The Economist on Why Greece Matters

OR why Paul Krugman should put more thought into his work here:

There is no reason for the Greek government to default. It is not in its interest and it can service its debt, whose size is half that of the Japanese government and the same order of magnitude as that of many other governments, including soon the UK and the US...Yet, markets can force the government to default if they refuse to refinance the parts of the debt that reach maturity. This is a pure case of self-fulfilling crisis...

A debt default by the Greek government, on its own, would be a non-event. Greece is a relatively small country (with 7 million people, its GDP amounts to less than 3% of Eurozone’s GDP). Contagion to Portugal, which is even smaller, would also be a non-event. Moving on to Spain and Italy is another matter...

The real worry is the banking system. Some European banks hold part of the Greek debt and, if still saddled with unrecognized losses from the subprime crisis, some might become bankrupt. Many governments have simply not pushed their banks to straighten up their accounts and they are now discovering some of the unforeseen consequences of supervisory forbearance...

Contagious debt defaults, along with bank failures, could lead to a double-dip recession in Europe, possibly affecting the US as well. If that were to happen, with the interest rate at the zero lower bound and fiscal policy not available any more, we could face a terribly bad situation.

Hellish Debt to Income Charts Should Break Out Asset Based Debt

Lots of these debt to income charts floating around this morning including the infamous chart I've shown here showing US debt to GDP at 350%. As sovereign concerns ebb and flow comparative debt charts are abundant.

However, these historical charts never break out asset backed debt vs debt secured by income.

The rise of asset securitization is one of the more important developments in finance for corporations and financial companies.

Given these charts are always debt vs income, should the assets not then be broken out?

If asset backed loans default, it's a bit of a different resolution process and it's often a bit simpler--the asset goes back to the lender and the asset price falls. We need to see a lot more of that happening to make the deleveraging process go a lot faster.

Paul Kedrosky "thought experiment" on US Spending

Great post by Paul Kedrosky simply taking US spending from 2000 and applying a 4% annual increase just to see what the deficit would be if we had grown by around the rate of inflation. Obviously, this doesn't account for military spending yet the point is relatively powerful.

If the US would simply cut spending to more rational levels we could eliminate the fiscal freight train heading our way. It's my belief, that even with the trillion or so in spending cuts this would require, much of this "slack" would be taken by private investment.

I believe a lot of private investment is being held back because people fear an imending fiscal crisis. It's a relatively rational assumption. Why engage in a large project when a potential debt crisis is right around the corner impacting long term costs of financing and the macro economy?

This dramatic cut in spending needs to take place both at the national and state level as folks were getting lifetime pensions after 5 years of service or other fat cat deals. All of these deals need to be recut or eliminated. That also means tackling medicare and social security.

What good is reinstitution "pay as you go" in Congress if you are already spending way too much?

Interestingly, the levels you get here are somewhat similar to those in my email last week where I said cutting by $800 billion is about right here.

Source here.

The Return Bond Vigilantes: Not that far downstream from US Cuts in Entitlements

-Greece

-Portugal

-Ireland

-Italy

-Spain

-Baltic States (although Lithuania had a great debt offering today)

-Rest of Eastern Europe

-Iceland

PIIGS+

All of these markets are causing problems this morning as the bond vigilantes cause a little havoc.

Most interesting is all the comments I hear from friends/money folks in the northern countries with statements like "kick the bums out" and calling the Greek politicians "liars" given their statistical agency fibbed about their budget numbers. Some might argue the BEA here in the US does the same. Most of this is bluster. While I've speculated about a possible exit from the EMU by Greece in the past, now that the crisis is here, I think it's highly unlikely. Too many other costs make this kind of a decision impractical and counterproductive.

The larger problem is too many EU banks hold too much of this debt from Greece and other PIIGS and Baltics. Once this panic on further write downs hits the EU leaders there will be severe pressure for the big EU countries to keep a safety net under the country. In the mean time, those buying credit default swaps are having a great ride.

On the other had, it does not appear that the EU has the necessary tools to really address this problem quickly if it speeds up. The EU has to fix this fast before it gets worse.

All this begs the question similar to points raised in a post yesterday. If you take all the deficits in the EU they amount to about 6% with the US deficit well above that at 10% or more. Just a few more years of this irresponsible spending and we will be right behind Greece. I'd rather just cut the spending now and get the pain over with.

Once the vigilantes are done buying credit default swaps in Europe, if the US budget crisis is being ignored by Congress where do they go next? I think it hits US out of control entitlements i Medicare and social security. There is now more public spending on health care than there is private spending. While these problems look difficult now, in 3-5 years they will appear impossible.

This keeps me out of health care other than emerging growth health care IT. The shoe that will eventually drop here is massive cuts in entitlements. The most out of control entitlement we have is Medicare and that ridiculously expensive prescription drug benefit. Constraints on over consumption by the US are a matter of "when" not "if". I'd rather just not be involved in the sector aside from health care IT. Other sectors like natural gas and technology can be waded into slowly as deleveraging continues to cause stresses.

UPDATE and --One more thing. I know my suggestion that spending be cut down below $3 trillion may seem painful. However, I think a lot of investors refrain from aggressive investment because they perceive a "reckoning" coming. If they were to see the president make serious cuts now below $3 trillion, a lot of private capital would come in to replace government. I think this feels to the president like defeat because he cannot pass the agenda as planned. Better I think to get the fiscal house in order and 3-4 years later revisit agendas from a sound footing.

For All You SlingPlayer Fans

AT&T has accepted the new version that allows 3G streaming over it's network. This is good news but somewhat ironic since AT&T PR sent me a note a few months ago saying they never actually rejected the app or were involved in the rejection of the app when it was submitted to Apple.

Well anyway, the non rejected app has finally been accepted by AT&T even though AT&T never had anything to do with rejecting it the first place and is accepting it now. Got it?

Should appear soon.

Pretty Cool-- Physicist Discovers How to Teleport Energy

Via MIT Tech Review with excerpt below

The technique relies on the strange quantum phenomenon called entanglement, in which two particles share the same existence. This deep connection means that a measurement on one particle immediately influences the other, even though they are light-years apart. Bennett and company worked out how to exploit this to send information. (The influence between the particles may be immediate, but the process does not violate relativity because some informatiom has to be sent classically at the speed of light.) They called the technique teleportation.

That's not really an overstatement of its potential. Since quantum particles are indistinguishable but for the information they carry, there is no need to transmit them themselves. A much simpler idea is to send the information they contain instead and ensure that there is a ready supply of particles at the other end to take on their identity. Since then, physicists have used these ideas to actually teleport photons, atoms, and ions. And it's not too hard to imagine that molecules and perhaps even viruses could be teleported in the not-too-distant future.

But Masahiro Hotta at Tohoku University in Japan has come up with a much more exotic idea. Why not use the same quantum principles to teleport energy?

Today, building on a number of papers published in the last year, Hotta outlines his idea and its implications. The process of teleportation involves making a measurement on each one an entangled pair of particles. He points out that the measurement on the first particle injects quantum energy into the system. He then shows that by carefully choosing the measurement to do on the second particle, it is possible to extract the original energy.

All this is possible because there are always quantum fluctuations in the energy of any particle. The teleportation process allows you to inject quantum energy at one point in the universe and then exploit quantum energy fluctuations to extract it from another point. Of course, the energy of the system as whole is unchanged.

He gives the example of a string of entangled ions oscillating back and forth in an electric field trap, a bit like Newton's balls. Measuring the state of the first ion injects energy into the system in the form of a phonon, a quantum of oscillation. Hotta says that performing the right kind of measurement on the last ion extracts this energy. Since this can be done at the speed of light (in principle), the phonon doesn't travel across the intermediate ions so there is no heating of these ions. The energy has been transmitted without traveling across the intervening space. That's teleportation.

Just how we might exploit the ability to teleport energy isn't clear yet. Post your suggestions in the comments section if you have any.

Backing out of Term Sheets Should Never Happen, Except Sometimes You Should

Chris Dixon has a great post about not backing out of term sheets. Dixon doesn't name names but it's usually not too hard to figure these things out. Generally, I agree with the comment that you should never back out of term sheets except in extraordinary situations. The trick is, extraordinary is a subjective term.

I never have backed out of either an institutional round or an angel round. However, I can think of one instance where I wish I had or at least gotten off the "my word is my bond shtick". While doing docs I felt like the CEO was being unusually ornery in several odd elements of final docs, the cash burn was excessive for the rapidly changing environment, and most notably September 11th hit and it was a telecom deal. Generally most telecom deals at that point had died or were dying and we were going to try and pick a winner to save. Telecom was already struggling and while this company had prospects, the diligence was done prior to the attack and spending clamped down materially after the attacks.

I wrestle with the decision to this day. How would I have backed out? What would I have said to the co-investors? How about my colleagues and the senior parters at the firm who wanted to do the deal even more than I did? One of their first wins was an IPO with this particular CEO and to back out would have been doubly horrible for the relationship. But the deal made me ill and I hadn't put a dime in yet? Should I have backed out or did I do the right thing?

At the time, I was of the school --your word is your bond -- just like Chris mentions in his post. However, in extraordinary circumstances and you get large amounts of data it's your job to revisit your decision. You really have a fiduciary duty to your LPs to do so, no matter how difficult personally. The trick is to do it with some class.

So how did it turn out? Not well.

The deal turned out to be problematic and a write off--here is what happened. We were in the deal with a lot of old school telecom investors and one of them said to me in a board meeting "John, we can't save our way to success". That's true, but the days of burning through mountains of cash to attract high profile acquisitions were over and not since returned. That whole style of investing was dead and they weren't quite ready to let go. I had gotten a sense of this in the diligence when I talked to the board and that should have stopped me right there or at least revisited the structure of the deal. A wiser man would have done so right?

I was in the deal though, so it was a fight at every board meeting just to get the burn down. I think they burned something like 10 million in cash in one meeting to the next. I was apoplectic and couldn't really focus on doing any new deals. A bad deal can really consume you.

The company had a great technology and an impressive CEO with amazing marketing skills-- to the extent he gave himself time to succeed and a long runway to allow the market to recover, the company had strong prospects and could win. While I was wearing them down, the cash balance was dropping quicker that I could persuade each board member or the CEO. Just a note on the CEO, he truly was one of the best marketing CEO's I have ever seen. The guy's pitch could make you cry it was so good. But he was in a bad situation and the market for his gear was very slow in recovering even though it saved carriers money.

If I had walked away and come back with a more viable structure that reflected the new telecom landscape and a longer runway, I think the outcome could have been very different for him and for the investment. Many of those variables uncovered in the diligence were difficult to control if you are stuck with the original deal designed 5 months prior.

Also, if you walk away, it gives the insiders time to reset their own expectations, test the market, and make some of the harder decisions before your cash goes in. i.e another option besides walking away is a punt.

They say it takes $20 million to train a VC, well I blew a good chunk of it on one deal my own gut said to walk away from. Like all good lessons, I still wrestle with it and I apply it to investments now.

It sounds like in Chris's post, the partner has done this multiple times and is doing this as some sort of stalking horse strategy. If so, that will get around very quickly and make quality deals very difficult stuff for the fellow. However, I'd suggest that in some cases, when the landscape changes or major new data is introduced, sometimes it's better for everyone involved if you either punt or "back out". In my case, I had several chances, I just didn't take them. Given that situation, would it have made me dishonorable (an attribute that is important to me). I'm not sure that it would have.

The bottom line is hard and fast rules are a weaker tool set. A lot of these "hard and fast" rules are often misapplied. Use your best judgement and do what you think is right for your investors and for the company your investors. Never let a rule like "your word is your bond" stop you from doing the right thing. Life is not always best boiled down to one thing.

As a guy who was an entrepreneur once before too, I know one rule that is as hard and fast as they come "the deal isn't done until the wire hits".

Chris Dixon's post here:

Yesterday, one of the 40 or so startups I’ve invested in (either personally or through Founder Collective) had a well-known VC back out of a term sheet for no particular reason besides that they decided they no longer liked the business concept. It’s the first time I’ve seen this happen in my career.

In later stage private equity (leveraged buyouts and such) it is a common trick to “backload diligence” – you give the company a quick, high-valuation term sheet, which then locks the company in (the no-shop clause prohibits them from talking to other investors for 30 days or more). Then the firm does their diligence, finds things to complain about and negotiates the price down or walks away. If they walk away, the company is often considered “damaged goods” by other investors who wonder what the investor discovered in diligence. This gives the investor a ton of negotiating leverage. In later stage private equity, this nasty tactic can work repeatedly since the companies they are buying (e.g. a midwestern auto parts manufacturer) are generally not part of a tight knit community where investment firms depend heavily on their reputation.

I learned the basics of VC when I apprenticed under Jeremy Levineand Rob Stavis at Bessemer. It was at Bessemer that I learned you never back out on a term sheet except in cases of fraud etc. I never saw them back out on one nor have I heard of them doing so. In fact, I remember one case where Rob signed a term sheet and while the final deal documents were being prepared (which usually takes about a month), the company underperformed expectations. The CEO asked Rob if he was going to try to renegotiate the valuation down. Rob said, “Well, if you performed better than expected I don’t think you would try to renegotiate the valuation up, so why should I renegotiate when you performed worse than expected.” That’s how high quality investors behave.

What's the Right Size of Government to Avoid Another Credit Crisis-Cut Spending by $800 Billion

The 'Bond Vigilantes" have not hit yet, but most people feel it's a matter of time. Despite the pervasive feeling that we've lost control of our destiny, the biggest headwind to future prosperity is actually something we can control--the federal budget. Through the efforts of our now book touring ex-treasury secrtary, much of the irresponsible private debt has now become public debt, and the current massive spending increases threaten another credit crisis--this time a public one, not a banker driven debt crisis.

The question at hand is, what macro number would be large enough not to bring us back into recession, yet be fiscally responsible given the size of our economy.

To get a sense for what might be practical it might be helpful to take a look at spending levels at the peak of the economic cycle in 2007. In 2007, the government spent about 2.7 trillion. In just a few years spending has shot up to 3.9 and 3.7 trillion in the president's budget. Obviously, the economy has not grown to merit that kind of spending increase, and not even Keynes himself would argue that government should be THAT stimulative in even the worst depression. A trillion dollar increase to almost 4 trillion just isn't practical or reasonable.

It doesn't matter if it's President Bush's fault or President Obama's the number needs to come down.

Really, if we dial it back to about 2.7 trillion as a baseline number, that's at least a starting place of where our spending levels should be. From there, we need about 400 billion in temporary investment and spending programs that invest in our future rather than pork. Examples of things that work include:

• Transition us off of foreign oil onto domestically produced sources like natural gas. This also creates millions of jobs right here at home. More nuclear plants. An modernized energy grid. This also means more US tax revenue and a stronger dollar.
• Modernize our infrastructure. High speed rail has it's problems, but if we make it the best in the world, that will result in more jobs, and also help with fuel dependence.
• Transition assistance for states to the new normal, broadband infrastrucutre, some form of health care reform--ideas like universal preventative care saves money, other priorities by the president.

Right now, even CBO budget estimates assume that we get huge increases in tax receipts ad growth up to 3.5 trillion in a few years that somehow fill the budget gap and bring it down to about half a trillion. This reminds me of the kind of fantasy revenue numbers you often see in startup business plans.

Right now, the government is actually expanding programs and it's workforce then promising eventual cuts in those same programs a few years later. What business would ever hire when it knows a few years later it's going to have to fire anyway.

Spending cuts in government workers are not particularly "keynsian" in nature. Government bureaucrats don't add to the economy, they suck it dry. (some of my best friends are government workers and they agree).

Right now, government borrowing is so outrageously high it is crowding out lending for small business. President Obama is angry about the lack of loans for small business-- well Mr. President, stop taking it all! The weekly treasury auctions are staggering and it's large US banks that are taking advantage of the easy money policy to just plow cash into treasuries.

The best thing to do is cut "baseline" spending down to 2007 levels to about 2.7 trillion, then have 2-3 years of special investments in updated infrastructure that create jobs and catch the country up with Europe and China perhaps taking spending up to $3 trillion. This kind of discipline will be tough, but it means lower long term interest rates, less borrowing and more loans available now. The temporary spending will result in a more updated and competitive US economy and give us a tax base that can pay back some of this huge spike in debt.

If we don't do this, we are looking at the potential for huge spikes in interest rates and a double dip back into panic. I'd rather take some small pain now then see the country face the Paulson Abyss Part II.

Great TED Talk on ALS and How it Inspired Innovation in Health Care

Really amazing TED talk about a family hit by ALS (also known as Lou Gehrig's disease) and how it inspired ideas on health care IT innovation. ALS is one of the first charities I was every involved with through Johns Hopkins and is one of the more horrible diseases out there. Impairs motor neuron function in the brain and you become helpless until you die. Importantly, the ideas the brothers came up with can be applied across health care. An industry that unfortunately lingers in the IT dark ages for a variety of reasons. Shows all the potential for how IT can help our health care system.

Hank Paulson Doing Rehab on the Weekend Shows

I presume this is for his upcoming book. I've never understood how Hank Paulson ran Goldman.

But the thing that bothers me the most is his handling of the financial crisis. It seeemed that at many stages he accelerated the crisis where at many points it might have been diverted or at least slowed.

• The man struggled for a structure to use to save the banks instead of tried and true methods used in every prior crisis that wiped out debt holders.
• He made it clear that at no point he would save Lehman when his handling of that failure and Lehman's collapse greatly accelerated the problem
• It's not clear that the system is saved, but rather put into some sort of suspended animation where the condition could relapse at any point.
• The Fannie/Freddie guarantees were obviously a difficult call especially with apparent rumors around Russian pressure on this debt however, the taxpayer liability here dwarfs anything I've seen.
• The bailout of the auto companies and unions.

If we had just forced debt write downs as part of the bailouts I think I might feel a bit less hoodwinked at a taxpayer. The standard line from him and Geithner was "It's the best alternative among a bunch of bad ones".

No, you could have let the write downs happen and the country now would have less debt.

It's not the same kinda feeling I had about Edwards when he campaigned where I thought he was a panderer and dishonest-- I just don't think Hank was a very capable Secretary of the Treasury. I think he panicked and was in over his intellectual capacity to solve problems. Not a bad or evil person, just not a competent or intellectually deep person.

Mr. Paulson wanted to have an impact as SOT, and he has left his mark.