Translation: what seemed like a chaotic ride on an emotional and spiritual roller-coaster was nothing of the sort. It was a predictable, logical and healthy process of mentally pulling up stakes and placing them down somewhere else. From Wall Street to Main Street. And I’d like to share some of what I went through with you, the experience of which might be of some value to someone out there. At least I hope so.

A Little Background

For me it started in 2002. I had been on the Street for 15 years. They had been really, really good years. I had been fortunate to build a great derivatives team at Deutsche, with a mix of skills, personalities and achievements that made coming to work every day a blast. I also had a great partner based in London and people whom I worked for that I respected. Was it all wine and roses? Of course not. But it was pretty damn good. But then a few things happened. Regulation made the business more of a slog. It just wasn’t as much fun. I had developed a group of talented people that could really take the reins and run with things and, in my opinion, really didn’t need me any more. This led to some soul searching, some open and honest conversations with my senior colleagues, and ultimately led to my writing an expansion plan for and being made CEO of the trading business DB Advisors.

This was a new experience. A very new experience. It was exciting. It was challenging. It was overwhelming. It stretched my skills to their limit - not my deal skills and not my quant skills, but my managerial skills. I had never run such a large, diffuse business (NY, London, HK, LA, with other relationships spanning the globe), and I had never run a trading business before. What was front and center for me was the further “institutionalization” of the business, bolstering its operations, risk management, legal and compliance capabilities. This was prudent given both the scale and complexity of the business and the goal of building a world-class control environment without strangling the ability of the trading teams to do what they do best - trade. This was a good plan. However, a bunch of things upset the apple cart: (1) the desire of some of the top teams to externalize, and set up their own independent shops; (2) the growing discomfort (from a legal and compliance perspective) with running side-by-side proprietary and client portfolios; and (3) the realization that “tail events” happen all the time, and that supporting a platform of this scale requires accepting a level of return volatility that is just not fun unless you are prepared to handle it. So these three factors conspired to make my 2003-2004 period one of great learning, great earning and even greater agita.

For various reasons I found myself at an inflection point in late 2004. My choices: new challenges at Deutsche? New challenges at other Wall Street firms? The opportunity to run a large hedge fund? Or maybe something else. The soul searching had begun.

What Now?

After some discussions with my boss Kevin Parker, who is a great guy, I decided a clean break was best. Take my toys and go home. Take a break and do some deep thinking. Ok, I said to myself. I’ve got money. I’ve got time. I’ve got a wonderful family and great friends. I’ve got my health. I’m 38 years old. Sounds great, right? I was scared as sh*t.  What the hell do I do now? I’ve got a big rolodex and even bigger ideas. My awesome wife says “Take it easy. Go to museums. Go to the movies. Go to the gym. Do those things you’ve long wanted to do. Teach a class. Take a class. Whatever.” All good and logical suggestions.

The problem: I’m Type A. My brain is always processing multiple threads, regardless of whether I want it to or not.  It is just part of my DNA. Generally it’s people like me that achieve the kinds of things I achieved on Wall Street. And we’re not very good at relaxing for extended periods of time. So notwithstanding my wife’s loving, caring words, I took almost none of her advice. I began networking. Speaking to people. Looking at deals. Making some investments. Staying busy. Because every time I felt like I wasn’t busy I felt like a worthless piece of sh*t. I was grasping. I wasn’t at peace.

The Phases of The Decision-Making Process

Phase #1 - Fear Feeds Activity. Feeling rudderless, feeling scared, feeling confused about where I might fit in and what I might do for the next 40 years. My response: frenetic activity that took in the universe of possibilities. Networking, talking, thinking, investing, and contemplating things both within and without my historic sphere of influence. In retrospect, this turned out to be a highly adaptive and functional response. It allowed me to basically collect data, lots of data, on the things that turned me on, turned me off, best leveraged my skills and experiences, and fit with my worldview and goals at that point in my life and career. So while it didn’t feel like it at the time, there was a method to my madness. And madness it was.

Phase #2 - Analyzing the Data. After spending several months meeting with people, evaluating opportunities directly related to and unrelated to my previous work experiences and just seeing how it all felt, I determined that, at this time, I wanted to do something completely different than what I had done previously. Not that the Street and hedge fund management isn’t great. It is. And who knows what the future holds. Maybe someday I will return to my ancestral home on the Street or at a hedge fund in some capacity. But at this time I had another goal - namely, pursuing the dream of building a business, and not a business inside a Wall Street firm but a new business where I could bring every bit of my skills and experiences to bear. I wanted to feel the rush of passion, intensity, and comraderie that comes along with building a company, and building a team of great people sharing a common set of goals and a common vision. Ok. Good realization. But what now? See deals. Lots of deals. Invest in some, but be in search of the Holy Grail.

Phase #3 - The Power of Networks. I found that my networks were great for seeing deals and meeting people. I seeded a quant-based asset management firm called Clear Asset Management, and invested in a few other comapanies as well that came to me through my networks. During this time a former colleague of mine at Deutsche, Jonathan Miller, synched me up with one of his old work colleagues from the early 1990s named Jeff Stewart. Jeff was a successful technology entrepreneur (his most recent company prior to our partnership being Mimeo.com, a truly disruptive online printing company) and was looking for “strategic” angel investors for his latest business idea, Monitor110. I loved the idea (duh!). It seemed like the Holy Grail to me. It also seemed that Jeff and I had very complementary skill sets. And over a period of weeks and months we explored the idea of partnering not just on Monitor110, but on other investing ideas where we had shared interests, which were many. Jeff and I shared the same passion, the same vision, and the same intensity in quest of greatness. And we felt our common ground initially was in our belief in Monitor110.

Phase #4 - Making a Decision. Around this time I had offers to do other things more in line with my hedge fund management/derivatives management experience. These were big money deals. Working with good people. Problem was, I really didn’t have the spark at that time to give it my all, which is the only way I do things. So money and prestige notwithstanding, my heart just wasn’t in it. And one of the reasons was my excitement with Jeff and the goal of making the vision of Monitor110 real. But of course, this decision meant walking away from big, big dollars in exchange for years of basically earning nothing while trying to build a company. And it was a decision I just had to make. Was it uncomfortable? Yes. I am a pretty risk-averse person who just decided to do something so seemingly off my internal “efficient frontier” that I could hardly recognize myself. But I had gone through a process, a thoughtful, rigorous process, to get to this point. And when I plotted my own internal utility function, this decision sat right on the curve. So I did it, discomfort and all.

Phase #5 - Living with the Decision. Fast forward two years. So how has it been? I gotta say, Main Street is pretty cool. I’ve built an entirely new set of networks and skills. I’ve immersed myself in the NY Technology, Venture Capital and Entrepreneur communities, met tons of amazing people, and tapped into a part of myself I didn’t know existed - the tech geek. While I am not a tech geek like the people I work with, I am about 1000x more tech literate than I ever was during my tenure on the Street. And it is fun. I have also become a part of a culture - the entrepreneurial culture - that is markedly different from Wall Street culture. Much more open. Much greater sharing. Much more helping your fellow entrepreneur who is trying to change the world. This just doesn’t happen on the Street. I must say, I am enjoying this new-found spirit of openness and collaboration - it took me a while to get used to it, but I reall dig it. I actually discussed this concept in a post I had written in the wake of the Web 2.0 Summit:

Wall Streeters are from Mars, Entrepreneurs are from
Venus

But before that, I feel compelled to share one particularly interesting
observation: the difference between competing on Wall Street and competing on
Start-up Street is night and day. It took me a while to figure this out, as the
cultural shift was abrupt and dissonant at first. While I generally had a
cordial relationship with my competitors during my time on the Street, there
certainly wasn’t any collaboration, any material idea sharing, or any “Hey, you
might want to interview this person. They’d be really great for you.” Pretty
much, Wall Street is a zero-sum game. I win; therefore you lose. Cooperation is
(generally) not rewarded (unless you are discussing “club deals” in private
equity and the like, which may or may not be anti-competitive, but anyway…),
because in most cases in transactional/trading businesses the outcomes are
digital - there is no gray. As a result, I was acculturated to be a royal
hard-ass. Protective of my teams, my territory and my IP. This, as I’ve come to
learn, is not exactly the case with start-ups in general and entrepreneurs in
particular.

There seems to be the concept of both enlightened self-interest and a “karma
boomerang” among entrepreneurs. While start-up managers are super competitive
and want to win as bad as any Wall Streeter (if not more), there appears to be a
tacit code of cooperation and a “we’re in this together and trying to change the
world” mind-set that permeates the dialogue. I just wasn’t used to this kind of
collaboration, sharing and communication with my competitors during my Wall
Street days. And this also applies to my interactions with VCs. I came to my
initial discussions with the following frame of mind: “I am assuming you are
trying to screw me. Therefore you need to prove to me that you are trustworthy
and that your intentions are totally above board.” In short, I seemed like some
hostile, alien life form (Martin, to be specific, like the dude on Bugs Bunny
with the funny brush hat). After I figured out that yes, they certainly want to
do the best deal for themselves, but that there is an inherent balance built
into the transaction (because a pissed off entrepreneur does nobody any good)
and that they generally possess good intentions, I mellowed out. But I’ve really
had to alter my perspective since entering this world. And I like it - a lot.
While I am still a Martian at my core (once a deal guy, always a deal guy), I
can now hang with folks from Venus without freaking them out.

Jeff and I have built a really cool company with the best people in the world, partnered financially with some of the best investors in the world, and are about to embark on a whirlwind tour of bringing a new product to market and trying to change the way institutional investors use the internet to make money. This is big, dizzying stuff. But truth be told, notwithstanding our success (raising $17 million from the likes of Draper Fisher Jurvetson and the legendary angel investor Ron Conway to name just a few, building a 50 person global team, bringing a massively complex 2+ year development project to culmination, etc.), I still sometimes get heartburn when I think about how much cash I’d be making if I’d only taken some of those jobs that were there for me. The Street has had a pretty good run since I bailed. But every time I think this I say to myself - think of how happy you’ve been these last two years, how much you’ve learned, how much you’ve grown, how much better you’ve gotten as a person and as a professional. And then I think - it has been worth it. In spades. What I am doing now is successful and will only become more so, and if I do decide to go back to the world of hedge funds or the Street I am a much better manager, business builder and problem solver having started and built a highly complex, global company than I was before. So net net, I rolled the dice and they came up boxcars. And I can’t tell you how proud I am to be able to say that.

Conclusion: Change is Hard - Period

It has been a wild ride. Emotional ups and downs together with periods of uncertainty (“did I do the right thing?”) against a backdrop of incredible learning, growing and fun. Thinking back upon the dramatic shift in my work life, all I can say is that it, like everything else, is a process. Go through your own process. Give yourself a break - acknowledge that even in the best of circumstances (and I think mine were about as good as they could get) it will be hard and you will have many moments of fear and self-doubt. But as long as you follow a healthy and rigorous process of self-assessment, analyzing the options, collecting data and making a thoughtful decision, it will work out. And “working out” doesn’t necessarily mean that the next thing you do is a home run - only that by doing it you will make yourself a better professional and a better, happier person. And at the end of the day isn’t this what really matters?

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