finance Archives - Kevin Low

What stays the same

Interesting how just when I was thinking about pivot points for change, I chanced upon this Farnam Street article on Bezos and Buffett’s thinking on the impacts of the new on the financial markets. The focus is not so much what will change but what stays the same.

Governments around the world would benefit from the same way of approaching problems – not so much by considering what will change but rather, what is going to stay the same. It is more important to consider what are the new elements that can build upon the existing than to go wild with considering what could throw things off the current course (why, everything and anything, of course!)

Con-tinuing

Despite the bad press for EY in Germany and PwC in Australia; the big four and their sprawling professional services activities continues to grow. Accounting and audit services aside, advisory services appears to be in demand across the international business world. Overall across the economy, as best practices across the industry spreads, companies becomes more competitive and efficiency goes beyond just market prices and matching of customer demands. Innovation takes place as well.

Consultants, through advisory services helps information and knowledge work themselves out in the market. Mariana’s Big Con argument about economic rents however, might still somehow stand in the sense that the fees they attain may be somewhat outsized compared to the value created. And I’m referring more to generic type of business consulting as compared to technical advice or consulting that augments capacity of businesses during special situations such as a transaction or some kind of innovation project.

Yet I would say that the bigger con that is present in the market is the financialisation of our economy and everything that the financial industry abd banking does to generate rents. The issue is that the labour of financial industry keeps serving capital, and capital, with its sustained bargaining power (as pointed out by Thomas Piketty), continues to direct rents towards the financial industry.

The main force that can change this will be the government and regulators; there has to be more research and thinking around the manner we are setting up our economies.

Feasibility of an Infrastructure

A huge part of infrastructure development work upfront is the feasibility study. What exactly goes into a full feasibility study and why is it so important? This article aims to explain that simply and more accessibly to people outside the industry. We’ll focus on the feasibility study rather than any documentation on projects generated prior to that (sometimes called pre-Feasibility Study – which could be considered a ‘lite’ version).

The feasibility study is like a professional evaluation of a business plan. For any infrastructure project, this is a comprehensive look into all the practical, legal, technical and commercial aspects of the project. Often, it will include social and environmental dimensions of the project in order to ensure that the lenders (ie. financial institutions providing debt to the project) is satisfied. In markets where there is significant social and environmental activism, the lenders are also on the receiving end of hate-mail, harassment and boycotts. Major project finance lenders internationally have therefore got together to be involved in The Equator Principles – a risk management framework that banks sign up to abide in assessing the environment, social risks involved in projects.

What then constitutes environment and social risks?

Infrastructure projects are physical, and will almost always require clearing of a piece of land to allow construction to take place. This would mean either resettling villages, people, farms, or redeveloping urban spaces, or even clearing swathe of rainforest. In cases of large hydropower dams, it will involve spaces not only for construction of the dam but also planned floodplains which can include multiple villages, broad swathe of forests. All of these impacts on human lives, biodiversity, alters natural landscapes.

Of course, the banks, developers, and builders care about people and rainforests. But beyond that, they are concerned about being harassed, haunted by NGOs, activist organisations trying to run them down reputationally for having been involved in projects that destroyed natural habitats for endangered species, upsetting livelihoods. These forms the environment and social risks; and the feasibility study tend to cover aspects of the social and environmental impact assessment, as well as to propose means to mitigate. Through that, the developers of the project also forms an idea how much resources they might need to expend to support resettlement, to help rebuild livelihoods destroyed.

How about practical and technical risks?

The feasibility study also goes into the technical and practical aspects of the project, including studying the possible technologies to deploy, the actual site conditions: whether the land can accommodate the infrastructure, whether there is actually sufficient demand for that infrastructure, and if the infrastructure has everything needed to service that demand – this could take the form of water supply pipe network, or an inter-connector to the national grid for a power plant.

The study needs to ensure that the proposed technical solution is able to deal with the problem statement at hand. For example, if we are using incineration for the waste, then we have to ensure that the waste stream is not too moist. If the waste is wet, the incineration system may not perform properly, which leads to potential technical breakdowns or stoppage.

And not forgetting the legal and commercial risks?

At the end of the day, the project will have to comply with the law of the land, and often, there will be a lot of permitting, licensing, government approvals that are needed for various components of the project. The feasibility study will investigate all of these and the developers will also do their best to make sure the requisite approvals and permits are obtain in advanced even often in parallel with the feasibility study just to make sure that the project is progressing in a timely fashion. These documentation will often be studied alongside the feasibility studies by the lenders.

Lots of parameters, and results from various aspects of the feasibility study would be captured into the financial model that is used to work out whether the project is commercially viable – that is, the total revenues/payments expected for the lifetime of the project is able to pay for its total cost over its lifetime. Governments may also undertake an economic cost-benefit analysis, to see if the total economic benefit of the infrastructure project is able to cover the total cost to society (more on this from a previous article I’ve written).

At the end of the day, flagging out, assessing and then measuring these risks enables the developers, lenders, and the government to have a better picture of how viable the project really is, hence its feasibility – from the various risks perspective as well as the resourcing that can be availed to the project. Doing proper feasibility studies can also help government better plan areas surrounding infrastructure, whether it is to mitigate some of the impacts of the infrastructure, but also to see if developments around the infrastructure can help improve its feasibility (eg. a larger substation might have to be built in the area to be able to accommodate a large utility scale solar park which would not have been able to feed power into the national grid).

This article is part of a series I’m working on to make topics in infrastructure a little more accessible to students and people from outside the industry who might want to get involved.

Lord of Finance

After leaving it on my bookshelf for a while I eventually took out Lord of Finance to resume reading books on my journeys. Written by Liaquat Ahamed, I bought it at one of Harris’ 20% storewide sales during a period when I was thinking about reading up more about Finance after the recent crisis. I thought it was good to beef up my knowledge of American finance since Age of Turbulence was the closest I got to reading about the financial sector of America.

The book turns out to be more than what I was expecting. Written in the style that feels very similar to Doris Kearns Goodwin’s Team of Rivals, Lord of Finance traces the little stories that demonstrated the personalities of the four most important central bankers prior to 1929. They had exerted huge influence on the economies of Europe and United States, and unintentionally engineered in the Great Depression with their policies and beliefs. It was interesting to get a peek at a world still obsessed with the almost divine quality of gold as a storekeeper of value and with poor understanding of monetary economics.

Even more intriguing is that monetary policies and innovations are being created by these people who has a nuanced view of monetary economics and poor understanding of the workings of the economy. The stories and opinions of civil servants, politicians and aristocrats in those years demonstrates the experimentation humans had gone through in order to figure out how this gigantic machinery works. Of course, this study and experimentation carries on today.

Liaquat Ahamed got really good reviews (here and here) from New York Times for this book, especially for the fact that the contents of the book chillingly echos the stories of Wall Street in the past couple of years, involving banking heros and monetary policies, speculative bubbles and a huge crash. The description of the mania and the built up to the eventual crash sounds rather familiar to me given that I just finished John Cassidy’s Dot.con a while back. Men’s penchant for not learning from History seems particularly pronounced in bouts of ‘Irrational Exuberance’.

For that, Liquat gives a brilliant analogy for the role of Central Bankers or the policies makers trying to stabilize the economy and also pushing for growth. He sees them much like Sisyphus in the Myth of Sisyphus, condemned the work hard to create the conditions fertile for economic growth only to have speculation and irrational exuberance extinguish the fruits of their labour – much like Sisyphus who have to push a boulder up a mountain knowing that when the deed is done, it’ll roll back to its original position for him to do it again. Perhaps Albert Camus is right, for the struggle probably do fill the central bankers’ hearts and the belief of their heroism keeps them happy.

Lord of Finance simply surprises me with the rich collection of anecdotes about the main characters of the story Liquat tries to tell and the manner it imparts knowledge on finance and the workings of money in the economy to the readers – subtly and not too overwhelmingly technical. As a result the book caters to a wide range of audience; students interested in economics, history, finance and perhaps just stories about great men’s mistakes.

Those interested in getting a preview before making a purchase of the book or going on a trip to the library to borrow it might like to check out New York Times.

Weekend Reads

We begin this week’s reads with an interview with Paul Samuelson by John Cassidy from The New Yorker. John Cassidy recently published a new book, How Markets Fail, which I’ll read some time soon. It won’t be that soon though – I’m still reading Thinking Strategically and moving on to Art of Strategy after that.

Eric Morris shared something about the cab industry in New York, which eventually concluded with urging for less regulation (ie. raising the supply of cab licenses or “medallions” as they’re called). One of the comments revealed a really humourous story of how the cabbie’s industry in Ireland got deregulated overnight; I shall reproduce it here:

A similar sitution existed in Ireland up to a few years ago. Change was brought about when the government went to issue more wheel chair accessable taxi licenses. The Taxi driver / owners group foolishly sued the government. They claimed that the government didn’t have the right to issue new licenses. They won but the court ruled that the government didn’t have the power to issue any licenses. The taxi ma[r]ket was deregulated overnight.

The current complaint from taxi drivers is that there are too many taxis etc etc. There were clear winners, the consumer and those new taxi drivers who are now free to ply their trade in a vastly increased taxi market.

The fact that GPS navigation on-board cars/cabs are widely available means that the tacit barrier to entry for the cab business have been significantly lowered. Anyone who can drive and have a car with on-board GPS navigation (and perhaps a meter) can technically offer good taxi services. Knowledge of the city and the different landmarks have become less of an advantage or requirement.

As for talks that you might want to listen to, Magnus Larsson speaks about structuring sand in deserts to prevent further desertification. His proposal won the Holcim Awards.

Irreducible Uncertainty

The Straits Times caught my attention again the week before with a particular article by Robert Skidelsky, which was a contribution to Project Syndicate. In Keynes versus the Classics: Round 2, Skidelsky highlighted the problem with today’s Keynesians being unwilling to work out the implications of irreducible uncertainty for economic theory. The article was essentially a response to the two economist, Krugman (his article) and Cochrane (his response here and here) who are engaging in an academic quarrel of sorts.

Krugman started out criticising the love for elegant economic theories of classical (implicitly speaking, Chicago school) economists. And Cochrane shot back, arguing that to attribute excessive fluctuations in the market to ‘irrationality’ is theoretical nihilism. And we all know that all that buying and selling has got motivations behind them even if these were results of false information, pure emotional preferences. I like Skidelsky’s analogy about the theater on fire (which might have been used previously by other economists as well):

It’s like what happens in a crowded theater if someone shouts “Fire!” Everyone rushes to get out. This is not “irrational” behavior. It is reasonable behavior in the face of uncertainty.

I’m not sure if Robert Skidelsky is a Post-Keynesian like Hyman Minsky but his extensive research into John M Keynes has brought him to write several volumes about this economist once touted as a saviour of capitalism. In any case, I believe Keynes simply sprinkled some important ideas that are pertinent to our study of the economy and there is definitely a need for further studies into the insights of Keynes about our modern capitalist economy and possible save it from itself once again.

Positive Feedback

The economy doesn’t (always) tend towards equilibrium as classical economics textbooks suggests. But things are worst when things tend towards an equilibrium that doesn’t benefit the society in general, many social phenomena that I’ve described in a previous post. The social/market forces are pushing the situation towards something no one wants; without an authority mandating stuff, no one have the incentive to help reach the collectively beneficial outcome.

In a recent article by James Surowiecki in The New Yorker, he discusses how success of big banks builds upon success and bring about the mega big banks that results in a concentrated banking system. It is thus possible that we allowed banks to grow big and stay so because the market naturally tends towards that and we have problems assessing the welfare gains from increasing bank sizes, as suggested by Surowiecki:

The trouble is that the “market” for banking is so distorted—by switching costs, by government subsidies and guarantees, and by the banks’ market power—that it’s hard to know whether big banks are adding value or are simply exploiting their oligopolistic positions.

The only problem that we know with the concentrated banking system is that they increase financial risk. That being said, regulations will have to start moving towards managing the risk that is contained in the financial system and if this really do result in policies that have to limit the size of banks then so be it. The government is the only one who can act as a dam holding up the floodwaters of market forces.