In the Senate hearings yesterday a statement was made by Goldman sachs CEO Lloyd Blankfein that, to me, summarized the difference in thinking between the leadership of excellent companies, and the thinking of the business folks who cause so much damage to the companies they run, their employees, suppliers and communities in which they operate.
"'We do hundreds of thousands, if not millions of transactions a day, as a market maker,' Blankfein said, noting that behind every transaction there was a buyer and a seller, creating both winners and losers." It seems to me that there has to be a winner and a loser behind every transaction if the trend line of the investment is like this:
Or even if the trend line is like this:
But there does not have to be a winner and a loser if the value of the investment does this:
The role of these investment people is supposed to be to help investors find opportunities to put their money into business ventures that will increase in value. When that happens, it is not a zero sum game with a winner and a loser. It is a win-win proposition.
The big problem with Wall Street is that they are all consumed with the belief in this winner and loser mentality, and with increasingly complicated derivative schemes and travesties like the buying, selling and looting of Simmons Mattress seven times in twenty five years; they are putting all of their intelligence and a lot of people's money into making money from investments with no underlying value – or even draining the value to create money-making opportunities.
That mentality is not limited to Wall Street. The purchasing/sourcing function of the poorly managed companies is driven by the same thinking. Supplier selection and negotiation is based on winner-loser/zero sum thinking. Rather than collaborate with suppliers to create more value, the driving principle is to take money from supplier profits and add it to their own. No thought given to how to make that which is being bought more valuable. It is perceived as a static thing, and price negotiations are all about who will win and who will lose.
Same thing with pricing and dealing with customers … dupe someone into paying a little more without adding anything to the value of that which is being sold, and you win while they lose. It results in stories like the one in which the Proctor & Gamble customer learned that she had been paying $17 for a bottle of shampoo that was virtually identical to the one she could have been buying for $7. P&G had been playing the winner and loser game with her – they won and she lost every time she paid an extra ten bucks to wash her hair.
That upward trend line – whether it reflects the value of the company in which someone is investing, the value of material being purchased, or the value of the product being sold – requires hard work, deep knowledge, and often quite a bit of patience. Nobody gets rich quick in the value creation business. But guys like Warren Buffet, who epitomizes the long term "value investing" philosophy, prove that you can get very rich over time – and not end up in court or in front of a Senate panel having to explain how you did it.
Lean thinking is the wholesale rejection of the Goldman Sachs principle that there must be a winner and a loser behind every transaction. It is driven by the idea that good management creates a win-win for buyers and sellers, as the total cost of products and the value of investments continually reflects more value and less waste.
William says
It’s funny that you should mention this; I’ve been chewing on a similar notion.
Long ago I used to work for financial traders, and we did two sorts of trade. One was where we were performing a service to our counterparties. E.g., taking on and managing risk, or providing liquidity. The other was gambling: we thought we knew which way things were going and bet with other players hoping they were wrong.
I’m honestly ok with both sorts of trade, in that even pure gambling can provide systemic value: by putting pressure on incorrect valuations, it can help keep markets efficient.
I think the problem comes when you bring the ethics and attitudes of gambling, where profit is the only possible proof of virtue, to the value-providing businesses. At Goldman, et al, the amoral gamblers have taken over. Culturally it’s become ok for all of Wall Street to make massive profits, even if they’re destroying value rather than creating it.
Jim Fernandez says
You make good points here. I’m going to try and express an idea I’ve had in my head for a long time. Let’s see if this makes sense.
Before stock markets existed people made money or created wealth by producing something. By making something of value or providing labor to do something of valued. Both the producer and the buyer were in a winning situation. Real wealth (money) is produced when something of value is produced. Make it for $1 sell it for $2. Profit is made. This is true even in a barter system. Both parties win.
Then along came this guy who came up with a way to make money from someone else’s production and/or labor. This guy invested money in the operation (provided capital). When the producers of value began making more money this guy was paid interest on his investment. Well that seems fair. However, one day this guy sold his interest in the operation and made a profit from the sale. But guess what. This guy never produced anything of value for the profit he made on his investment.
Consequently because there was no value created for this profit, there had to be a winner (the guy who sold his interest in the operation) and a loser. Ok who is the loser? The loser is the second guy who brought the interest in the operation. And another loser is the operation itself. Why are they losers? It is because the second guy who brought interest in the operation paid money for “perceived” value. Or in other words he paid money that he expects the operation to repay him for. And again this second guy is not producing anything. So the operation has to somehow come up with the money to repay this second investor.
I say that whenever wealth is created when nothing is produced there has to be a winner and a loser. Because nothing is produced, someone somewhere has lost something. I go back to the original premise that real wealth (money) is created only when something is produced.
The kind of wealth (money) that wall street creates is not real wealth. My 401K is not real wealth. As soon as I cash it in, there is a loser somewhere. Most of the economy is a house of cards. Consequently in the stock market and in investment banking there is always a winner and a loser. The reason it appears to be working is that the loser finds another loser. And once in a while the loser can’t find another loser. So the last guy in line is a “real loser”. Right now my house is worth 30% less than I’m currently paying for it. I ended up being the last guy in line.
Am I completely off base here????
Marc says
Jim,
I don’t think that you’re completely off base, but I do think that investors can create value, just as managers can create value (and we all know managers don’t actually produce anything except charts, spreadsheets, and powerpoint slides).
For example, I have a few product ideas that I think would be worth developing, but I don’t have the cash and can’t find an investor. If I could find an investor he would create value for me by funding my efforts and assuming the bulk of the risk – after all, my idea might be a flop! Even if he sells to another investor, that is after the fact. The seed money is what made the difference. He can even create value for the second buyer because at the time of the sale because the first investor may have made huge returns in exchange for his huge risk, but the second investor isn’t buying a concept but (hopefully) a proven cash generating business. The second investor may not be willing to take a huge risk and a lower stable return might be acceptable to him. The seller may want to take his cash and develop the next big
thing (more high-risk/high-reward for him). This is how win-win should work.
Marc says
Jim,
Just to continue the discussion further, when you have a goose that lays golden eggs, you can nuture the goose and collect the eggs, sell the goose, or be a complete imbeccile and slaughter the goose to rip out all the golden eggs (which off course there are none). Ultimately it is the masses that feed into this frenzy of a mindset. If you are constantly trading stocks for the highest returning security every day or month, you are feeding into this mindset. If you are buying a house so you can “flip” it without even making improvements to the home, you are feeding into this mindset. If you buy a home three times bigger than you need (I think Bill has touched on this before) just because you think your house should be your biggest investment, you are feeding into this mindset.
If you are a fan of Buffet, you know that he doesn’t care if the stock prices are booming or crashing, his focus is on the performance of the business. Likewise, if your house is 30% less than you paid for it, you shouldn’t be bothered as long as the home is still as structurally sound as
you expected it would be at this time. I doubt you would complain if your car was worth 30% less than you paid, because it probably is, if not worse. If you have the cash to buy a second home, for investment or vacation or hobby farm, now is a great opportunity, but in the meantime you can
still enjoy the home you have – it hasn’t changed, just other’s perception of its value. Investment wise, a home is just a commodity, just like gold or timber or dirt. It’s not an investment until
you move out and rent it to someone for income, but you will still need a home for yourself somewhere. If you took out a 30 year mortgage on a home that you planned to sell in 5 years, then I think you may be suffering from the same mindset as our friends at Goldman Sachs.
david foster says
The financial industry provides an essential set of services in allocating capital, but the amount of resources (human resources especially) that it is consuming has grown disproportionately large. The same is true of the legal industry, which also provides essential services but has become way too big.
Both industries are in a sense *control systems*…they are sort of like the governor on an engine, which doesn’t generate energy itself but is necessary for the proper functioning of the engine. But if (say) 20% of the engine’s horsepower was being consumed by the governor, we’d think something was wrong.
Jim Fernandez says
Marc:
Thank you for the clarification. I don’t have an issue with the first investor. I was suggesting that there is always a winner and a loser when the first investor sells his interest in a company to the second investor. This is because if the stock was sold at an inflated value, this extra value has to be either made up by the company, or taken as a loss by the buyer. And my point was that no value was produced to compensate for the inflated stock price. It was a (before the fact) (hoped for) perceived value.
I guess I’m just frustrated seeing so much money being made by people who create no value.
Marc says
Jim,
Don’t forget that it can and often does work the other way as well. Say an investor was expecting a 30% return but the business environment changes and he now realizes that he will only reap a 15% return. A 15% return might be a great deal for a part-time investor who isn’t willing to go through all the research and planning that the original investor put in. If the original investor finds another opportunity that he feels has an even better chance at reaping 30% then it might make sense for the original investor to sell his investment to free up cash to put into the other idea. While the first investor would be the “loser” in this case, he is still better off making the deal because he can earn a higher return in the other investment without necessarily taking a loss by selling his first investment. The buyer might not be savvy enough to pursue the other investment opportunity, but for him and his situation he comes out a winner with a 15% return, which might be much better than the other options he had available. Regardless of whether the company is sold or not, the company will have the same obligation to its shareholders, and changing the names on the certificates doesn’t make much difference unless the new owners try to change things. As for an inflated price, I’d pay more for a company that has earned a 15% return three years in a row than an identical company that hasn’t earned anything but is promising 30% returns.
Value is created for the buyer because of the information to help the buyer determine the present and future value of the company. For the buyer, perhaps his purchase is 90% investment and 10% speculation, but for the original owner it may have been 10% investment and 90% speculation. While you can say the first investor is “speculating”, he’s not just moving commodities around, he is building a business. The first investor deserves to be compensated for taking the larger risk. The first investor is also benefiting his community by creating jobs and offering a product or service that is a better value, perhaps even forcing competitors to increase value to their customers. The first investor probably had to put a lot more time and effort into making his decision compared to the buyer.
You could compare this to careers – a doctor makes more than a nurse, but also has more years of school, more student loans, and sometimes more stress, risk exposure, and so on. Many people are happier working as a nurse even if the pay is less than a physician.
I agree with David that there are too many finance people and lawyers, and when markets like these get crowded you see things like ridiculous speculation (which is not investing and should be avoided like the plague) and you also see an increase in junk lawsuits. These behaviors tend to make things worse for everybody, such as inflated house prices from flippers, inflated oil prices, and inflated stock prices, almost like a self-pertetuating ponzi-scheme. Same is true with debt – if everyone is borrowing money to buy the things they want it only forces the prices up, making it more difficult to try to live debt free.
There are times when it just doesn’t make sense to buy a stock, even though the price just keeps going up, but this is where investors need to be educated and disciplined. Emotionally charged speculation does create losers, but these losers make their own choices while the savvy investors are mocked for holding cash that is “losing value” from inflation. Sometimes you just have to hold cash even if that means negligible short term loses.
I think that other losers are those who believe that they need to invest in the stock market in order to have enough money for retirement. Unfortunately a large number of players in the stock market are average folk with a 401k who are good at their jobs but lack the financial literacy to recognize the difference between a good deal and a raw deal. Some of them can learn and succeed (I like to think I have) but a single mom with an associates degree working two jobs might be better off holding safer assets that she can understand, and possibly learn about proper investing later on (though later on she will have missed out on the better long-term investments).
I think one other case you have losers are when one party or a broker is deceiving the other party. This is where due diligence comes into play, and our economy would probably work better for the masses if regulations were better established to prevent Enron’s, Maddoff’s, and the like. You cannot blindly trust an advisor’s advice because you cannot always know if they have a conflict of interest. Goldman Sachs released a report the day before the price of oil crashed in 2008 claiming that prices would continue to soar with no end in sight, and I believe Sachs came out the biggest winner as a result of their own chatter. The losers were the speculators left holding the bag. In speculation there are winners and losers, which is why I don’t play that game.
Jim Fernandez says
Thank you Marc for making it more clear. When I made my comments I was just thinking that maybe Blankfein was correct when he said “behind every transaction there was a buyer and a seller, creating both winners and losers.”
But you made it clear that in good healthy financial transactions the need for “winners and losers” in every transaction is not always the case.