Anthony Holmes

08 July

THE END OF DENIAL?

In an earlier blog entry (last year) I argued that the behavioural economics of the decline phase of the credit/business cycle would be characterised by a movement in sentiment from denial through concealment to confrontation.

To some degree these 'conditions' are most visible in the media which operates  as a kind of feedback system by reflecting general sentiment but also by shaping and confirming it and therefore magnifying the condition.

Also the comments of government officials are important signals. It is often said that government is late in admitting the severity of economic ills and  early in declaring a return to health.

Both institutions can no longer, even if they were so inclined, deny the severity of the economic downturn or that it will by confined to the financial and housing sectors.

Surveys published in the US & Europe reveal a dramatic deterioration in general business confidence indicating that we have moved out of denial and are within the concealment stage. This is the period of some months in which corporate management recognises that they are confronting unavoidable difficulties but believes that they must attempt to resolve them internally and minimise the extent to which their anticipated problems leak into the public domain.

This will be particularly true of listed companies whose directors will no longer feel that they can relieve financial pressures by raising new capital from the market.

Some will succeed in restructuring but many will not and the time they spend in 'concealment' will have a negative effect on their prospects as management fails to act with sufficient vigour by abandoning projects and assets in which they have a significant emotional investment.

The stage following 'concealment' is confrontation with stakeholders whose interests are exposed to the company's failure to deal with its difficulties. This is rarely the kind of positive discussion that took place when the economy was in growth.

There is little long term credibility to be lost by engaging stakeholders at this stage but managerial egoism often dictates that to admit to unpreparedness or the need to adopt a new strategy is reputationally damaging and therefore to be avoided.

Stakeholders shouldn't sit back and wait for the bad news to leak out but should act now to encourage corporate management to share their concerns.

Good words but it will happen in too few cases. Why? you may ask. Well, stakeholders also want to deny and conceal the problems to which they are exposed.

The result is that too many parties exposed to the same issue it is easy to avoid discussion at this stage but doing so invites the confrontation that will follow in a few months.



03:44 GMT  |  Read comments(0)

29 June

The Quiet Past

Abraham Lincoln's second State of the Union address contained a phrase that I think summarises the current situation perfectly;
 
"The dogmas of the quiet past are inadequate to the stormy present.

The occasion is piled high with difficulty, and we must rise with the occasion.

As our case is new, so we must think anew and act anew."

07:33 GMT  |  Read comments(0)

17 June

Is there a deep association between the credit crunch, oil & food price inflation?


I have discussed previously and elsewhere the thesis that the world economic system is able to absorb one substantial shock without  destabilising but that it cannot withstand two or more simultaneous negative events.

The 9 months to May 2008 were the phase of the bank liquidity crisis. Now we have this plus the emergence of rapid oil price inflation and food prices increasing at a higher rate than general inflation.

We may ask; is there a connection between these events? If so how does it operate?

It does seem to be remarkably back luck that the bruising effect of the 'credit crunch' should be magnified by the emergence of two other  significant destabilising  events. To some degree, but not completely, it may be argued that food price increases result from increased transportation costs caused by more expensive fuel. But, as to an association between bank liquidity and oil, this is not apparent.

Maybe bad luck and coincidence is the answer. However I have a niggling intuition that there is something deeper at work. I do not mean to imply a conspiracy theory but simply a potential relationship that is obscure.

My initial thought extends no further than the belief that success of the fiscal measures used to avoid a cyclical adjustment around 2000 have contributed to the formation of an economic pressure wave and that it is this that caused the initial rupture in the weak point of the US sub prime mortgage market and thus caused financial market illiquidity.

The same pressure wave, in part formed of rapidly expanding demand from China and India, was not relieved by its venting through the financial markets and the next vulnerable points are the oil and food markets.

Are they sufficient to reduce the waves energy? I do not know. No doubt the damage caused will have its own contingent impact less generally. (corporate distress, negative equity in housing etc). But the main concern has to be whether sufficient energy remains to fuel a further significant event in some other arena. This could be either economic or political.



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13 June

The next piece in the jigsaw?
 

The last major recession occurred in the early 1990's and was was notable for high inflation and high interest rates.

Some commentators of the current economic unpleasantness suggested, albeit a few months ago, that this phase of financial turbulence would not degenerate into a recession like the 1990's because interest rates and inflation are both comparatively low and, hence, corporations and individuals, are still able to afford to service debt from current budgets.

What has changed?

Energy prices have risen dramatically to introduce a second and very forceful shock to already destabilised economies.

Energy prices have magnified already significant underlying inflationary pressure and rising food prices have added to the downward pressure on consumer disposable income which will, in turn, depress sales of discretionary goods.

Inflationary pressure will lead central banks to act by increasing base rates to prevent further price inflation, banks will use this to make marginally higher still increases in their effective lending rates.

Hence we are heading towards the third element in the recessionary equation; high inflation and higher interest rates.

It is looking more likely that a major economic adjustment is in progress and that few if any sectors of the western economies are going to escape its effect.

This is not an unforeseen (by some at least) or, indeed, an unprecedented event. But I still see so little comment on the lessons from the early 90's. Where are the conferences & seminars? Where is the professional preparation?

What issue could be more important?

Perhaps those who arrange these things do not know where to find the expertise and experience in which this knowledge resides.

They should look harder!


06:30 GMT  |  Read comments(0)

29 May

Are we at the beginning of a significant transitional event?
The current economic turbulence has caused us to discuss whether or not there will be a world wide recession and if so how deep it will be and how long will it last.

All reasonable and important questions but what if we are at the beginning of a more profound event.

What if we are about to encounter a major transitional event not a relatively short term phenomenon after which the world will be, more or less, as it was  previously?

What if we will not return to some marginal variant of the status quo anti but enter a new structure?

Let's consider some important evidence;

1. The world banking system has been found to be potentially unstable when it is exposed to new 'flavours' of derivative instruments. The old system of capital adequacy and liquidity management seems unable to absorb the increased systemic risk associated with these instruments. Our economic growth relies on the stability of this flawed system.
2. Over the longer term the US must at least reduce if not erase its trade deficit otherwise the US economy will be unable to maintain its growth and the Dollar will fall further.
3. This remains a critical issue while the US continues to be the prime mover in world economic activity. Within the next 30 years its dominance will be reduced by both China and India to the extent that by 2050 it is feasible that the US will be the 3rd ranking economy. This will be the same significant economic event as at the turn of the 19th/20th century when the USA changed the world balance of economic power.
4. Key commodities such as food and energy will be in comparative short supply for the foreseeable future as demand from emerging economies puts pressure on supply. The rapid and substantial increase in prices will fuel inflation in the developed economies and political unrest in the developing world.

These factors alone carry the potential to change the economic and perhaps also the socio-political balance of the world in ways we are unable to predict.

I don't know whether current events are symptomatic of these long term issues beginning to impose themselves. But I wouldn't bet against it!


11:09 GMT  |  Read comments(0)

25 May

Is there a memetic explanation for the business cycle?

Memes are controversial. They are abstract. They are provocative.

They also offer coherent explanations for many intractable problems  and  socio-political phenomena.

What are they?

Well if you're really interested I suggest you follow this link meme.

Here's a definition to be going on with;

A meme is any unit of cultural information, such as a practice or idea, that is transmitted verbally or by repeated action from one mind to another.

To many it seems that movements in the business cycle affect entrepreneurial confidence and that these changes in sentiment feed back and magnify the underlying trend making a positive economic situation unsustainably exuberant or turning a deteriorating situation into a crisis. There is much to be said for this feed back loop but I do not believe it is the whole story.

The original causal event that moves the market's sentiment from optimism, through neutrality to pessimism is the key factor and I believe that this is memetic in nature. How can this work?

• Cyclical movements are dependent on the expectations of individuals conducting transactions.
• These expectations are determined by received information.
• Inadequate data is supplemented by opinion/speculation to yield a forecast of trend.
  
• If the forecast is pessimistic then assets are sold and the general market turns down. The funds released are reinvested in countercyclical or low risk assets such as gold and government bonds and their price increases. Predict economic optimism and investors are receptive to a higher risk profile and the market in general increases.
• The information ( especially the speculation/rumour) can be defined in terms of memes.

I therefore suggest that the market moves from optimism to pessimism as a result of the growing strength and dissemination of pessimistic memes. A rumour that a bull market is coming to end has credibility if the market has grown continuously for an extended period. It grows in strength as more investors hear the same rumour and attach to it similar credibility until it becomes the generally held view which is then translated into hard economic data as assets are sold.

The pessimism meme continues to dominate and gain strength until a new meme of optimism enters the arena.

This meme suggests that the asset sales are ending and that, because the depressed economic conditions have persisted for an extended period, a cyclical upturn must be close. This has historical credibility and therefore grows in strength as a result. It also has the opposite 'sign'  and therefore has a neutralising effect on the pessimism meme. It strengthens and becomes pervasive until it dominates and eradicates the pessimism meme in the same way that a biological immune system gradually neutralises a virus.

Hence the business cycle has a hypothetical memetic explanation and that is why governments are always at pains to deny the onset of recession and premature in their declaration that depressed conditions are at an end.

The print media are the principal exhibitors of the current memes. At the moment they are dominated by pessimistic comment whereas the reported economic data does not reflect this gloom. This suggest, crudely, that conditions will probably deteriorate further until the hard economic date is balanced with the pessimistic comment. This should mark the bottom of the sentiment trough.


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22 May

The new oil shock

In 1861 the real price of oil (at $2007 prices) was circa $100 per barrel. In 1973, just prior to the recession caused by the oil price rise, the price per barrel was, in real terms, circa $17 and rose dramatically to $50.

At the time of the 1990 recession the real price per barrel increased dramatically again to $90.

Now, in current terms, the price toady touched $133 (over $150 in real terms).

Most recessions require two significant problems to arise simultaneously from different regions of the economy. We have agonised over the banking liquidity crisis, which is a fairly novel event. We do not know what compound will emerge when it is mixed with the steep rise in oil prices that caused one recession and was closely associated with another.

If there was some residual hope that the western economies might work through the banking crisis  with out enduring a  significant economic adjustment I fear that a sustained increase in the oil price  is a factor we are unable to absorb.


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19 May

Political & economic turbulence are interlocked
There is a tendency to believe that government stands outside economic turbulence observing it and able to manipulate it.

This is illogical although probably psychologically understandable as people affected by economic difficulties need to believe that someone is able to take action to rectify the problems.

This unpacks firstly as a belief that the economic problems are a natural phenomenon unrelated or only weakly related to the actions or inaction of government. As if governments can make it worse but cannot prevent it.

Secondly, and paradoxically, that the same government has the power and the responsibility to instigate remedial action.

Governments tend to encourage this  belief by claiming that  economic turbulence  is caused by external events over which they have no control but , now the problem has arisen, they are capable of dealing with it.

This is simplistic nonsense.  Governments of the western economies account for up 40% of the economic activity of the state and therefore they are unable to stand outside of the economy. The argument that they are unable to prevent downswings in the economic cycle is correct as these are caused by international forces beyond the control of any  state. It therefore follows that remedial action is also beyond the reach of  intra state economic management. But it is politically unacceptable to admit that, as a government, you are not really in control of your national economy.

This doesn't mean that government should be inactive. It can follow the Keynesian route and borrow in order to inject economic stimulus which may, at some future cost, mitigate the severity of the problems. They can ensue that their state is prepared to capitalise on the upswing by formulating rehabilitation policies. They can, and do, talk-up the economy in order to manage sentiment.

But the interesting observation is that economic problems appear to correlate with political problems. Heads of government tend to encounter their lowest ratings at the time of economic difficulties so their economic impotence is magnified by their lack of credibility and political instability.

So what's the answer? I believe that it is evident that the credit cycle is a major causal influence on the economic cycle. In brief I believe that governments need to cooperate in their supervision of the credit markets to prevent banks, in particular, from weakening their credit standards in the second half of the cycle in order to gain market share.  They lend (and invest) imprudently and in volumes that ensure that default, when it inevitably arises, cannot be absorbed by the international financial system without a crisis adjustment and this causes considerable collateral economic damage.

Better independent regulation trumps political attempts at economic management.



03:54 GMT  |  Read comments(0)

14 May

Virtues & Vices

One of the principal themes my writing over the last couple of years (soon to be published as A Time to Lead & A Time to Manage) is that a significant fraction of the success of leaders and managers depends on the situation in which each deploys their abilities as the dominant organisational style.

It occurred to me that the underlying principle didn't require a book (although I shall still publish, of course!) but was succinctly stated as;

people are consistent in the application of the technical and personal skills but these virtues become vices when the context in which they are deployed changes.

The significant argument I make is that the contexts in which domination by the virtues of managers become vices are those in which the vices of leaders become virtues.


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09 May

Contextual Intelligence & leadership
Professor Joseph S Nye of the Kennedy School of Government gave an interesting talk at the London School of Economics last night about leadership.

Nye is best known for his thesis on soft & hard power skills applied in the political arena especially in international relations (IR) but his ideas extend to the corporate arena.

I found the following elements of his presentation particularly interesting;

• He places great emphasis on contextual intelligence which is the understanding of how the dominant situation changes to become apposite to the conditions in which leaders are able to deploy their attributes successfully. In the field of IR the mark of a successful leader is that he/she further modifies the situation to create a new context  in which their skills are no longer appropriate.
• The erosion of the hierarchy (much slower than many academics would have us believe) leads to the weakening and ultimate redundancy of the 'hard power' skills associated with authoritarianism and control by scientific management. Nye argues that these behaviours are to be replaced by 'soft power' skills of persuasion, alliance building and (Machiavellian)  political skills.
  
• Nye asked an interesting question, '...what does leadership on the internet look like?'

I also think that he touched on an important aspect of leadership training (about which I am sceptical). I accept that it is possible to teach the 'hard power' skills but I agree with Nye that too little emphasis is given to the 'soft power' skills perhaps because they are more difficult to teach. But without them wannabe leaders are only in possession of the managerial toolkit of how to control through the application of authority.




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06 May

CEO Tenure

Most organisations regard their senior executive as a person for all seasons, capable of operating effectively in most situations that can be expected.

Do we really still believe in the generalist as CEO? Not when you speak to HR specialists and not if you consider the empirical evidence of the reducing average tenure of CEOs. But practice remains exactly the opposite to our belief. ‘You will run our company until you fail’ is what is implied when appointing a CEO.

History shows this practice be founded on a hopelessly invalid contention made worse by the observation that changes are only made when a problem has become a crisis and the deficiencies of the incumbent be ignored.

It makes better sense to accept that regular leadership change is a natural feature of any corporation and that the CEO should be appointed to deliver specified objectives within a reasonable timescale after which their continuation should be considered in relation to a new set of objectives and the economic conditions that are imminent.


08:28 GMT  |  Read comments(0)

02 May

What happens next?

We seem to have reached that stage at which the decline into recession is not perceptible. Almost as though we are suspended between crisis and salvation. Many think that the US economy has been in recession and may now be emerging. Some economists reckon that the UK economy may escape a recession but will remain shaky and stressed for at least a couple of years. However they also argue that the UK will not be able to absorb a further shock to the system equivalent to Northern Rock.

It is not so much that the capital markets would be incapable of containing a further shock, what matters is how it would affect sentiment which remains fragile.

The sub prime problem is now reaching its end phase. Inter bank loans are beginning to mature and within a couple of months the web of secondary and tertiary exposure will be clear and banks able to understand their capital adequacy. Hence the cause of the difficulties of the last 6 months is diminishing in force. What is there to replace it?

The obvious contender is declining consumer expenditure which will feed through to reduced investment. This is taking place in a climate in which savings are comparatively small and therefore there is little capacity for consumers to supplement disposable income from savings and less inclination (the sentiment thing) to do so with credit.

Unlike preceding periods when the possibility of recession was significant we are not passing through phase of high interest rates. Quite the contrary. Therefore the extent to which economic slowing will be transmitted into corporate liquidity problems will not depend on the inability to service debt but the capacity to refinance on reasonable terms.

Highly leveraged business that intended to pay down borrowings from asset sales will be hit hard over the next year and hence many private equity deals concluded in 2007 will experience problems.

Additionally consumer led businesses will encounter problems as their cost rise at the same time as sales and margins decline. In the UK we have already seem an increase in the number of retailers entering insolvency procedures.

I suggest that it is possible that we might not experience the traditional 'V' shaped recession which, while painful, tends to be over and done with in 2 to 3 years. Instead we might endure a long period in which the growth is positive but low (0.5%<1%) and the economy remains stressed (the elongated 'U').

The former exposes the weakest companies quickly and recycles their assets. The latter is more pernicious, like an infectious disease that doesn't kill a few but disables many.


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01 May

Remembrance of Times Past.

In a Management Today article dated July 1994 Martin Vander Weyer, the editor of Spectator Business, said;

“It remains to be seen whether the lessons of the recent recession will be remembered long enough to deter the next generation of entrepreneurs from repeating the same mistakes and the next generation of financial experts from missing all the vital signals. Hindsight and human nature suggest that they probably won't.”

He was correct and probably will be again.

Financial experts have once again taken extraordinary risks that they were unable to manage and we are about to see how some entrepreneurs, encouraged by the financial sector’s preparedness to accept additional risks, have also taken managerial risks beyond their capacity to control.

I find it lamentable that we seem to have brought forward so little learning from the last major downturn.

Perhaps I can offer an explanation. The artificial suppression of the credit and business cycle, that successfully averted the natural cyclical correction that should have arisen around 2000, means that the majority of those responsible for handling this turbulent phase have little, if any, direct experience of operating in the previous crisis. As George Santayana said “ Those who cannot remember the past are condemned to repeat it.”

My own career as a turnaround specialist began during the last serious recession and I realised afterwards how unprepared lenders and investors were but, more significantly, the extent to which some directors of major companies had deluded themselves about the resilience of their company and entered denial until the company’s problems could not longer be ignored. They spent too long apportioning blame rather than making the necessary leadership changes.

We still regard the problems of corporate instability as just another, albeit more testing, challenge for senior managers who we believe, as professionals, should able to modify their behaviour and adapt to any set of conditions. This is to subscribe to the notion that one type of senior manager fits all circumstances.  Will this costly delusion persist?

The worrying thing is that a crisis is a not a good time to test this belief and it is certainly the worst time to regroup at the bottom of the crisis leadership learning curve.

07:52 GMT  |  Read comments(0)

30 April

Why the Enterprise Act is not an aid to corporate turnaround
The Enterprise Act 2002 (EA) made some worthwhile changes to UK bankruptcy law but it remains fundamentally legislation designed to give protection from the claims of creditors to companies that are in financial distress.

It is not appropriate assistance to those companies that are experiencing difficulties but are unlikely to collapse if they are not taken into 'intensive care' for up to a year.

Although some people have argued that the EA was designed to promote corporate turnaround the public disclosure of administration that it requires confirms that the subject company is in a precarious financial position. This declaration of instability immediately increases the perceived risk of the company placing it in a special and undesirable category of company. his is something shareholders will seek to avoid.

From a creditor perspective the company may or may not benefit from the enforced period of stability administration provides. If it does not then possibly your recovery of monies owed may be less tomorrow than it is today.

The EA remains a tool to be used with caution and only when other turnaround procedures have been exhausted or are unavailable.

For any company with prospects of turnaround it is preferable that what is necessary is undertaken free of any legal restraint on creditor action. Creditors can be approached and invited to participate in a voluntary but binding standstill in the form of a temporary stay of claim. Most will take a positive view as they appreciate that the  EA can be used to compel them to do so. But most would prefer to participate in gaining a full recovery and a continuing profitable relationship rather than needing to take a provision today.



15:36 GMT  |  Read comments(0)

The Enterprise Act 2002 may not protect your business

00:49 GMT  |  Read comments(0)

29 April

Leadership may not exist
We seem to encounter enormous difficulty when trying to list the attributes of leaders and in identifying the individuals who might lead. But we continue to believe that we need them, especially in times of crisis when established institutions and conventional procedures cease to function effectively.

I wonder whether leaders truly exist or whether we, the followers, create them by conferring the title on charismatic individuals who are unable to resist the accolade.

Then by some process, as yet unidentified but linked to reification, the 'leader' originates little of value but acts as a catalyst enabling the followers to take meaningful action that would not have been possible otherwise.

This would explain why we can find no other common features amongst the leaders of history other than their narcissism, communicative ability and charisma.


16:26 GMT  |  Read comments(0)

TURNAROUND SPECIALIST vs INSOLVENCY PRACTITIONER
I have read an interesting paper by Vanessa Finch entitled “ Doctoring in the Shadows of Insolvency” (Journal of Business Law, Issue 6, 2005).

Basically it explores the perceived advantages of insolvency practitioners (IPs) over turnaround specialists (TPs).

My conclusion is that IPs & TPs are not competitors (although I am sure that the big accounting practices take a different view) but each is appropriate at a different stage of a company’s crisis.

I concluded that TPs must offer stakeholders (shareholders, lenders and creditors) a better outcome from their actions than would be the case were IPs to be appointed at the same time. Otherwise there would be no marginal benefit to be gained from a TP and the stakeholders would take advantage of the protection afforded under the Enterprise Act and appoint an IP.

15:20 GMT  |  Read comments(0)