Culture Crash

As the financial landscape is being reshaped in one of the largest crisis of confidence ever encountered by the American form of capitalism, I cannot help but wonder whether what we are witnessing is the beginning not just of an economic crash but also of a cultural crash.

A few months ago, I started getting the feeling that we are in the process of moving into a post-boomer era, and highlighted some of my thoughts on the subject. This was a surprising change of pace to my readers, who are generally more used to my studying things with technology as my focus lense but it was the beginning of an evolution in my thinking.

As the first rumbles of the economic crisis started appearing a couple of years ago (HSBC, my employer at the time, was one of the first companies to aggressively write off bad loans), I started wondering whether the crisis in the mortgage space was only the beginning and thinking that the credit card crisis was probably going to dwarf the mortgage crisis if it ever happened.

At the time, however, I had been so focused on looking at the world with a technology focus that I was failing to find the words to really describe what I was witnessing. My gut was telling me that this was a big turn but I neither had the audience nor the vocabulary to express my thoughts in a clear fashion.

Furthermore, not being a citizen yet, I felt that it might be presumptuous of me to point to the ills of a country that was hosting me as a guest, a country that had offered me so much opportunity. So I kept quiet.

But I now believe that it’s time to attempt to highlight a few things that do not appear to be part of the debate surrounding how to deal with the current crisis. And since I have the luck of dealing with readers who generally are much smarter than I am (and many of them much more powerful than most people), I thought that maybe, just maybe, I could get some of the basic discussion started here, spreading a meme around the concept of a culture crash.

In this particular case, I think the issue is around the destructive culture of credit America has been cultivating with the rise of the post-WW2 generations. I am not saying baby boomers because they are only part of the problem, as my own generation ( Generation X) and the following one, are also involved in the same destructive addiction to credit.

At issue is the concept that over-extending oneself is a good idea. It may be because I am coming from a foreign country, or it may be for other entirely different reasons but I have always had an aversion to credit. When I took my first mortgage, I worked hard to try to repay more of the principal than was requested by the bank. My concept was simple: I thought that if I could repay my loans early, I’d give away less as interest and could then use that interest to pay myself. It turned out to be a smart move but I have no idea as to how I came around to that conclusion. The funny thing is that I had discovered the concept of, to put it in terms that are now being used by every pundit, “liquidity is king.”

Whether it is credit cards, mortgages, or other forms of loans (student loans, car loans, etc…), I’ve always been suspicious of the idea that one could spend more than they had. I was aware of the concept of assets but ultimately, I felt that assets should be, for the most part, tangible. And a bank account with cash in it is about as tangible as things get.

Living in the USA, however, I have always been surprised by how much of a credit culture the country has. When asking for a mortgage, I had to fight my bank to get a “lower” mortgage amount because they felt I was asking for too little. The idea of lowering the risk (both mine and the bank’s) of financial default seemed to go counter to many in the go-go run-up of stock prices in the dotcom era, following by the go-go run up of real estabe prices in the recent housing bubble. Sure, I didn’t spend a lot of time jetting around the world on a lot of vacations as I toiled to ensure that my mortgage was paid off (and it took me a few years to do so)  but I discovered that many of the people who had run up their bills based on the promise of paper fortunes represented by their dotcom options were the same people who were financially wiped out when those paper gains evaporated.

The same phenomenon seems to have repeated itself with the housing crisis, as people refinanced their houses to take cash out and traded those houses as investment vehicles up until the point where the virtual gains they had made in the run-up on prices evaporated.

The similarities between the dotcom crash and the housing crash are a little eerie and, with the benefit of having gone through one of those crisis, I am now starting to gain perspective on the other one.

Meanwhile, the risk of dangerous investment securities (the so-called structured investment vehicles) seem to have been balanced by taking a few bad loans and mixing them with good ones. The problem was that these mixes got increasingly complex and, as I was talking to a friend of mine involved in developing some of those products, my gut feel got stronger. The thing in my discussion with said person (who shall remain anonymous in order to protect the guilty parties) was that “no one really understands many of those investment products anymore.” It felt a bit like a house of cards to me but once again, I figured that I didn’t really know enough to talk smartly about it.

Until this current crisis.

Students of history are familiar with the concept of a run on the bank. As I was reading up on such issues as part of my preparation for a speech, I started thinking about how brittle our economic system really is. Ultimately, most of the financial markets are based on people’s perception of value and, if that perception changes, the whole thing can unravel pretty quickly.

I think we are now at the tipping point of a major shift in the perception of what a good financial decision is. Wall Street may be the most impacted by this for now but I suspect that it will spread relatively quickly (my gut tells me the perception will be generalized globally within the next 3-12 months). The change is coming from the fact that growth may no longer be considered as valuable as tangible assets.

During the dotcom days, I received a couple of crash courses in perception management. The first one was going from VC to VC with a plan trying to raise around a million US dollars for a start-up. The company was slated to be profitable within 2 years and would grow at 15-20 percent afterward, per our projections. To say that our financing efforts were not going well was an understatement. The moment of realization came when, in another disastrous meeting, a VC told us “you’re asking for a million dollars, and will only give us 15-20 growth after the initial couple of years. Your plan lacks ambition.” The whole time, we had been basing our plan on realistic achievable numbers and I failed to understand why we were considered to not be ambitious. Things got worse and, in a fit of desperation, my business partners over-rode my decision of conservative growth based on solid revenue and created a projection set based on year on year tripling of the business, starting with an initial investment valuing the company in the 15-20 million dollar range. I thought were were going to be laughed out of the room by the first VC we presented this but something truly scary happened: not only did the VCs like it, but some of the people who had previously given us a soft no were now banging on our door, trying to get into the round. Of course, we took a first round, and a few more afterward, and enjoyed a nice liquidity event that achieved a nice profit for the initial investors. The company continued on air until the dotcom crash, which it didn’t survive as a going concern.

The lesson here is that VC investment, IPOs, the housing bubble, etc… all have one thing in common: they are based on the idea of future payout, due to year on year growth that is often based on numbers that are wishful thinking in the best of cases ( and outright fraud in the worst cases, as we have learned from Enron and Worldcom)

I think this concept is now hitting the wall. The problem is that it has yet to be replaced by something else as we are moving through the irrational stage that generally marks the end of every great cultural movement. So the operative word is “sell, sell, sell” and confidence has shaken some of the mightiest institutions on Wall street as it will shake up other institutions soon.

On Wall street, they are now well aware of that reality and some of the cooler heads are realizing there may be some ways to profit from the stampede by acquiring assets at fire sale prices.

However, I’d venture that both the panic and the cool reaction are relatively contained right now. Contained to people in the financial industry, the media (who have never seen a crisis they can’t hype), and the reacting investors.

A few days ago, I was at a party in the tech community, and the happy atmosphere reminded me of the euphoria I had experience in the late 1990s, only a few months before the dotcom bubble went crashing down. As I travel in the murky waters between Wall Street and the technology world, I was shocked by the contrast between the panic I was witnessing in the financial space, and the relentless optimism I encountered in the tech space. The assumption that the crisis is contained to Wall Street was well engrained (and may yet change as more people see their 401k go down) but I started wondering about the disconnect. When presented with the issue, one person pointed out that a lot of people would go to grad school, as had happened after the last dotcom bubble and the only thing I could think of, upon that remark was “and where will they get their student loans from?”

Once again, I was getting stuck in the credit mindset and it made me uneasy but it came from the realization that credit is a core basis for the current US economy.

What I suspect is now going to happen, after the credit culture crash, is a move to core value, with people working hard to save up in order to buy things in cash. Actually, I hope that that is the case because any other option only seems to provide a short term band-aid to a major problem. If we fail to take the opportunity to move beyond the credit mindset, the next crisis will make this one look as easy to deal with as the dotcom crash currently looks to us: a big deal for a few people but ultimately something we can get past.

And I’m afraid that we will continue to spiral down the road of an ever increasing amount of debt until such time as there is no other thing to do but crash the culture in order to reset it.

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