Andy Kessler

NYT: Trust Me

Is there trust anymore? We are caught between Obi-Wan Kenobi saying, “Let go, Luke. Luke, trust me,” and Eric “Otter” Stratton in Animal House declaring, “You [Delta House language] up. You trusted us!” Heck, the civilized world still shakes hands to show we aren’t packing daggers. In business, “trust me” often turned out to be the two most dangerous words in America.

Joe Nacchio is the latest trust-destroying manager, convicted on 19 counts of insider trading and dumping Qwest stock while smiling to shareholders. Names like Ebbers, Kozlowski, Skilling, and Martha are now synonymous with fraud, scandal and even in polite conversations are likened to the thin film that covers standing ponds. (I did meet Martha once, and she gave me a recipe for flourless waffles, so let’s give her a pass, shall we?)

Wall Street research was long ago disgraced, but add to that mutual fund late trading, options backdating, onerous interest ratings and insurance premium overinflating, and what you have is a lot of folks whose reputations have been shredded into scraps finer than Arthur Andersen documents. And the government? Given all the lying in D.C. on both sides of the aisle, you would think Scooter Libby’s defense would have been selective enforcement.

So here I am at my Carrie Bradshaw moment: Will we ever trust anyone again?

NYT: Blank Slate Hedgies

As heard on TV one morning while shaving:

Morning Show Talking Head: So tell us what drives hedge fund managers?
Hedge Fund Dude: It’s just never ending. Thinking about what is going to work next. I have a friend who is worth $150 million who is working some new ideas for a fund.
Talking Head: If I had $150 million, the last thing I would do is start a hedge fund.
Hedge Fund Dude: That’s why you don’t have $150 million.

What exactly is a hedge fund? It’s nothing more than an investment vehicle that can buy and sell almost anything. Unlike mutual funds that just charge 1 to 2 percent of assets as a fee no matter how they do, hedge funds get to keep 20 percent (and often more) of their investment gains. It’s an incentive for their managers to lead bizarre lives and suffer from mental anguish. You think they should go crazy for free?

According to Hedge Fund Research, $1.568 trillion dollars is now managed by hedge funds. This isn’t small potatoes. Who are these masked men and women? And how is it they make so much money, some of them hundreds of millions of dollars a year, for themselves?

While capital sloshes around the globe seeking its highest returns, most money is slow, almost sedentary, kind of meandering around like a humpback whale looking for easy pickings. Hedge funds, on the other hand, are playing a game of Whac-a-Mole. Whenever anything with a potential return pops up its head, young cobras staring at multicolored screens blast the mole into submission, quickly buying underpriced shares or dumping overpriced ones. How do they know what is over- or underpriced? That’s their dirty little secret. There is no one answer.

NYT: A Colossus Mistake

In H Block at Bletchley Park, the historic code-breaking facility 50 miles from London, visitors can view a rebuilt working model of a Colossus, one of the first electronic digital computers, built during World War II to decrypt Nazi codes. If only they hadn’t waited 60 years to put it back together — there might still be a British Empire. And Silicon Valley might be in some bog outside of Bletchley Park.

During World War II, there were two major Allied efforts — one British and one American — to build electronic computers. The United States needed artillery-firing tables for their big-gun battleships. Until then, the word “computers” referred to people, mostly young women, who slowly fed error-filled information into number crunching machines. One such operation, at the Aberdeen Proving Ground in Maryland, was used to solve differential equations involving speed, wind, distance, etc., to improve accuracy. Over at the University of Pennsylvania, John Mauchly and J. Presper Eckert, with help from the U.S. Army, were working on the design of the ENIAC, an electronic and programmable computer, to help automate and speed that task, and fire those human computers. The contract to build it was signed in 1943, but it was still being developed as the war dragged on. In the meantime, most artillery shells fired during the war simply missed.

The British had more pressing needs. They knew the Nazis were sending messages to troops and to U-boat submarines in code, using a code generating machine called Enigma. The Enigma had actually been used by Germany and other European countries since the 1920s. The Poles developed a model that successfully cracked the Enigma code in 1932. But by 1939, the Nazi’s had learned to change the critical key every day instead of every month. As Poland fell, the Poles smuggled their model, known as the Bomba, to the British, who set up a top-secret effort, ULTRA, at Hut 8 in Bletchley Park to decrypt the Enigma messages. Even with the help of the Polish Bomba it would take several days by hand to determine each day’s key.

Alan Turing, who conceptualized programmable computers at Princeton, was brought to Bletchley Park to design a machine called the Bombe out of electromechanical relays to automate this decryption task. Bombe was delivered in March of 1940 and by December of 1944, there were 192 Bombe machines, more calculator than computer, decrypting code. The Germans, by the way, also had a computer effort, led by Konrad Zuse, which was eventually destroyed by Allied bombing.

Hitler and his high command then developed a tougher code to communicate, named Lorenz (the Brits called it Tunny). An extra letter in its key made it much tougher to crack — it could take weeks to decipher the key instead of a day. In March of 1943, the brains at Hut 8 developed a programmable machine out of vacuum tubes to speed up breaking the Lorenz code. It was named Heath Robinson, after the British Rube Goldberg, as it was more of a contraption than a computer and didn’t help much.

Tommy Flowers and later Alan Coombs of, get this, the British Post Office, improved on the Robinson and by December of 1943, their aptly named room-sized Colossus computer was breaking the Lorenz code (or other codes as it was reprogrammable) in hours instead of weeks. The Colossus was the first real programmable computer; with 1500 vacuum tubes, it could read messages at 5000 characters per second and do 100 calculations at a time, all searching for patterns.

The Colossus played a crucial role in D-Day. By understanding where the Germans had the bulk of their troops, the Allies could decide which beaches to storm and what misinformation to spread to keep the landings a surprise.

The ENIAC, on the other hand, was no help in the shelling of German positions on D-Day. How do I know this? It wasn’t done yet. It wouldn’t be operational until February of 1946, fully two years after the British Colossus, and well after the war was over.

So why, one has to ask, is the computer industry so uniquely American? Why is the U.S. a superpower and the British lapdogs instead of bulldogs? At least in part, blame the Russians. Or British paranoia.

After VE day, the Cold War started immediately. The British were scared to death of Russian spies stealing the plans for the Colossus, of which 10 had been built. So they got rid of them. Yup, destroyed them — took an axe to the machines and lit a match to the plans. All the Bombes were destroyed, too. Can you believe it? Apparently, British Intelligence kept two Colossus machines for their own use (training Secret Agents 001 through 006, perhaps?). But these final two were destroyed the 1960s. It didn’t matter. Secrecy or paranoia, the general public didn’t learn about the Colossus machines until the 1970s. Now you know why there is no Sir Bill Gatesford, Duke of Bits.

Meanwhile, back in the U.S., the ENIAC was finally done and the War Department didn’t burn it. Instead, on February 16, 1946, it put out a press release and then held the first computer conference to explain how the ENIAC worked. Talk about open source! Every major corporation and university sent representatives, each of whom came back home and declared, “I gotta build me one of them things!”

And there you have it. The computer was born at Bletchley Park but the computer industry was born in the good old U.S. of A. Innovation ran rampant. In rapidly changing businesses, secrecy is not always the best policy. Silicon Valley popped up to supply cheap transistors for this uniquely domestic industry. Software grew. Today, companies make billions doing the same searches the Colossus “search engine” pioneered. The military even got their payback, eventually computer-guiding bombs via global positioning satellite coordinates instead of artillery firing tables. A trillion dollar press release!

Poor England. Technology today is a multi-trillion business dominated by American companies, thanks to simple British paranoia. Their century-long lead as an industrial power evaporated with nothing to replace it. A truly Colossus mistake! Let’s hope paranoia is not constraining the United States in the next wave of technology or potential wealth creation: offshoring, F.D.A. approvals, nuclear energy, stem cell research, bandwidth auctions, Area 51?

http://kessler.blogs.nytimes.com/2007/04/19/a-colossus-mistake/

NYT: Share the Air - A Capital Idea

Our friends at the Prague Stock Exchange would agree that common ownership of property has been proven to limit innovation. So should our airwaves be publicly owned or privately controlled? Bet I surprise you with my view!

In less than two years, on February 17, 2009, that 27-inch Sony Trinitron with the rabbit ears antenna on top that your parents bought you for graduation will go dark. Well, sort of. That’s when a government mandated transition to digital television signals will be complete. That old analog broadcast signal blasting from the top of the Empire State Building and elsewhere is going the way of the typewriter. Sure, grandma is going to have to pony up for cable or a special digital adapter to watch “Fear Factor,” but wow, progress from a government bureaucracy —these are heady times.

Considered “beachfront property,” a twisted metaphor if there ever was one, some of the airwaves in the 700 MHz band used by UHF channels that once blasted “Gumby” reruns 24-7 are being given to public safety organizations and first responders. The rest are to be auctioned off by Uncle Sam for billions of dollars to existing or wannabe monopolists, including Reed Hundt, a former head of the Federal Communications Commission. Too bad. Electromagnetic spectrum coupled with innovative technology is one of the few examples where public use vs. private ownership has already been proven out. It should be made open to everyone.

NYT: Hot Stocks and Vice Precedence

Should you care if the companies you invest in have a dark side, if they make money in ways that might end conversations at cocktail parties or operate in the same slop bucket as the seamy underworld you’d rather not have your name associated with?

Back 10 years ago in my hedge fund days, one of our greatest investments was this tiny little tech company that made laser diode drivers. The stock was $3 a share and no one cared about it – heck, I had to look up what a laser diode driver even was. These little devices could turn read-only DVD drives into ones that could also record. Pretty cool. We figured that someday, VCRs would be obsolete. We were way too early on that, but sometimes, you just have to be in the right neighborhood. These $2 lasers also enabled the CD drive on your computer to record onto read/write CDs. But big deal. No one cared — until Napster came along and everyone and their uncle began illegally downloading music and buying CD-RW drives so they could burn discs for their car or portable CD players.

At the time, maybe 1 percent of PCs shipped with these read/write drives, but a few years later, 95 percent of PCs had them. Sales boomed, profits went through the roof and we sold the stock between $150 and $200 (makes up for all the $3 stocks that went to $1), all because law-abiding citizens like me (and admit it, you) didn’t feel all that bad ripping off music companies – maybe because we figured they have been ripping us off for years.

NYT: In Medicine, It's Man vs. Machine

Last week, a new study showed that radiologists don’t need no stinking machines. Radiologists read mammograms, at $120 a pop, to look for breast cancer. One out of every 200 films shows a suspicious pattern the radiologist recognizes from years of experience. It’s tedious work in a dark room with a magnifying glass. And mammograms are often read twice — another $120. A new system called computer-aided detection, or CAD, can identify the same patterns a doctor can, by referring to a database of known cancer films. And now a third of all second mammogram readings are done by CAD, for $20 each. But the study from the University of California, Davis, showed that a radiologist with CAD was statistically no better than a radiologist alone in finding cancer. Round 1: Doctors.

Yet what’s amazing about this is not that the dog can’t speak English so well, but that the dog can speak at all. A machine can read mammograms! The value of CAD is not in assisting radiologists but in getting rid of them. A better study would use the CAD system to read all mammograms and, in the few cases with suspicious patterns, call in the radiologist for a second read. But what radiologist is going to volunteer for that study?

Ever cheaper technology is making its way into medicine in fits and starts. In the many industries it’s transformed, technology works by getting rid of the people in its way — operators, tellers, travel agents, librarians, stock traders and on and on.

NYT: A Fork in the Road for Google

Whenever companies sue each other, my ears perk up. Not that I really care who wins, but lawsuits often showcase hidden vulnerabilities. Inevitably, as the fight plays out, the market thinks a lot differently about the long-term prospects of both parties, and money often sloshes away to play elsewhere.

The Internet has been all cute and cuddly throughout its childhood, given a pass for youthful indiscretions like stealing music and video clips. That just ended with Viacom’s copyright infringement suit against Google. By the time this lawsuit and others are finished, Google may have to change its way of doing business. That would be a shock.

Viacom, which owns cable channels like MTV and Comedy Central, recently charged Google with blatant copyright infringement for hosting 160,000 clips of Viacom shows and then having the audacity to allow bored workers and kids at home to view them 1.5 billion times. Viacom had to sue to protect itself because, well, beneath the surface, Viacom and Google are both in the same business, selling ads. For all Google’s claims to be a technology company, 99 percent of its business is ads — for essentials like megapixel cameras, poker sites and ambulance-chasing asbestos lawyers.

NYT: Sloshing

Left to their own devices, and couches, humans instinctively resist change. Kings and C.E.O.s like it at the top. Workers don’t volunteer to give up their jobs in the name of progress. Profits and productivity may create wealth, but how it gets into the right hands is another matter. Money doesn’t flow — that sounds so planned. It sloshes. There’s a difference. As scary as it sounds, it’s the chaos of markets that keeps us well fed and out of trouble.

You work, you get money. Congratulations. After covering bare essentials like food, shelter and a high-definition plasma TV, you save the rest. You can shove it in your mattress, but central bankers like our Federal Reserve, who haven’t the foggiest clue how much money is needed to run our economy, print more money every year. They target 2 percent inflation, which is another way of saying that they overprint dollars by 2 percent, diluting your worth. How rude. A 2-percent haircut by your very own government. Annoying, but it’s been going on forever. The Roman Emperors debased their coins from 4.5 grams of pure silver to less than a 10th of a gram over a few centuries. Deal with it. Stored wealth is an oxymoron - Weimar, Germany and Argentina are more modern diluting disasters. Don’t get mad, get even.

Liza Minelli insisted that money makes the world go around (along with that whole “life is a cabaret” nonsense), but it’s really the opposite: money goes around the world looking for profits — peeking in skyscrapers, factories, alleys, even gutters. Money sloshes around the globe seeking its highest returns, on a risk adjusted basis.

NYT: It's a Profit Deal

Needing relief from medieval churches and cutesy cafes on a trip to Prague a few years back (O.K., and a tax break), I paid a call on the Prague Stock Exchange, tucked in a blocky, Soviet-style building off the main drag. I climbed a few flights of poorly lit stairs and entered a dour, dusty-musty office. I didn’t expect John Thain clapping with happy C.E.O.s at the opening bell, but heck, this place might as well have been a D.M.V. I started pining for stained-glass windows again. Nonetheless, I learned more in the next 20 minutes about how the world works than I had in the last 20 years sweating on Wall Street as an analyst and running a hedge fund.

Back home, everything on Wall Street is beyond complex: Men in funny sports coats grunting and littering the floor of the New York Stock Exchange. Dow Jones industrial averages rising and falling in seeming random correlations to sunspots or something. Million-dollar bonuses to traders younger than that Rolling Stones T-shirt in the back of your closet. Derivatives. Rate hikes. Credit swaps. Sub-prime loans. Discounted free cash flow. Man, this stuff is harder than Chinese arithmetic. I craved for a simple explanation on what it all meant. It was right in front of me.

There in the Prague office I spoke with a nice chain-smoking gentleman in an ill-fitting suit who was no doubt a district member of the Party a decade earlier. I quickly learned that, duh, there is no Prague Stock Exchange, not physically anyway. It’s just a bunch of computer servers sitting in a backroom that match trades all day. O.K., I get that. But how is it that the Czech Republic has stocks to trade in the first place? One day the government owns every business, bloated with beer-breath bureaucrats, and bleeding money if they ever bothered to check. And then one day, boom, the Berlin Wall falls, Prague is wrapped in Velvet, and the next, you have capitalism? Tricky transition.