Lessons From 2007: A Baker's Dozen - RealMoney

Summary:
Barry Ritholtz with some lessons learned about markets from 2007. Ignore market rumours. Buy sector strength and avoid sector weakness. Never blindly follow the big money. Day-to-day stock action is mostly noise. P/E matters less than you think. Ignore deteriorating fundamentals at your peril. Nothing is more costly than chasing yield. Know what you own. Simple is better than complex. Stick to your core competency. Fess up. Never forget risk management. The trend is your friend. (Published: 01/02/08)

Notes:

1. Ignore market rumors
• Sometimes the big bucks don't even have to make the buy, they need only have to be rumored to be kicking the tires.
  
• That was never truer than in 2007.
  
• It seemed every time some firm was in trouble, the same gossip was floated that Warren Buffett was about to buy them. Time and again, these tales proved to be unfounded money-losers.
2. Buy sector strength (and avoid sector weakness)
• It's a truism of real estate: It's better to own a lousy house in a great neighborhood than a great house in a lousy one.
• The same is true for stock sectors: Buying mediocre companies in great sectors generated positive results, while great companies in poor sectors struggled.
  
• The losers are obvious: The homebuilders, financials, monoline insurers and retailers all struggled this year.
  
• Goldman Sachs (GS ) is a perfect example. Despite record revenue and earnings in 2007, the stock was up less than 15% in 2007. In 2006, on much weaker revenue and profits, shares climbed more than 50%. Great house, bad neighborhood.
• The winners? Anything related to agriculture, solar energy, oil servicing, industrials, software, exporters, infrastructure plays -- even asset-gatherers thrived. Stocks in these groups consistently showed up in the 52-week-high list.
  
3. Never blindly follow the "big money"
• Because professionals make dumb mistakes too.
  
• 2007 saw a number of surprise investments where so-called smart money bought big chunks of troubled companies
• Bank of America (BAC) buying a chunk of Countrywide (CFC) being Exhibit A.
  
• Many people chased the so-called smart money into these trades.
  
• Unfortunately, all of these trades have proven to be jumbo losers. If this keeps up, the "smart money" may need to start looking for a new nickname.
4. Day-to-day stock action is mostly noise
• Markets eventually get pricing right.
  
• But the key to understanding this is the word "eventually."
  
• Over the shorter term, markets frequently under- or overprice a stock before settling into the right approximation of value. This process typically occurs over broad lengths of time.
  
• Unfortunately, that doesn't stop some rather suspect interpretations of what these short-term movements mean. I look at these tea readings as Rorschach tests, revealing more about the speaker than they do about the subject.
  
• Case in point: The homebuilders.
  
• It seemed that every time there was even the slightest uptick in the group, some bozo would declare that the bottom of the real estate cycle was in. Indeed, every dead-cat bounce or short squeeze was trotted out as proof positive that the housing problem was over. Only it wasn't, and the homebuilders cratered some 70% off their highs.
  
• You don't need to be a technician to know this: The little squiggles on the chart mean a whole lot less than the big squiggles do.
5. P/E matters less than you think
• P/E ratios alone tell you very little about a stock's future prospects.
  
• If that sounds like blasphemy, please look at a few examples: Google (GOOG) , Apple (AAPL) and Mosaic (MOS) all sported high P/Es at the beginning of the year. Their stocks have done splendidly. On the other hand, back in January, retailers, financials and homebuilders all had reasonably cheap P/Es. (How'd they do?)
  
• It helps if you think of P/Es not as a photo but as video. The direction matters more than the mere number:
  
• Were P/Es likely to come down as sales ramped up? Or were P/Es modest because they were at the top of a profit cycle, and were likely to fall? The answer to these questions explains the difference between the winners and losers, and that leads us to:
6. Ignore deteriorating fundamentals at your peril
• At various points in 2007, we saw or read recommendations to buy the unholy trinity: retailers, financials and homebuilders.
  
• Each of these buy recommendations came despite the deteriorating economic fundamentals of each sector.
  
• That turned out to be a recipe for big losses.
  
• One would think this doesn't need to be said, and yet it does: When the fundamentals of a given market, sector or consumer group are decaying, profit gains are sure to slow.
7. Nothing is more costly than chasing yield
• For fixed-income investors, what matters most is not the return on your money, it's the return of your money.
  
• Reaching down the risk curve for a few bips of additional yield is one of the dumbest things an investor can ever do.
8. Know what you own
• This very basic issue was mostly forgotten in recent years, and it was forgotten by pros and individuals.
  
• Investment banks like Bear Stearns, Morgan Stanley (MS) and Merrill Lynch (MER), big banks like Citigroup (C) and Washington Mutual (WM) , and GSEs like Fannie Mae (FNM) and Freddie Mac (FRE) were scooping up assets apparently without doing their homework.
  
• The complexity of these pools of mortgages almost guarantees that no one truly knows what's in them (see the next rule). If you don't know what you own, how can you properly manage risk?
9. Simple is better than complex
• Here's why this blindingly obvious observation bears repeating:
• Start with a few million mortgages of varying credit-worthiness and create a series of residential mortgage-backed securities (RMBS) from them. Then take the RMBS and stratify them. Then leverage them up into collateral debt obligations (CDOs). Once that bundling is complete, make complex bets on which layers might default, via credit default swaps (CDS). Gee, how could anything possibly go wrong with that?!
• It turns out plenty can go wrong there. Remember, in the universe of financial engineering, simpler is better than complex.
10. Stick to your core competency
• E*Trade (ETFC) is an online broker; what was it doing writing subprime mortgages?
• Why was Bear Stearns running two hedge funds?
• Isn't H&R Block a tax preparer? It was making mortgage loans why?
• And exactly what was GM's expertise in underwriting mortgages? (The snarkier among you might be wondering exactly what business GM's expertise is in.)
• Had these companies stuck to what they did best (or least bad), they wouldn't be in as much trouble today.
11. Fess up!
    
• Whenever a company runs into trouble, they seem to take a page from the same PR playbook:
  
• First, they say nothing. Second, they deny. Finally, they make a begrudging, pitifully small admission. Eventually, the full truth falls out, and the stock tanks with it.
  
• Companies (and their shareholders) are much better served when the company admits its mistakes, apologizes and tries to make amends.
  
• Promising to do better in the future never hurts either. Even when bad news hits a stock, a quick admission of error makes the pain less severe than it might have otherwise been.
12. Never forget risk management
• This applies to everyone who is involved in anything financial: investors, companies, even the Fed.
  
• Consider what could possibly go wrong, and have a plan in place in the event that unlikely possibility comes to pass.
  
• If there is to be upside, then there must also be a corresponding and proportional downside.
  
• For investors, that may be something as simple as using stop losses and being appropriately diversified.
  
• For others, it means knowing what risk factors face their businesses: the price of oil, interest rates, a hurricane. You may not be able to control these things, but you can anticipate, prepare for, even hedge against all of them.
13. The trend is your friend
    
• Despite the year's parade of horribles, this market cliché was proven true once again.
• The Dow, S&P 500 and Nasdaq are all higher this year, as their long-term trends have been tested but remain intact.
• The exception, the Russell 2000, broke its trend earlier this year. That made trend traders abandon the small-cap index, which has since fallen even further.
  
• This confirms the corollary: "except for the bend at the end."
  
• As long as the index trend lines stay intact, investors can sleep easy. But once those trendlines break, well, then you better apply some of the earlier lessons (see numbers 2, 3, 4, 6, 7 and 12!).
  

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Schumpeter: The Prophet of Bust and Boom - International Herald Tribune

Summary:

Sharon Reier on Schumpeter's creative destruction process; entrepreneurial spirit; Greenspan and Schumpeterian economics in 1999; transforming agents; monopolies (10/06/2000)

Notes:

• Marx: labor is fundamental unit of economic value, proletariat as key agent of change; Schumpeter: entrepreneur is cornerstone of capitalism
• Schumpeter: vital force behind capitalism is innovation and the entrepreneur willing to introduce it; introduction of innovations was responsible for both the progress and the instabilities of capitalism, i.e. creative distruction
• creative destruction: "process in which new technologies, new kinds of products, new methods of production and new means of distribution make old ones obsolete, forcing existing companies to quickly adapt to a new environment or fail."
  • Best for governments not to interfere with the "prosperity-creating potential of this radical kind of capitalism," even if it leads to job losses as established companies are brought down
• Schumpeter departed from mainstream economic theory that viewed market and capitalism as stable
• Entrepreneurial spirit: different way of looking at the world; will to create empire for one's self; dynamic force that stems from disposition of people; not necessarily intelligent or subtle people; want to attack the world in a certain way; cfr. adventurers
• By advancing new products, technology or productive methods, entrepreneurs provide impulse for change
  • Schumpeter: perennial gale of creative destruction (Capitalism, Socialism and Democracy, 1942)
• Greenspan using Schumpeterian economics to explain remarkable non-inflationary expansion in US in past 8 years
  • Greenspan, 1999: "The evident acceleration of the process of creative destruction, which has accompanied these expanding innovations and which has been reflected in the shifting of capital from failing technologies into those technologies at the cutting edge, has been remarkable."
  • Greenspan, cont'd: "The innovations in information technology have begun to alter the manner in which we do business and create value, often in ways that were not readily foreseeable even five years ago. As this century comes to an end, the defining characteristic of the current wave of technology is the role of information."
  • Greenspan, cont'd: "We do not know, nor do I suspect anyone can know, whether current developments are part of a once-or-twice-in-a-century phenomenon that will carry productivity trends nationally and globally to a new higher track, or whether we are merely obscuring some unusual variations."
• Major advances occurring every 50 or 100 years: echoing Schumpeter's analysis of economic cycles;
  • capitalism's restless history punctuated by long and short waves;
  • long upswing stimulated when a new set of technologies and industries ("transforming agents") comes into existence
    • early 19th century: rise of textiles, iron, coal and steam engines
    • mid 19th century: steel production, construction of railroads
    • early 20th century: automobiles, electric power, related products
  • transforming agent opens up opportunities while clearing out old areas of activity and ways of behaving
• However, "booms contain the seeds of their own destruction"
  • entrepreneur brings along something new, source of profit; others come into market and whittle profit away; as they copy, more investment; changes in investment; changes in profit; speculation cycle starts; lots of people speculating on the markets and market starts to boom; eventually, once everyone has the car, internet access, etc., there is only replacement demand, stop buying
• Schumpeter: nothing wrong with monopolies, could me more effective purveyors of innovation than many start-ups
  • get monopoly position because you're very good
  • should judge monopolies by their innovation record, not by whether or not it has monopoly profits
  • but as long as there are open markets, all monopolies are transient
• Schumpeter was wrong about capitalism's endgame: thought it would become bureaucratic, squeezing out individual entrepreneur and making innovation routine subject to centralized management

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Quote of the Day

"The trouble with the first time entrepreneur is that he doesn’t know what he doesn’t know. After a failure he does know what he doesn’t know and can beat the hell out of people who still have to learn." - Don Valentine, Sequoia

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Quote of the Day

"The world of technology thrives best when individuals are left alone to be different, creative, and disobedient." - Don Valentine, Sequoia

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Venture Capital's Hidden Calamity - BusinessWeek

Summary
Consensus in the industry that it's a bad time to be a VC. Not enough home-runs. Industry becoming more the font of outsourced R&D for big firms. Many investors worried that only a handful of firms will break even on the current crop of funds, much less produce stellar returns. Only IPOs are one-off companies, not hot new stuff. SarBox is making IPO less appealings. Acquisitions disappointing: time to acquisition is longest in 20 years and returns small. Yet a lot of money around. Billions of dollars in VCs' coffers fight to get in what few great companies there are. Driving up valuations, VCs paying more to get into the best deals. Terms between venture guys and their investors getting harsher. (Published: 03/10/07)
Notes:

• bad time to be a VC
• anyone who says different is either
  
• raising a new fund, or
• works at one of the few firms having a good year
  
• numbers look great on the surface:
• value of deals rose a solid 8% of Q2 of 2007
• investors pumping $7.4b into emerging companies
• money is funding some legitimately exciting frontiers
• web2.0: $500m in H1
• cleantech: $1.1b in H1
• IPOs up for the year
• Q2: venture-backed companies tapped the public markets for $2.73b
• most raised in a 3-month period since 2000
• Q4: 46 companies looking to file
• but: closer look at numbers reveals disturbing trend
• IPOs
  
• mainly one-off companies that were founded years ago and have slogged away at building solid businesses for a half-decade or more
• no big overall tech movement that's getting Wall Street revved up
• feeling mutual among entrepreneurs
  
• Sarbanes Oxley and other regulations have made the prospect of going public far less appealing
• picture worse for acquisitions
• Q3: $10b, but spread among 90 deals
• typically companies that have been plodding for 6+ years, chewing through $30m in VC cash, to eventually get bought for $50m or so
• median length of time it took companies to get bought was longest since Dow Jones VentureOne started measuring 20y ago
• meanwhile, valuations keep rising
• as billions of dollars in VCs' coffers fight to get in what few great companies there are

• venture firms not destitute
• have plenty of "base hits"
• but: "home runs" increasingly elusive
• Venture capital is a home-run business, where the top 10% firms make up nearly 80% of the returns.
• many investors worried that only a handful of firms will break even on the current crop of funds, much less produce stellar returns
  
• VC veteran's wondering whether they should get out/build a startup

• unless something changes, VC is in for upheaval
• industry may become more the font of outsourced R&D for big firms
• less breeding ground for the next great tech powerhouse
• returns will be lackluster for the majority of firms left out of the best deals

• current calamity has been long time in the making
• since NASDAQ bubble, firms learned the hard way that you could no longer take companies from idea to public in 18 months
• instead, "it's a business of building companies, it's a business about people, gut calls, and the art of building a portfolio one deal at a time"

• paradox:
  
• venture industry has been downsizing, but those investing in the venture industry as a whole only wanted to invest in venture firms more
• i.e. world's largest pension funds and institutions
• money wanted to get into a shrinking business
• is giving marginal firms another shot, keeping shakeout at bay
• web 2.0
• only one company, YouTube, had a $1b plus outcome when purchased by google
• only handful have sold in the hundreds of millions
• because the costs of starting these businesses are so low, venture investors own smaller stakes than they did in the last Web bubble
• clean-tech
• has seen a few exits
• two IPOs in 2007 so far, 3 in registration
• but: deals have been small
• most of the clean-tech market is still experimental, in both technology and market opportunity

• valuations are on the rise
• venture investors paying more to get into the best deals
  
• valuations are an important barometer of who holds more power at any given point in the Silicon Valley economic cycle
• the higher a valuation, the fewer shares a VC's dollar buys, and the more leverage entrepreneurs have
• high valuation not all bad news for the venture set
• e.g. step-ups in valuations between rounds mean that on paper early stage investors are showing gains
• just on paper
• valuations typically driven up by the prospect of an IPO or big acquisition
• now they're mostly being driven up by the piles of money looking for the next hot deal
• venture investors getting all the drawbacks of a hot market
• competition to get in on the deals and high prices
• without the benefits (blockbuster IPOs and acquisitions)
  

• NVCA: almost half of venture investors surveyed predicted a decrease in the number of VC firms even as returns improve overall

• terms between venture guys and their investors getting harsher
• limited partners increasingly demand lower management fees and so-called "key man" provisions
• "key man" provisions give investors an out if certain rock-star partners leave a firm
  

• bright side
• with so much cash floating around the Valley, entrepreneurs have never had it so good
• lot of dumb ideas are getting funded, but nearly any great idea has a good chance of getting funded too

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Globalisation generates dark thoughts - FT.com

Summary:
Chris Giles discussing FT/Harris opinion poll. Public sceptic about globalisation. Want competition among rich countries but feel threatened by emerging countries. Perceived unfairness of corporate executive rewards. Support more taxation for highest earners. (23/07/2007)

Related article Globalisation backlash in rich nations - FT.com (22/07/2007).


Notes:

• FT/Harris opinion poll: more people in rich countries believing globalisation was having negative effect than positive; Britain, US, Spain: less than fifth think globalisation beneficial
• contrast, most economists believe globalisation has been boost to economic performance of rich countries as well as poor
• public feeling gap between rich and poor in their countries getting larger, that inequality is rising
• majority of respondents in all countries (except Italy) think greater rewards for corporate executives are unfair; Britain and UK least likely to respect corporate bosses
• large majority in most countries support more taxation for highest earners
• strong transatlantic divide concerning executive pay; most of Europe, 2/3 of respondents think governments should set pay caps for executives, vs. 1/3 in US
• many studies have shown that childeren of poor are much more likely also to be poor in US and UK; yet according to poll, US and UK citizen's have the opposite impression
• across Europe, large majority thinks free competition should be one of EU's objectives
• message clear: public want competition among rich countries but feel threatened by emerging countries

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Vijay, the world's most desperate venture capitalist - Dilbert

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So You Want to Be a Venture Capitalist - New York Times

Summary:
Number of VCs in Silicon Valley declining, ascribed to exodus of "tourist VCs." Huge amount of turnover below the surface in VC industry. No obvious resume for the perfect venture capitalist. You're a natural athlete (good sense of small about a deal) or you're not. Only way to find out is by taking to the field. E.g. failure of Mitch Kapor (Lotus 123) at a VC firm. According to Kramlich (Sequoia), venture capital doesn't necessarily take a lot of technical talent. I mean, it doesn't hurt, but it's more about people skills and the ability to assess whether there's a market for something. (Published: 22/05/05)

Notes:

• exodus of "tourist V.C.'s"
  
• Silicon Valley term for people from nonfinancial backgrounds
• hundreds fewer venture capitalists in 2005 compared to 2003
• Darwinian characteristics to venture capital
• huge amount of turnover below the surface
• talent for spotting promising technologies and undiscovered start-ups before others not sufficient
• no obvious résumé for the perfect venture capitalist
• "Venture capital doesn't necessarily take a lot of technical talent. I mean, it doesn't hurt, but it's more about people skills and the ability to assess whether there's a market for something." (Kramlich, Sequoia)
  
• need to have good sense of smell about a deal
• can't really have people learning on the job
• venture investing is best left to the professionals
• you're a natural athlete or you're not
• "Some can do it, and some can't, and like with athletes there's no way of telling until they take the field."
• e.g. Mitch Kapor
• founder of Lotus Development (Lotus 123)
• enormous success investing for himself
• e.g. RealNetworks and UUNet Technologies
• staggering payouts
• joined VC firm Accel Partners
• failed to choose a single company that made him any money (0-for-5)
• "The fact that it's someone else's money you're investing, and that you're investing as part of a partnership, that was more different than I thought it would be."
• At the end of the 90's, it seemed everyone in Silicon Valley wanted to become a venture capitalist
• ranks of venture capitalists more than doubled
• from less than 5,000 in 1995 to nearly 10,000 by 2001
• firms started hiring people from outside traditional fields like finance or operations
• suddenly many lawyers, entrepreneurs, journalists and executive recruiters were trying their hand at playing venture capitalist
• reason:
  
• vast rewards
  
• a general partner at a top-tier firm typically earns at least $1 million in salary
• real payoff is what venture capitalists call "the carry"
  
• the 20 to 30 percent of the profits they share among themselves before disbursing the rest to investors
• a partner working at a top-tier firm in the 90's could pocket roughly $50 million over the life of a single fund
• thrills
• not unlike a movie producer auditioning tomorrow's stars
• "Being a venture capitalist was viewed as a very exciting, top of the feeding chain sort of thing. But what I think a lot of people learned is that it's not as much fun or as easy as it might have looked from the outside." (Scott Dettmer, founding partner at the Silicon Valley law firm Gunderson Dettmer)
• early years are often painful
• John Doer: "training a new venture capitalist was not unlike preparing a fighter pilot for battle: it takes probably six to eight years and you should be prepared for losses of about $20 million. Of course, while we take risk, we work like hell to avoid crashes."
• venture gods
• someone who has made $100 million to $500 million on a single investment
• e.g. Mr. Doerr, Mr. Kramlich and Michael Moritz at Sequoia Capital

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A Unified Theory of VC Suckage - Paul Graham's blog

Summary:
Paul Graham on how the economics of the VC business is the reason many VCs behave the way they do and are so disliked by many founders. Problem with VCs is that they're funds, and that a lot of money is at stake. As a result, VCs take an agonizingly long time to decide, their due diligence feels like a "cavity search", they steal your ideas, and they want to micromanage your company. Add up all the evidence of VCs' behavior, says Graham, and the resulting personality is not attractive. "In fact, it's the classic villain: alternately cowardly, greedy, sneaky, and overbearing." But they're not intrinsically jerks: "VCs are like car salesmen or bureaucrats: the nature of their work turns them into jerks." VCs often complain that in their business there's too much money chasing too few deals. Few realize that this also describes a flaw in the way funding works at the level of individual firms. (Published: 23/03/05)

Some reactions to this essay: VenChar, global-themes.com, Rick Segal

Notes:

• problem with VC funds is that they're funds
• get paid a percentage of the money they manage:
  
• about 2% a year in management fees
• plus a percentage of the gains
• want the fund to be huge
• means each partner ends up being responsible for investing a lot of money
• since one person can only manage so many deals, each deal has to be for multiple millions of dollars
• explains
  
• why VCs take so agonizingly long to make up their minds
• why their due diligence feels like a body cavity search
• with so much at stake, they have to be paranoid.
• why they steal your ideas
• every founder knows that VCs will tell your secrets to your competitors if they end up investing in them
• only reason VCs are so sneaky is the giant deals they do
• with so much at stake, they have to be devious
• why VCs tend to interfere in the companies they invest in
• with so much at stake, VCs can't resist micromanaging you
• huge investments
  
• something founders would dislike, if they realized how damaging they can be
• VCs don't invest $x million because that's the amount you need
• but because that's the amount the structure of their business requires them to invest
• like steroids, these sudden huge investments can do more harm than good
• Google survived enormous VC funding because it could legitimately absorb large amounts of money
• less fortunate startups just end up hiring armies of people to sit around having meetings
• giant investments mean giant valuations
• otherwise there's not enough stock left to keep the founders interested
• high valuation not a great thing
• you can't benefit from a high valuation unless you can somehow achieve what those in the business call a "liquidity event"
  
• the higher your valuation, the narrower your options for doing that
• puffed-up companies that went public during the Bubble didn't do it just because they were pulled into it by unscrupulous investment bankers
• most were pushed just as hard from the other side by VCs who'd invested at high valuations, leaving an IPO as the only way out
• only people dumber were retail investors
• VCs are like car salesmen or bureaucrats: the nature of their work turns them into jerks.
• VCs often complain that in their business there's too much money chasing too few deals.
• Few realize that this also describes a flaw in the way funding works at the level of individual firms.
  
• 
  

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Squanderville versus Thriftville (2003) - Fortune Magazine

Summary:
Warren Buffet, writing in 2003. Predicts the dollar will decline in value and is therefore buying foreign currencies. Decline will have serious consequences for US economy. Growing trade-deficit is to blame. Explains this by means of tale: Squanderville vs. Thriftville. Thriftville owning Squanderville bonds. Government devalues Squanderville national currency to reduce value of IOUs (bonds). Thriftville sells bonds and buys Squanderville assets (direct ownership) with proceeds. Ends up owning all of Squanderville. One generation of Thrifters gets a free ride for which future generation pay (rent, interest) in perpetuity. Story similar to that of US since late 1970s. Declining dollar value not the solution. Buffet proposes system of Import Certificates in order to rebalance trade. (Published: 10/03)

Notes:

• Buffett: "Through the spring of 2002, I had lived nearly 72 years without purchasing a foreign currency. Since then Berkshire has made significant investments in - and today holds - several currencies. It is largely irrelevant which currencies they are. What does matter is the underlying point: to hold other currencies is to believe that the dollar will decline. Both as an American and as an investor, I actually hope these commitments prove to be a mistake. Any profits Berkshire might make from currency trading would pale against the losses the company and our shareholders, in other aspects of their lives, would incur from a plunging dollar."
• our trade deficit has greatly worsened, to the point that our country's "net worth," so to speak, is now being transferred abroad at an alarming rate
• a perpetuation of this transfer will lead to major trouble
• see tale of Squanderville and Thriftville
• Tale of Squanderville and Thriftville
• two isolate, side-by-side islands of equal size
• land only capital asset
• communities primitive: need only food and produce only food
• working 8hrs/day, each inhabitant can produce enough food to sustain himself
• each society self-sufficient if everybody works 8hrs/day
• Thriftville citizens decide to do some serious saving and investing
• start to work 16hrs/day
• continue to live of food produced in 8hrs, and export remainder to Squanderville
• Squanderville citizens decide to live their lives free of toil and eat as well as ever
• pay Thrifts with bonds
• bonds at their core represent claim checks on the future output of Squanderville
• a few Squanderers smell trouble coming but are ignored
• the debt Squanderville is piling up will eventually require them to work more than 8hrs/day
• Thrifts begin to get nervous
• question the value of the Squanderville IOUs
• sell most of the bonds to Squanderville residents for Squanderbucks
• use proceeds to buy Squanderville land
• eventually the Thrifts own all of Squanderville
• Squanderers have nothing left to trade
• must return to working 8hrs/day in order to eat
• must also work additional hours to service the debt and pay Thriftville rent on the land imprudently sold
• Squanderville has been colonized by purchase rather than by conquest
• present value of the future production of Squanderville must forever ship to Thriftville
• can be argued that both have received a fair deal:
• equates the production Thriftville initially gave up
• however, dramatic "intergenerational inequity" has arisen
• one generation of Squanderers got a free ride and future generations pay in perpetuity for it
• Squanderville government facing ever greater payments to service debt
• sooner or later will decide to embrace highly inflationary policies
• i.e. issue more Squanderbucks to dilute the value of each
• Squanderbonds are simply claims on specific numbers of Squanderbucks, not on bucks of specific value
• making Squanderbucks less valuable would ease the island's fiscal pain
• in response, residents of Thriftville opt for direct ownership of Squanderville land rather than bonds of the island's governement
• most governments find it much harder morally to seize foreign-owned property than they do to dilute the purchasing power of claim checks foreigners hold
• "Theft by stealth is preferred to theft by force"
• comparison with US
• 1945 - ~1970: operated in industrious Thriftville style
• regularly selling more abroad than purchased
• invested surplus abroad
• net investment increased
• i.e. holdings of foreign assets less foreign holdings of US assets
• country's net worth consisted of all the wealth within borders plus a modest portion of the wealth of in the rest of the world
• late 1970s: trade situation reversed, producing deficits
• running initially at ~1% of GDP
• net investment income remained positive
• net ownership balance hit its high in 1980 at $360b, due to power of compound interest
• since then downhill
• pace of decline rapidly accelerating
• 2003:
• trade deficit exceeds 4% of GDP
• US consuming 4% more than it produces
• roughly equal to $500b per year, at this rate
  
• net foreign ownership of $2.5tr
• rest of the world owns $2.5tr more of the US than US owns of other countries
• roughly 5% of national wealth (~$50tr)
  
• some of this $2.5tr investested in claim checks (US bonds, both private and governmental)
• some of it invested in assets, e.g. property and equity securities
• at current trade-deficit level (4% of GDP), foreign ownership will grow at about $500b/year
• will be adding 1% annually to foreigners' net ownership of national wealth
• as that ownership grows, so will the annual net investment income flowing out of the country
• will leave US paying ever-increasing dividents and interest to the world rather than being net receiver as in the past
• "We have entered the world of negative compounding - goodbye pleasure, welcome pain."
• Economics 101:
• countries can not for long sustain large, ever-growing trade deficits
• at some point, the spree of the consumption-happy nation would be braked by currency-rate adjustments and by the unwillingness of creditor countries to accept an endless flow of IOUs from the big spenders
• but: US enjoys special status
• can behave today as it wishes because past financial behaviour was exemplary and because it is so rich
• neither its capacity nor its intention to pay is questioned
• continues to have a mountain of desirable assets to trade for consumables
• Buffet: time to halt this trading of assets for consumables and to balance trade
• proposal: Import Certificates
• Import Certificates
• issued to all US exporters in an amount equal to the dollar value of their exports
• exporter can sell the ICs to parties wanting to get goods into the country
  
• exporters abroad
• importers here
• inevitable result: trade balance
• price of certificates determined by supply and demand
• if our exports were to increase and the supply of ICs were therefore to be enlarged, their market price would be driven down
  
• e.g. certificates selling for 1o cent
  
• means 10 cents per dollar of exports behind them
• means producer could realize 10% more by selling his goods in the export markets than by selling them domestically
• extra 10% coming from sale of ICs
• no such thing as a free lunch
  
• foreigners selling to us would face tougher economics
• not nice, but that's a problem they're up against no matter what trade "solution" is adopted
• but: plan does not penalize any specific industry or product
• in the end, free market would determine what would be sold in the US and who would sell it
• ICs only determine aggregate dollar volume of what was sold
• also negative consequences for US citizens
• prices of most imported goods would increase
• so would prices of certain competitive products manufactured domestically
• cost of ICs would act as a tax on consumers
• but: also drawbacks to letting the dollar continually lose its value or to increasing tariffs on specific products or instituting quotas on them
• "The pain of higher prices for goods imported today dims beside the pain we will eventually suffer if we drift along and trade away ever larger portions of our country's net worth"

• A gently declining dollar does not provide the answer
• would reduce our trade deficit to a degree
• but: not by enough to halt the outflow of our country's net worth and the resulting growth in our investment income deficit
• action to halt the rapid outflow of our national wealth is called for
  

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Strategies For Microarray Analysis of Limiting Amounts of RNA - Brief Funct Genomic Proteomic.

Summary:
This review evaluates current signal and sample amplification technologies, including those that can be used to generate labelled cDNA populations for array analysis from as little as a single cell. Options for expression profiling are to increase cDNA labelling and hybridisation efficiency, or to use an amplification strategy to generate enough RNA/cDNA for use with a standard labelling method. Sample amplification approaches must preserve the representation of the relative abundances of the different RNAs within the starting population and must also be highly reproducible. (Briefings in Functional Genomics and Proteomics, Vol 2, No 1, 31-36, April 2003)


Notes:

Introduction

• microarrays
• have become a standard technology for measuring relative and absolute levels of gene expression
• interest in increasing resolving power of this technology has grown
• particularly in terms of input material required to generate robust data
• drive for this
  
• partly technical
• partly motivated by biological and clinical concerns
• main goal is to use defined populations of cells or small pieces of complex tissue (e.g. clinical biopsy) for expression profiling
  
• associated with a reduction in the amount of cells that can be harvested
• e.g. laser capture microdissection: possible to collect defined cells from fesh and fixed tissue sections
• ultimate aim of this increase in resolution:
  
• to enable reproducible expression profiling at the level of single cells
• several reports that this is currently feasible
• likely to be in general use in the near future
• current methods
• require microgram amounts of total RNA for generating labelled cDNA populations for microarray analysis
• equivalent of over 1 million cells
• efforts to reduce this requirement focus on two complementary approaches:
  
• signal amplification and detection
  
• allowing the use of smaller amounts of input RNA
• RNA sample amplification
• to generate enough material for standard labelled cDNA synthesis, hybridisation and detection
• combination of both

Signal versus sample amplification: theory

• ideally:
  
• extract the RNA from a single cell, directly label that RNA and hybridise it to some form of microarray
• many practical issues
• from: difficulty of harvesting picogram quantities of RNA contained in a typical cell
• to: hybridisation kinetics for very small numbers of molecules at relatively low concentrations
• mRNA abundance: three classes (tissue based estimates from brain cDNA libraries)
1. high abundance transcripts
• ~1/6th of the mass of mRNA
• represents 100 different transcripts
2. medium abundance
• ~45% of mass of mRNA
• 2,000 different transcripts
3. low abundance
• ~40% of mass of mRNA
• 45,000 different transcripts
• inherent technical challenge in labelling all of these low abundance transcripts for microarray hybridisation under any circumstances and developing hybridisation conditions that would ensure that all molecules hybridise in a reasonable timeframe
• under conditions where the input RNA and the corresponding absolute numbers of each low abundance transcript are low, these problems become more accute, with less room for errors in each step of the generation of labelled cDNA population
• a final technical hurdle is the detection of the extremely small numbers of molecules harvested from single cells

Signal amplification

• currently: two main methods for generating labelled cDNA populations for array analysis
1. direct incorporation of fluorescent label-conjugated nucleotides
2. incorporation of modified nucleotides followed by dye coupling to those modified nucleotides
• amino-allyl labeling method
• introduced for
• relative cost reasons
• reduce the biases in incorporation rates of different fluorophore-labelled nucleotides
  
• in widespread use and commercial kits available
• novel strategies
  
• labelling cDNA populations as well as amplifying that label such that smaller numbers of hybridised molecules can be reproducibly detected and quantified
• e.g.
• enzymatic amplification
• e.g. tyramide signal amplification
• use of dendrimers
• increases amount of label per nucleotide and thus per labelled cDNA molecule
• several hundred fluorescent tags per dendrimer
• input amounts of RNA down to 0.5ug
• still considerable amount
• hybridisation takes far longer than with standard methods
  
• due to size of molecules
  
• typically of order of several days
• alternative detection methods, e.g.
• quantum dots
• rolling circle amplification

Sample amplification

• amplification of the input RNA to generate enough material for standard labelled cDNA synthesis
  
• alternative to signal amplification
• currently: two approaches
1. PCR-based or exponential amplification
2. linear amplification
• linear amplification
  
• first described by Eberwine et al. as a method for single cell analysis; now common method
  
• antisense RNA synthesis from a population of double-stranded cDNA molecules, all carrying a standard recognition site for T7 RNA polymerase
• used in Affymetrix system
• curretnly, amplification of nanogram quantities of total RNA (equivalent of 50 - 1000 cells) requires two rounds of T7 linear amplification
• feature: shortening of the amplified transcripts, compared to their parent mRNA population, with the associated 3'-bias in the amplified material
• disadvantages:
• labour intensive
• requires synthesis and purification of double-stranded cDNA from the starting RNA, followed by at least one round of RNA synthesis and amplification
• this RNA is in turn used to synthesise double-stranded cDNA, followed by a second round of RNA synthesis
• typical time taken to generate amplified RNA from picogram quantities of input total RNA is of the order of 3-5 days
  
• PCR-based amplification
• general principle: introduction of PCR-priming sites at either end of each reverse-transcribed cDNA molecule, followed by global amplification of the entire population of molecules
• potential pitfalls (sources of sampling, non-representative amplification):
  
1. during each step
   
• failure to introduce priming sites to the ends of every RNA/cDNA molecule in the starting population will introduce sampling into the amplification process with under-representation and possible amplification of those molecules
2. during the oligo-dT primed reverse transcription steps
3. during the PCR itself
• when the exponential nature of the process amplifies any variations in the amplification efficiency of particular templates
• most significant source of error during PCR based amplification
• Clontech's SMART system
• has been succesfully used for generating labelled cDNA for array analysis from limiting amounts of RNA
• has been shown to preserve the relative abundance of RNA molecules in the amplified population
  
• advantages of PCR
• rapid (exponential) amplification of cDNA population: less than 1 day
  
• short, relatively simple protocols
• particularly useful in medium- and high-throughput situations where many smaples are to be studied
• amplified material can be labelled to generate labelled cDNA populations for array analysis in a number of different ways
• RNA generated by linear amplification can be labelled using standard direct and indirect labelling methods, or with signal amplification methods
• amplified cDNA can be labelled by random primer-mediated incorporation of either directly or indirectly labelled nucleotides

Pushing the system: the challenge of single cell expression profiling

• even with current labelling technologies, generating enough cDNA from a single cell for a single microarray hybridisation requires around 10^6-fold amplification of th emRNA content of that cell
• total degree of amplification depends on the cell type used, given the wide range of total RNA content in different cell types
• from as little as 1pg to as much as 50pg
• only 1-5% of this mass of RNA is composed of mRNA
• containing an estimated total of 100,000 - 300,000 molecules of mRNA
• amplifying 300,000 molecules of different abundances to generate this mass of material represents a considerable challenge
• the particular acute problems for amplifying single-cell material are
  
• the efficiency of priming the intial RT and
  
• the efficiency of the subsequent steps to prepare the cDNA for amplification
• be they the introduction of a second priming site for PCR amplification or production of dsDNA from the single stranded material
• failure of either step for a sub-population of the cDNA will result in the absence of detection of low abundance transcripts
• assuming that all amplification methods introduce some degree of error over the million-fold amplification procedure, it is likely that amplification from single cells is an inherently noisy procedure

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The Economics of "Creative Destruction" - Harvard Gazette

Summary:

Aghion on the power of entrepreneurs; designing institutions to foster innovation; free enterprise alone not sufficient; balance between anti-trust laws and patent protection; allocation of authority and control rights within the firm; different types of financial instruments (05/02/2001)

Notes:

• Philippe Aghion: relationship between economic growth and institutions; using Schumpeter's concept of creative destruction
  • Schumpeter: entrepreneurs constantly looking for new ideas that will render their rivals' ideas obsolete; by creating something new, successful innovators destroy profits that motivated their predecessors
  • innovations as main source of economic growth
• Aghion: how to design institutions that foster innovation
  • Aghion: free enterprise alone is not sufficient; need a finely tuned balance between business and government, between markets and legislations
  • market will not prevent powerful incumbents from barring entry to new innovators; lobbying governments to introduce administrative procedures, taxes, trade barriers, and regulations to oppose further technical progress
  • aim of anti-trust laws is preventing this; political constitutions aimed at circumventing vested interests
• But entrepreneurs must be able to profit from their innovations: patent laws and intellectual property
  • if creative destruction too easy, not enough incentive to innovate
  • strike balance between patent protection and anti-trust laws; not easy
• Aghion contribution to field of contract theory and corporate governance
  • how to allocate authority and control rights within a firm;
  • or between entrepreneur and investor
    • entrepreneurs want investors to keep pumping money into their projects; wary investors may want to pull plug and cut losses
  • previous attempts to resolve tension between entrepreneurs and investors have focused on comparative incentive effects of standard debt and standard equity; both merely different ways of sharing monetary revenues between both sides
  • Aghion: different types of financial instruments can result in different control allocations between the two parties

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