Today we have a guest blogger, David Friedman (Yale School of Management and former partner at McKinsey & Company).

Here are his recent thoughts on crowdsourcing.

I’ve been thinking a lot about crowdsourcing and the types of problems where it (and some team-oriented variants of crowdsourcing) could work. In my research, I ran across the story-so far-of the crowdsourcing of solutions to the blowout of the Deepwater Horizon well in the Gulf. I say so far since as of this writing the problem is continuing only slightly unabated.

BP didn’t post the question of what to do on any of the available crowdsourcing platforms, like Innocentive. It didn’t launch a crowdsourcing site of its own for a long time, although it has one now that claims to have over 7800 suggestions. However, BP is not very transparent about what it is doing with the suggestions, as highlighted in this article. Other people have leapt into the breach, providing venues for people to offer suggestions. These included the Guardian newspaper and a site called BPOilnews.com. People also apparently began submitting comments the the U.S. Environmental Protection Agency’s Open Government site (since it was open and had “EPA” in the title); eventually the EPA opened another site specifically to deal with the BP situation. The EPA’s new site defines the problems it is interested in help with — which is one advantage of being slightly proactive (even if you are dragged to being proactive by other people).

In a very interesting post, Laurel Papworth notes that the PR advantages of crowdsourcing — of asking for help and at least pretending to listen — would have been valuable for BP. Instead, they have taken the route of trying to be the experts and instead looking quite foolish.

The desire of people to help is impressive. Their capacity to help might be very large. It appears that BP is resistant to taking help, although it’s admittedly hard to know (lack of response by them, lack of publicity by them of their response doesn’t mean they aren’t reading what they are getting, but it does make one wonder). It would be nice to see some response, and some evaluation publicly of the ideas that have been received.

What do you think BP should have done? What should it do now to get the most from the public?

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Leslie Pratch, Ph.D. is a clinical psychologist who trained at Northwestern Medical School with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.

David Friedman is a friend who describes himself as a consultant, educator and thinker who cares a lot about people and what happens to us. He is dedicated to creating high integrity individuals beginning with early childhood. He can be reached at  (312) 863-3489.

Today we have a guest blogger who thinks deeply about relationship and trust building-David Friedman (Yale School of Management and former partner at McKinsey & Company.

There’s been a lot of writing about the relationship economy.  I have been wrestling with some of the fundamental issues/ questions and would love to have an engaged dialogue with people about it.

What I get, and deeply believe

(1) People working together with new electronic tools can create immense economic value. Many  tools (social networks, etc.) are are inexpensive or free. Leveraging these tools and the relationships they facilitate (new relationships, stronger relationships) are central benefits of “the relationship economy.”

(2) Relationships in themselves are valuable to people. There is a social value to being connected to other people ; for example, people who have lots of friends live longer. Relationships are also the major (maybe sole) mechanism for personal growth, and people want to grow personally (become wiser).

(3) Many people understand that establishing rewarding relationships begins with giving, and creating trust begins with trusting.

What I’d like to think more about and talk with people about is the bigger “so what”

The relationship economy is a big deal for sure; I’m wondering if it’s a giant deal.

(1) Is the “relationship economy” just a new front in the old self-interested free enterprise economy? It certainly is that: it gives brands a new way to connect with people and can change the way companies innovate. It definitely provides some power shifting within the economy. But it would only be a fundamental change economically if it changed economics so much as to alter the world in a meaningful way. For example, if better innovation could cut the cost of what we buy by 50%, effectively doubling our income – then that would be a fundamental change (where a quantitative shift leads to qualitative difference).

(2) Is the “relationship economy” most important because it lets people start to value relationship and the experience of relationships as extremely valuable in themselves? People are starved for attention from other people–real attention, real understanding. They want the social benefits of connecting, for the experience itself. I had this “social benefits of connecting” experience while posting my first LinkedIn question. It was about software and I got 20 responses. I engaged in dialogue with about half the people, and feel like I found a new friend or two – because I asked for help and they responded effectively.

(3) Is the “relationship economy” a critical phase in the explosion of the Internet, creating a “new nervous system for the planet” and making it much easier for people to think about the whole?  If this leads to more interest in the “whole” and less in “my share of the whole” then it is transformational. I think by analogy of this picture of the Earth taken from space. Seeing the planet shows us a whole and makes it harder to disregard it.  Will we start thinking about the “whole” (whatever that is) and focus on making that healthy? To repeat, that would be transformational.

Which is it? Or is it all? Or is it up to us to make of it what we do?  Comments are most  welcome.

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Leslie Pratch, Ph.D. is a clinical psychologist who trained at Northwestern Medical School with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.

David Friedman is a friend who describes himself as a consultant, educator and thinker who cares a lot about people and what happens to us. He is dedicated to creating high integrity individuals beginning with early childhood. He can be reached at  (312) 863-3489.

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Ah, Sarbanes-Oxley. It’s that albatross that has hung around so many business owners’ necks since it was unfurled in 2002. No wonder one of the top questions I’m asked is, “Scott… what do you think the future of SOX will be?”

Since I’m not gifted with the powers of 100% accurate prognostication, I can only speculate as to where the Sarbanes-Oxley Act will head in the coming years. However, based on the current economic climate, the intense debate surrounding the regulations and the media it’s been getting, I’ve put together a few predictions:

1. Small Businesses Will Continue to “Rage against the Machine”

For small businesses that are publicly owned, Sarbanes-Oxley has brought larger financial ramifications than it has for monolithic corporations. Thanks to the fixed costs associated with SOX compliance, those smaller businesses are forced to spend a larger percentage of their revenues on SOX-related measures.

Of course, the SEC has granted several SOX extensions to small public companies, namely those dealing with Section 404. The next is scheduled for June 15, 2010. However, no one is jumping for joy at the news. This constant pushing back of SOX deadlines is akin to being on death row and receiving a stay of execution. Sure, you’re glad that you’re not going to the electric chair right away, but you’re still on death row.

Fortunately, unlike a prisoner, small businesses are free to fight back politically and legally. I think you’re going to see plenty of that as the next Sarbanes-Oxley deadline for small businesses closes in.

2. SOX Will Undergo Revisions

The Enron scandal that created Sarbanes-Oxley is coming up on its 10-year anniversary, and the memory of the problems that precipitated SOX are waning in the minds of the up-and-coming generation of entrepreneurs and execs. Consequently, I think you’re going to see some minor – and perhaps even major – revisions when it comes to the way that Sarbanes-Oxley will shape the future of the business world.

Currently, many politicians and business leaders have set their sights on reshaping SOX. Truly, not a day goes by that financial bloggers around the world aren’t discussing Sarbanes-Oxley. Some find it praiseworthy, others find it loathsome. But all find it highly interesting and relevant, and that keeps SOX in the public’s eyes and minds.

Though this may sound like great news, it’s important to be realistic… so I have to say that…

3. SOX Is Probably Not Going to Significantly Change for Many Years

Given the fact that laws are tough to change, the chances of SOX going away tomorrow are nil. That means that all businesses – especially public small businesses – need to be prepared.

Last year we notified small public clients of procedures that should be taken. Most said “Let’s wait and see before incurring unnecessary costs given the economic climate.” The SOX audits loom over these businesses again this year and most are expecting another reprieve. Again we will reiterate last year’s notification of procedures that should be taken, and again we will probably wait on the enforcement ruling.

So will my Sarbanes-Oxley forecasts come true? I don’t know. But I do know that it’s absolutely critical for any publicly-owned business (or business that’s considering going IPO) to stay up to speed on the direction of SOX today and tomorrow.

About the Author: FinancialFutureCFO.com is a division of McPherson, CPA, PLLC and serves all 50 states. The firm provides an inexpensive alternative to hiring a full time person. All services offered are overseen by Scott McPherson, CPA, CFE, CVA. Visit http://www.financialfuturecfo.com/ for more information.

IRS Circular 230 Disclosure: Any tax advice in this communication is not written or intended by McPherson, CPA, PLLC to be used, and cannot be used, by a client, entity or other person for the purpose of avoiding penalties that may be imposed by the Internal Revenue Service.

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Leslie Pratch, Ph.D. is a clinical psychologist with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.

Today we have a guest blogger, a friend David Friedman (Yale School of Management and former partner at McKinsey & Company, who is deeply interested in creating trusting relationships.

If strangers want to collaborate together, they need to know something about each other and how to work together. It would be great if each person would make available the critical information that others need to see, in advance, whether a collaboration is likely to be useful and possible. And to see how best to get started.  Here’s a start on what could be critical:

1. My skills
2. My values
3. Things I am willing to take questions about
4. How best to contact me on different subjects, if you are a known acquaintance (or come referred by a close contact of mine)
5. How best to contact me on different subjects, if you are a stranger to me
6. The timeframe in which you can expect a response from me
7. What I am pursuing right now – in case you’d like to try to help me first on something I’m doing (which for most people would be a good way of getting me interested in helping you)
8. How much time and availability I usually make for new inquiries and projects, and whether now is a “usual time”
9. Key members of my social network (perhaps for business people something like my first circle of “LinkedIn” connections) – in case you know any of them. Then, if you happen to know any of them, you can contact them for an introduction (and raise your odds) or else contact them and find out what’s the best way to approach me and what to expect when you do (e.g., “If you send him an email and haven’t heard in two days, try again. He doesn’t mind being re-emailed”).
10. My style of working — perhaps using something like a Meyers-Briggs Type Index, or some other system that many people are familiar with

In fact, if these could be put into a standardized form like something like the Vcard, then they would be searchable. In his blog, Taylor Davidson has coined the phrase “personal API”; he means something different than I do, but I think the phrase captures well “a machine-readable publicly available version of how best to interact with me”.
Real life examples are hard to find. Here’s a non-machine readable example. It’s wonderful, although it might not encourage you to contact the owner of it, who is a professor of mathematics at UCLA.

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Leslie Pratch, Ph.D. is a clinical psychologist who trained at Northwestern Medical School with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.

David Friedman is a friend who describes himself as a consultant, educator and thinker who cares a lot about people and what happens to us. He is dedicated to creating high integrity individuals beginning with early childhood. He can be reached at  (312) 863-3489.

This week Ronald Grover, Tom Lowry and Michael White of Business Week report on Avatar, the phenomenon which is not just a movie, it’s a game-changer for the entertainment industry. By now we all know that Avatar has broken box office records: it’s the highest-grossing movie of all time. The movie to hold this title before was Titanic, another James Cameron film.

Business Week says “Cameron is the most important commercial force in modern film, and his vision for the future of the movie business is rapidly demolishing anything that gets in its way.” That sounds like quite a vision. But Cameron is the one who brought us Aliens, The Terminator, and The Abyss. Don’t underestimate him.

Not only is the sheer magnitude of revenue impressive, but how that bucket of cash was achieved is unprecedented. The movie business will never be the same. BW points out that Titanic hit $1 billion after a few months, and it took Avatar only 17 days to reach the same milestone. And no, inflation was not the cause. What did help is ticket prices 30% higher for 3D. Cameron said, “I decided, let’s make a movie they can’t ignore.”

In spite of Cameron’s past success with so many films, Twentieth Century Fox was not about to put all its eggs into Cameron’s basket. Not when Cameron was asking so much to begin with. James Cameron has been called not just a director, but also an entrepreneur. He developed the camera that would be indispensable to the film, using his own funds. Now with other movie makers lining up to use his technology – for a fee, of course – that was his first big success with Avatar.

3D technology existed before, but not quite at the scale of Avatar. This movie proved that people will pay more to see something great, and I predict we will be seeing more. Cameron started to develop the script back in the mid 1990’s, before Titanic hit the theaters. But in the 1990s, the technology did not exist, so the six-legged creatures and blue princess had to wait.

Cameron paid $12 million of his own money to hire Vincent Pace to work on the 3D technology. BW says that Hollywood wisdom is to “never sink your own money into a movie.” But, Cameron proved conventional wisdom wrong, and came out ahead. Fox would not foot the bill for Avatar even though Cameron had proved himself to be a sure thing. Not to be deterred, Cameron went to the private equity industry (see my previous post on Private Equity 101) and persuaded two firms to invest in his gargantuan project.

Cameron worked with Jeffrey Katzenberg of DreamWorks Animation. They created an animated world and put real human characters into the dream world. BW says that rivals in the entertainment world often root against each other, but Katzenberg was a big supporter of the project.

Cameron had to agree to cut his fee in half, cut other expenses and he took a lower percentage of the film’s revenues. Given the blockbuster success, I’m sure Cameron has made up for any financial considerations he had to give up in negotiations.

Production started at Cameron’s hangar in Playa Vista, CA and word soon got out. Other directors began visiting, to see the possibilities of 3D. It is important to note that not all movies benefit from 3D. BW uses the example of a Woody Allen film not being appropriate for 3D. Yikes – Woody Allen up close on the big screen? No thanks. Some things are best in 2D.

BW points out the risk of incurring the extra cost for 3D can pay off. Vincent Pace, Cameron’s technology guy, has a “steady stream of inquiries since Avatar was released.” If you want to make a 3D movie, he’s the guy. There has been interest expressed in 3D commercials and 3D TV sports broadcasts. Now that sounds worthwhile – your favorite sport, truly happening live in your living room.

Pace and Cameron hold the patents on the 3D technology. Of course, anyone smart enough to do what they did, would know to claim a piece of future revenues. Now theater owners are investing in the capability to show 3D movies. They want a piece of the pie, too.

In short, what Cameron has done has completely changed the nature of the business. He has showed that big budget films can pay off, developed the 3D technology that will be the “in thing” for a while, and has made sure that he will be at the top of Hollywood’s A list for years to come.

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Leslie Pratch, Ph.D. is a clinical psychologist with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.

Pamela Mearsheimer has an M.B.A. and an undergraduate degree from The University of Chicago. She is currently pursuing a CPA  via a program at Northwestern University. She is a financial Manager with experience helping small businesses and individuals get their financial house in order. Her specialty is financial analysis and reporting, business research, and consultation.

Jesse Westbrook of Business Week has a great analysis of what’s going on – or not going on – at the S.E.C. After the Bernie Madoff debacle, Mary Schapiro, chair of the S.E.C. was ready to crack down and show the backbone of the S.E.C. This was in contrast to the easier years of the S.E.C. under former chair Christopher Cox. And I’m sure we all wanted to see Mary jump on her horse, ride off after the bad guys, and come back with a whiff of smoke rising from her six-shooters. At the time she said “Investors are looking to the S.E.C. to assure the safekeeping of their assets. We cannot let them down.” But this has not happened yet.

At first, Schapiro proposed inspecting almost 10,000 money managers. Somehow this number was reduced to 1,600 in December. Not surprisingly, this change in project scope came after Schapiro met with many executives of fund companies.

BW reports that there were several proposals which sounded great at first, that were then scaled back or delayed . Hedge funds lobbied, and short-selling rules were delayed. Corporate Beard rules were also delayed. Schapiro claims that the S.E.C. is overworked, understaffed, and doing the best it can, which may be true. But why raise our expectations beforehand? The agency may be improving, but it still has a ways to go. Former S.E.C. chair Richard Breeden says, “You get zero points in history for what you propose…you get points for what you get over the goal line.”

Schapiro is an old hand at financial regulation, having started out at the Commodity Futures Trading Commission, and after different assignments at the S.E.C. and CFTC, ended up as CEO of FINRA, the Financial Industry Regulatory Authority. For those of you who read your brokerage statements, you should see the acronym “FINRA” somewhere on the statement. FINRA is a private organization which regulates brokerage firms and trading markets. In its own words, it is “the largest independent regulator for all securities firms doing business in the United States”. The unfortunate souls who invested with Bernie Madoff probably did not see the acronym “FINRA” on their monthly statements. So Schapiro was no slouch by the time she came to the SEC.

People who own stock receive those pesky proxy forms and annual meeting notices once a year. Most of the time, this doesn’t mean anything for the little investor, as the average guy on the street does not own nearly as much as either Warren Buffet or a large institution to actually make a difference. But Schapiro wanted to make it easier for shareholders to “wage proxy fights”. However, the U.S. Chamber of Commerce did not share her opinion and almost filed a lawsuit. Somehow this action – on both sides – was delayed until 2010.

Barney Frank, a politician himself, has noticed that Schapiro is under political pressure. He wanted the uptick rule reinstated, somehow this too is in limbo. Hmm… I’d like to see Schapiro get back on her horse and chase after the bad guys. After all, if the rest of us have to follow the rules, why not them? And if anyone can do it, Schapiro has the right background. However, don’t we all know about organizations which have grand plans, then fail to deliver? Wait and see… per my previous post, I wouldn’t bet much on regulation at this point.

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Leslie Pratch, Ph.D. is a clinical psychologist with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.

Pamela Mearsheimer has an M.B.A. and an undergraduate degree from The University of Chicago. She is currently pursuing a CPA  via a program at Northwestern University. She is a financial Manager with experience helping small businesses and individuals get their financial house in order. Her specialty is financial analysis and reporting, business research, and consultation.

This week the BusinessWeek cover story is about the attempts – or lack thereof – of reform and regulation of the financial markets. BW starts out by describing the media following Barney Frank in the wake of the 2008 financial crisis, as if the media is paparazzi and Frank is a celebrity. Why Barney Frank? He’s the chairman of the House Financial Services committee, which became a key player in the political process last year.

In the fall of 2008 and the disastrous first few months of 2009, public opinion was calling for the heads of the “fat cat” bankers and other ne’r do wells who toppled our 401ks, jobs and the monetary value of our homes. The time was ripe for reform. Frank’s potential power multiplied overnight. The Federal Government jumped in to help with the TARP , the nationalization of Fannie Mae and Freddie Mac and various other involvement.

BW points out that rescuing the system is not the same as reforming it.  When we had a crisis, there was a real chance for reform, and now the crisis has passed, the enthusiasm for making lasting changes has dissolved. Paul Volcker, former chairman of the Federal Reserve and chair of Obama’s Economic Recovery Advisory Board, says that bankers and regulators around the world “have not come anywhere close to responding with necessary vigor.”  Volcker wants the big banks to be split up into smaller banks, but in fact they have only gotten bigger.

The stock market rose by a tremendous amount in 2009. Good news or bad news? For those of us closely watching our 401k balances, we wonder how the news could be anything but good. But to fuel the regulatory fires, good news has a way of placating people so they no longer see the need to change the system. The modest sign of recovery in the economy have also served to dampen the urge to reform.  And now we have the health care bill, a major distraction.

What is really slowing down possible regulation is the New Democrat Coalition (NDC). What is this? A moderate group within the Democratic party, formed during the Clinton years. The Democrats believed they couldn’t win elections without a “strong moderate platform” The NDC has 68 “68 fiscally conservative, pro-business members” in the House of Representatives. Joseph Crowley of New York is the chair of the NDC and states that most of them come from business backgrounds. Crowley has even been on Air Force One with Obama – I’m sure that’s one flight he didn’t want to end.

The NDC has strong ties to Wall Street, both from Goldman Sachs, and from far less glamorous ( and lower-paying) jobs. Melissa Bean of Illinois, whom I have heard speak, received the most donations from the financial industry.

The Obama administration and the House Financial Services committee was itching to implement change last summer, but the NDC “pushed back” and let it be known that they would not let such legislation go through. Derivatives trading – remember that? – is a hot issue. As it stands now, derivatives are unregulated, and often traded in less than transparent markets. JP Morgan Chase, Goldman Sachs, and Bank of America earned more than $35 billion in the second quarter of 2009 trading unregulated derivative contracts. That’s a lot of clams, even for those big firms. So guess who wants to be Melissa Bean’s new best friend – you guessed it – the financial industry, to thwart regulation that would impede their sources of revenue.

Now banks have to report derivatives trades to regulators, but the trades themselves not regulated. Companies who use derivatives to hedge risk, such as airlines (fuel) energy companies and hedge funds are considered end-users of derivatives, as opposed to speculators, who use derivatives in search of profits. There will now be an end-user exemption in the new House Financial Services bill. But a representative from Cargill counters by saying that the amount of end-user derivatives will not make a significant impact.

Melissa Bean claims she “isn’t carrying water for Wall Street” as BW says, but it certainly  looks that way. The proposed Consumer Financial Protection Agency has been watered down as a result of Bean’s provisions. Barney Frank readily admits it is the “New Dems” who have lessened the regulation. Not surprisingly, he is not one of them.

The New Dems may have their fingers all over the House, but the senate seems to be still split. Clearly the Republicans will not want much in the way of regulation. Paul Miller, an analyst with investment bank FBR Capital Markets, says that “Wall Street is probably happy with the slowness of the process…because the slower the process, the more you can drag it out and water it down”.

At this point, it looks like we will get hardly any regulation at all. BW says the “onslaught” from the financial services industry on the legislators shows no signs of letting up. Which makes sense. From the perspective of Wall Street, why not take some of those profits, spend it on lobbyists, to ensure more profits in the future? There is an ad campaign called “no sleep”, about the worries of small business owners. But something about that seems wrong to me. Small businesses are generally not the ones using derivatives and requiring a lot of regulation.

Bonus season is coming up, and that will make a difference. Why? Much of the labor force is either unemployed, underemployed, or still in a bad economic way due to the great recession. Lawmakers have a vested interest in appeasing some of the negative public sentiments toward big business. Senators McCain and Cantwell would like to reinstate the Glass-Steagall act. This act was instituted in 1933 to separate the public-utility like function of commercial banking from the casino-like function of investment banking. I read a recent interview with Paul Volcker who is not convinced that bringing back Glass-Steagall will fix our problems now. But don’t forget, Volcker is in favor of using this opportunity for reform.

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Leslie Pratch, Ph.D. is a clinical psychologist with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.

Pamela Mearsheimer has an M.B.A. and an undergraduate degree from The University of Chicago. She is currently pursuing a CPA  via a program at Northwestern University. She is a financial Manager with experience helping small businesses and individuals get their financial house in order. Her specialty is financial analysis and reporting, business research, and consultation.

Business Week gives an end of the year recap of 2009. They start by asking, was it a good year or a bad year? Well…By most counts better than the disaster otherwise known as 2008, but nothing like the good times of 1999.  The S&P went up 23%, the Nasdaq went up 40%, but unemployment followed an upward trend also…up to 10.2%, and the budget deficit grew, like so many people’s waistlines. If your name is not Tiger Woods or Bernie Madoff, then 2009 was probably better than 2008. Even GM and Chrysler emerged from bankruptcy.

What did we miss? 2009 could have been a year for “real financial reform” in the words of Paul Barrett of BusinessWeek. Public opinion was strong enough to encourage politicians to enact real regulation, but not much happened. BW points out that 2008 was a “once-in-a-lifetime opening to overhaul the U.S. financial engine”. Well, we’ll have to wait for the next financial crisis. And – not to be dramatic – but back in the Great Depression in the 30s, it was only after the second fall in the economy that the new securities laws were passed.

President Obama, after a great 2008, showed us he is not as strong once he is in office. In fact, he seems like, dare I say – a politician! And so many people thought he was different. No, he’s like the rest of the men and women in office – beholden to the people who put him there, and subject to the political winds, wherever they blow. It almost seems like we caught him sweating as he gave one of his speeches. He has become more like our past presidents – not as effective in real life as he is in the idealized world of campaign speeches.

Do we really believe Lloyd Blankfein, CEO of Goldman Sachs, that he is doing “God’s work” ? Hmm… I’m the first to say that the world needs business services, but really, “God’s work”? Methinks he is taking the concept too far.

Did the bailout do enough, or was it too weak as described by Paul Krugman? We will never know for sure, but we do know things could have been worse. Then again, they could have been better. In January, Krugman wrote “this looks a lot like the beginning of a second Great Depression”.  As much as I don’t like the idea of handouts, we can look to Japan to see what happens when a federal bailout is too little, too late. Let’s do what we can to avoid another lost decade – the “aughts” are a decade we don’t want to repeat.

Let’s put AIG to sleep once and for all. It is still limping along on life support, after all those bailout funds were swallowed up. Do we really need to hear about that company again?

Too Big to Fail: this problem has only gotten worse. Look at the size of the Bank of America, for heaven’s sake. It was big to begin with, then it acquired Countryside. After a big burp from ingesting that meal it acquired Merrill Lynch. I have seen Ken Lewis, the beleaguered CEO looking angry so much of the time, I would recommend he take time off for health reasons. All that stress can’t be good for him.

If an institution is too big to fail, it is too big to guarantee, and our tax dollars have already been spent. Paul Volcker is a big proponent of chopping up the banks into smaller players, so that when one of them goes down – which does happen sometimes – the event is not cataclysmic. Remember when Microsoft was being hounded for antitrust actions? Why not the big banks? Especially because our tax dollars are at risk – and the pile of federal income is so much smaller than it used to be.

Regulate derivatives. However, at the risk of giving you a sneak peak at a future post, I can tell you it’s not going to happen, due to shrewd lobbying and swayed politicians.  We should all have listened to Brooksley Born a long time ago. Brooksley Born is a brilliant woman who recognized in the 90s what a problem derivatives could be if not regulated. Born is an attorney who was head of the Commodity Futures Trading Commission (CFTC) from 1996 – 1999. She warned Congress of the risks of derivatives, and ended up going against Alan Greenspan, Robert Rubin, Larry Summers and Arthur Levitt (of the SEC).  These big names all pooh-poohed her legitimate concerns, and look at the mess we are in now. The one bright spot is that this year, in 2009, she received a Profiles in Courage Award for standing up to the naysayers. However, instead of an award, it would have been better had they actually listed to her and acted. Think of what we could have avoided!

The next future problem is climate change derivatives. If something is not done to regulate these I predict we will see derivatives fraud redux within the next five years. Combining financial fraud and the environment will really bring out the demonstrators – stay tuned for that one! I’ve heard there were so many crazies at the recent Copenhagen conference, and they will be looking for something new to do soon. Even George Soros is wary of this development, and that should tell you something.

And while we are on the subject of the environment, let’s revisit Cap and Trade. Cap & Trade is a wonderful idea in theory, but will it work in practice? It requires a strong central agency, and who is that? One of my future posts has to do with the loopholes in Cap & Trade. How about simple mandates? One bright spot in the last century of the United States is the development of the EPA and the environmental movement. And believe it or not, the government has done a few positive things which has kept our beautiful country from becoming a big asphalt parking lot. Maybe a combination of Cap & trade and mandates will be the answer, I would also like to keep tabs on the situation in California, a state with amazing natural resources, a huge population that needs those resources, and no money in the state coffers to help out. I welcome comments from readers on this issue – there is no easy answer.

The U.S. economy is fundamentally different at the end of ’09 than it was in ’07. The U.S. Government has truly become big brother, and now big boss. Now that they own so many companies, will they hang onto them? Government Motors? We’ll see how this does – hard to imagine it can compete against Toyota. Have you seen the ads for Ally? Wonder where this bank came from, and why you never heard about them before? Ally is the bank that GMAC created in order to become eligible for TARP funds.

Neel Kashkari, who worked under Henry Paulson to administer the TARP funds, is one of the smartest guys of all. He left D.C., and took time off to live in an idyllic setting in the woods. He was able to breathe fresh air, get some exercise and relax. Maybe Ken Lewis should follow the same program. Kashkari now works for PIMCO with Mohamed El-Erian, another respectable sort who seems to have his head screwed on right and can deliver a return.

Sarbanes Oxley – what will happen to this? It went to the Supreme Court in 2009, and we will see what happens in 2010.

Tim Geithner – what a tough job. But, he’s not a Goldman Alum, like so many others. So that is good. I predict he will be out by the end of 2010. Too many people are looking for a scapegoat, and he’s an easy target.

Ben Bernanke – he’ll stay (and he deserves several Nobel Prizes for keeping the economy stable).

Vikram Pandit at Citicorp – not looking so good, but he did pay back the TARP funds.

Some version of a health care bill will be passed, but costs will stay high. After all, these bills are about health insurance, not health care. We are still stuck with the same fraud, waste and duplication in the system that we all pay for in our high premiums.

Our sympathies to Saturn and SAAB owners – may you always find someone to service your cars, long after the brands have been shut down. Cross your fingers – maybe with the dearth of those cars, they’ll rise in value, like antique cars. One can only hope.

That’s it for 2009! In spite of so many negative comments, we are looking forward to 2010 – who knows what will happen! And since we can’t predict the future, we might as well hope for a bright one, in the spirit of American optimism. Stay tuned, and we’ll keep writing about whatever happens in 2010.

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Leslie Pratch, Ph.D. is a clinical psychologist with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.

Pamela Mearsheimer has an M.B.A. and an undergraduate degree from The University of Chicago. She is currently pursuing a CPA  via a program at Northwestern University. She is a financial Manager with experience helping small businesses and individuals get their financial house in order. Her specialty is financial analysis and reporting, business research, and consultation.

This week Emily Thornton of Business Week reports on the new activity at KKR. You may remember them from a long time ago. For those of us who were reading the business news back in the 80s, we all remember the leveraged buyout of RJR Nabisco. That was the largest buyout transaction ever (at the time, and remained so for 17 years) and the subject of the book Barbarians at the Gate, by Bryan Burrough and John Helyar.  For those of you who were paying attention to something else back then, KKR is Kohlberg, Kravis and Roberts, a trio who emerged from Bear Stearns, back when it was a great company. Henry Kravis and George Roberts are cousins. They went to college together in California, and worked at Bear Stearns, along with Jerome Kohlberg. Kohlberg was the senior statesman of the group. He eventually went his own way, and Kravis and Roberts carried the baton for the next twenty plus years.

Fast forward to 2009, and KKR is a leader in the world of private equity. TPG, Blackstone, Carlyle, and others are the other big players, but KKR has been around the longest. Who would argue with success? It appears as though Henry Kravis would: He’d like to be more like Warren Buffet. BusinessWeek has a wonderful term for it: portfolio envy.

What do Warren Buffet and Berkshire Hathaway have that KKR might want? Berkshire Hathaway (BH) is a publicly traded company, and doesn’t have to go through the rounds of raising money to provide new capital for its investments. In the past KKR never had trouble, but the slowdown in 2007 made raising funds tougher for everyone. According to BusinessWeek, in the last two years 543 private-equity owned companies went bankrupt – ouch! That will slow returns, and all those institutions looking for a place to park their cash will be choosier in the future.

KKR will most likely be just fine and come out a winner on the other end, but being the bright people they are, they are using this slowdown opportunity to become a better player, ready to surge ahead when the economy turns around. For one thing, private equity has changed: it’s not just a world financed by debt anymore. For an explanation of private equity, see our previous post.

KKR now has a four-part plan which they divulged to BusinessWeek. The first part is an in-house investment bank to handle the underwriting, sales and other investment bank functions needed. Next, KKR is going public in the U.S. to have a ready source of investment cash.  The third part is to take a greater number of smaller investments in the form of minority stakes and joint ventures. The last part is new management techniques in their own company.

John Canning of Madison Dearborn Partners, a Chicago-based private firm, has also said that things are changing, and firms must change with the times. Will other buyout firms follow the lead of KKR? John Mack of Morgan Stanley, now a commercial bank, also predicts wider options different from the usual previous situations.

Blackstone and Fortress, two other private equity firms, went public in 2007. However, they had the misfortune of going public at the peak of the market, and now have to live with their reduced share price.  KKR – if it goes public now – will do so in a more favorable market, with an upward trend line.

How is KKR different from Berkshire Hathaway? The green gecko for one. BH is mostly an insurance company. And BH financed its acquisitions with equity, not debt, which matters over time.

KKR will encounter all the usual challenges when its takes the plunge into being publicly owned – compliance and scrutiny. But they must also satisfy the institutions who have invested with them and are looking for continued returns. BW points out KKR could lose focus on its main business. Six companies owned by KKR may have financial trouble.

Kravis and Roberts are handing over more authority to other managers within their company, which is appropriate given their long tenure at the firm.

KKR has been creating an in-house financial services firm, part one of their four part plan. It has taken an effort to get it going and sell the idea to the rest of KKR, but it seems to be taking flight now. Merrill Lynch, Lehman and Bear Stearns are now out of the picture, resulting in less competition, and in 2009, KKR was the lead underwriter for an IPO (of Dollar General) for the first time. The deal was shaky for a while, but due to 11th hour intervention, all ended well.

Warren Buffet apparently has no affection for the private equity industry. He says the industry piles on debt and burdens companies with fees. But KKR still wants to be like them. KKR wants to be public, so they can use their own stock to buy companies. Henry Kravis says, “ We’re not just a private equity firm…we’re an asset management firm.”

But the investors who come to KKR for outsize returns are just as capable of investing in ordinary mutual funds, and if KKR takes too many small positions, they start to look a lot like a mutual fund. A mutual fund with outsize fees, that is. KKR has experimented with taking an active role in Kodak, without owning it directly. They’ve done this through providing needed financing, receiving seats on the Kodak board, and a role in management. The Kodak stock price is still low; the jury is still out on that one.

KKR has expanded, making it vulnerable to the challenges of a big, lumbering company. With a former McKinsey consultant on board, they are implementing changes to try to avoid this. Rajat Gupta, the advisor, says “The vision is to develop a premier global institution for alternative investments”.  BW follows with “More than anything, Kravis and Roberts want to create a mature, meritocratic company that will long outlast them.”

This has all come a long way from the days of RJR Nabisco. Kudos to them for lasting so long, so successfully, and for being innovators in a ruthless field. BW closes with a great quote from Henry Kravis: “The days are long gone when you just buy a company and hope that financial engineering will work. Our job today is to create value. Private Equity to me, is thinking and acting like an industrialist.”

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Leslie Pratch, Ph.D. is a clinical psychologist with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.

Pamela Mearsheimer has an M.B.A. and an undergraduate degree from The University of Chicago. She is currently pursuing a CPA  via a program at Northwestern University. She is a financial Manager with experience helping small businesses and individuals get their financial house in order. Her specialty is financial analysis and reporting, business research, and consultation.

For those of you not familiar with private equity, here’s some background to help you understand the next post bout KKR.

Private Equity is essentially equity investments that are not publicly traded. Equity investments are stocks, which represent shares of ownership, and debt investments are bonds, which represent lending. Over the past 20-30 years, private equity companies have multiplied. Generally large institutions invest in private equity firms. Other investors may be accredited investors, which are high-net-worth individuals who meet certain requirements for participating in alternative, higher-risk investments.

Private equity firms raise funds and take the large investments to make equity placements in companies. Sometimes the placement is large enough so that the company is delisted, or taken off the public exchange and now privately owned either partially or in full by the private equity firm. Private equity firms usually prefer to take a majority stake so that they effectively own the company, and then put in their hand-picked management team.

Why invest in private equity? The institutions and accredited investors invest in private equity firms because they are looking for better returns than they can find elsewhere. They are sophisticated investors who understand the risks of alternative placements, and are under pressure to provide returns for their own investors. The institutions are usually pension funds, university endowments, insurance companies, banks and hedge funds to name a few.

Regulation D (Reg D) is an SEC regulation which means smaller privately owned companies can sell equity or debt on the private market without having to go through a public offering. Companies which sell securities must be either registered with the S.E.C. or meet an exemption, and Reg D is one of them. A company may avoid a public offering, also known as “going public,” because of the enormous cost, hassle, and ongoing compliance requirements of publicly- owned companies. You can read my earlier post on Sarbanes-Oxley to see that a lot of smaller publicly owned companies – and even the largest ones – are not happy with the ongoing requirements of Sarbanes-Oxley.

For our last question, why the growth of private equity since the 70s? As with most developments, changed regulation led to changes in the marketplace. In 1974, ERISA was passed. ERISA is a comprehensive law regulating employee benefit plans and retirement plans. ERISA allowed corporate pension funds to invest in more risky securities, thus creating a supply of funds for investing and a demand for returns. In 1981, the Reagan tax changes went into effect, which lowered the capital gains tax and created new demand for investing in securities. Late in the 80s things slowed in the private equity market with the fall of Drexel Burnham and the S&L debacle. But of course, everything picks up again, and so it did in the 90s.

The bursting of the internet bubble in 200-2001 ushered in a temporary slowdown . In 2002, deal making rose again. Activity in Europe loosened up, providing even more supply of funds for investing and greater demand for alternative investments. The trend over time has gone from short-term benefits to long-term. In the 2000s many private equity firms hold their companies, put in a management team and plan for the long-term. This takes us up to the credit crunch starting in 2007 which put the brakes on debt financing and brings us to the following post on KKR.

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Leslie Pratch, Ph.D. is a clinical psychologist with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.