Professor Brady's Management View
It's a wrap
The world of high finance is complex and fascinating. How, for example, can somebody failing to make a mortgage payment in the US affect the price of bonds issued by Arsenal to raise finance for the Emirates Stadium? The answer is monoline bond wrapping. What? You heard, monoline bond wrapping. In the 1970’s a business developed when US insurance companies decided to insure the bonds issued by local government. This enabled the bonds to be more marketable because they were effectively ‘wrapped’ in the security of a AAA-rated company. So, in effect you bought the security of the wrapping company. This practice was then exported to London and boomed in the 1980’s with the advent of PFI activity. Investors were unsure about such initiatives because they were concerned that they could not properly calculate the long term risks. Wrapping that risk, however, made them feel comfortable which, in turn, allowed the investment to flow. It is now at least a £50bn industry.
As they say in the gambling industry, and to be honest that’s what we are talking about, here comes the kicker. Those same AAA-rated monoline companies are now being hit by the sub-prime crisis in the US. They have been taking on some of the sub-prime debt. So, if that exposure damages their credit ratings it will also damage the price of the bonds they are wrapping.
For example, the Arsenal bonds have fallen badly over the last few months because investors fear a sub-prime ripple. Of course, if investors act rationally this turbulence will subside and Arsenal and our PFIs will be safe.
But when did investors ever act rationally?
If Vin Diesel Can Do it
Some time in the not-too-distant future Bournemouth will have a major casino. Gaming is an industry that often attracts bad press and I’m sure some of it is justified. However, such criticism may also be out-of-date because gambling is one of the most regulated businesses around. Notwithstanding the ethics involved, gambling is an activity that is worth business students studying for the insights it provides.
Last week in London two men were arrested in a “Boiler Room” scam. If you don’t know what that is then do some research and/or see the film, Boiler Room . Generically a boiler room scam is a variant of the “confidence trick”. To quote from another great film, House of Games – “Why do they call it a confidence trick? Because you give me your confidence? No! Because I give you mine!”
In all businesses the objective of the sales pitch is to give the buyer confidence in the seller, the product, the service, but most importantly in the relationship. Contemporary research tells us that the public have lost confidence in authority. We don’t trust the commissioner of the Metropolitan Police to tell the truth, we don’t trust politicians and we certainly don’t trust big business. How can we, when those who have recently overseen the credit crunch that resulted from the disastrous forays into the sub-prime market are being paid huge sums to leave? They bet, they lost, but they still managed to win. And that’s where a knowledge of gambling and confidence tricks would have helped.
Gambling/con trick defence No 1:
If it looks too good to be true, it probably is. For both those buying and selling sub-prime mortgages there must have been a disconnect with reality, an inability to see past the immediate future.
Gambling/con trick No 2:
If you can’t afford to lose it, don’t bet it. People put their trust in men (and mostly it is men) who had no risk involved for themselves personally. So they had no incentive not to lose your money. Chuck Prince (CEO of Citigroup) oversaw the loss of more than 20% of the market value of his company with the write-down of more than £10bn of debt before leaving with a £40m payout. His counterpart at Merrill Lynch, Stan O’Neal, had to write down in excess of £5bn of sub-prime related debt but walked away with a $160m pay-off.
So we return to gambling for a lesson. Imagine if the performance related pay of those senior executives was linked to market value in the way that spread bets operate. That is, for every point above the spread you are rewarded, for every point below the spread you are punished. If that were the case both Prince and O’Neal would now owe the shareholders money. Gambling is a simple and ancient pastime and has many lessons for the astute business student. Perhaps the most important lesson, however, is to study it from a distance.
Making Business Sexy
The current issue in the Business School world is how relevant are business schools to business? Can we as researchers, lectures and students deliver products to the corporate market that they consider valuable? The answer is to constantly combine form and function in such a way that it is recognisable and useful to the business community. We need, therefore, not only to research, teach, learn, discuss, debate and argue about business, but also to behave, look and act like the best businesses in the world. That is one of the reasons we are looking to develop an iconic new building, invite senior business people to assist with designing our curriculum and help us to deliver our courses.
However, I am also aware that when we talk about things being business-like it can be a bit of a misnomer, because there are a lot of businesses that are rubbish and we don’t want to be like those; we only want to be like the best businesses. So we need to look at what it is that they do and how they do things that makes them the best. Maybe it would be better to say what we want to be is professional, smart, clever and sexy.
When President Carter was a young student he finished 5th in his class out of 300. When asked if he could have done better at anything he thought for a while and said actually I might have done a little bit better at maths. His questioner then asked, “Why didn’t you?”. From that moment, before he did anything at all, Carter always asked himself one question – why not be the best? Why not?