Ballmer’s Gift: “Just The Facts, Maam”

By Rob McCreary

Few businessmen make outright gifts to the American people. John D. Rockefeller gave his estate in Maine to the National Parks to create what is now one of my favorite venues, Acadia National Park.  The views of the Atlantic Ocean from Rockefeller’s carriage roads are simply breathtaking and certainly worthy of a place on your bucket list. Recently, Steve Ballmer, former CEO of Microsoft, published the first ever Annual Report and 10K on American federal, state and local government. While he did not match the natural majesty of Rockefeller’s gift, in many ways his compendium of government information is possibly more valuable, coming at a time when no one knows the truth and powerful forces are attempting to bend reality to their own agenda.

Mr. Ballmer personally underwrote the project which took several years and more than $15 million. He explains the purpose of his Annual Report and 10K as follows:

“USA Facts is a new data-driven portrait of the American population, our government’s finances, and government’s impact on society. We are a non-partisan, not-for-profit civic initiative and have no political agenda or commercial motive. We provide this information as a free public service and are committed to maintaining and expanding it in the future.”

Interestingly, the New York Times’ Andrew Ross Sorkin really likes the project and for the first time in years I can provide a quote that is actually balanced:

“In an age of fake news and questions about how politicians and others manipulate data to fit their biases, Mr. Ballmer’s project may serve as a powerful antidote. Using his website,, a person could look up just about anything:  How much revenue do airports take in and spend? What percentage of overall tax revenue is paid by corporations? At the very least, it could settle a lot of bets made during public policy debates at the dinner table.”

When you read it, you will like it too. What struck me about the 162 page Annual Report for the year ended September 30,2014 was how we have improved as a country in only a few objective measures over the measurement periods. On a positive note, I was stunned to learn the average net worth of the bottom 20% of the US population was $86,000.

Like many of you, fake news has been making me anxious. I have stopped listening to all network news and am increasingly suspicious of iconic brands like The New York Times, The Washington Post and The Wall Street Journal. They broadcast in loud and urgent tones suggesting end of days mostly to promote only one way of thinking.  It is nice to read the government’s own facts and form your own opinion. Here are some examples comparing 2014 to 1980 unless otherwise indicated:

  • Persons in jail grew from 184,000 in 1980 to 1.6 million in 2014
  • Married Parents dropped from 40.6% to 29.4%
  • The poverty rate is about the same while aid to disadvantaged  is up 3.4x
  • Obesity increased from 16.8% to 29.8% of the population
  • Average household debt rose from $51,000 to $117,000
  • 6.5 million young adults (25-34yrs) live at home
  • Federal, state and local governments have a combined negative net worth of $5.3 trillion
  • Hate crimes based on race declined from 5,396 in 1996 to 2568 in 2014
  • Religious hate crimes were unchanged for the same period

I urge you all just to browse through this wonderful gift to America. It sure beats all the fake news on TV. It may lift your spirits (race relations) or depress you (governmental deficits) but for the first time in a long while you will be thinking for yourself.

Rob McCrearyBallmer’s Gift: “Just The Facts, Maam”

Bezos Rocked Me Like Muhammad Ali

By Rob McCreary

I have a great high school friend who knows how to motivate me. When I was editor of the high school newspaper he would always provoke me to write controversial editorials by posing the unanswerable question knowing, full well, I would be crazy to find an answer.

Fast forward to our respective retirement transitions and he is doing it again, but this time he is suggesting answers to tough questions. I guess that is maturity-his not mine. The letter he sent me was from Amazon’s 2016 Annual Report entitled “Jeff, what does Day 2 look like?”

If you like business and want to understand winning organizations, this is an insightful and inspiring message from Amazon’s CEO, Jeff Bezos. He gets business just like Warren Buffet gets the stock market.
Jeff answers his own question like this:

I’ve been reminding people that it’s Day 1 for a couple of decades. I work in an Amazon building named Day 1, and when I moved buildings, I took the name with me. I spend time thinking about this topic. Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death. And that is why it is always Day 1”… at Amazon

We all should be interested in the question of how you fend off Day 2? What are the techniques and tactics? How do you keep the vitality of Day 1, even inside a large organization?
Mr. Bezos recommends a “starter pack” of essentials for Day 1 defense:

• Customer obsession;
• Skeptical view of proxies;
• Eager adoption of external trends; and
• High Velocity decision making

Customer Obsession

“There are many advantages to a customer-centric approach, but here’s the big one: customers are always beautifully, wonderfully dissatisfied, even when they report being happy and business is great. Even when they don’t yet know it, customers want something better, and your desire to delight customers will drive you to invent on their behalf. No customer ever asked Amazon to create the Prime membership program, but it sure turns out they wanted it, and I could give you many such examples.”

Resist Proxies

This intrigued me, what does Mr. Bezos mean by proxies? He can’t be talking about those mind-numbing, single spaced documents I get from my broker? Not really. He suggests that taking comfort in process may be a proxy and can be“dangerous, subtle and very Day 2.” He suggests that market research and customer surveys can become proxies for customers:
I’m not against beta testing or surveys. But you, the product or service owner, must understand the customer, have a vision, and love the offering. Then, beta testing and research can help you find your blind spots. A remarkable customer experience starts with heart, intuition, curiosity, play, guts, taste. You won’t find any of it in a survey.

Embrace External Trends

Mr. Bezos says that spotting big trends is easy but they are hard to adopt. He points to machine learning and artificial intelligence as one such trend that affects Amazon. That Amazon beat Apple, Google, Microsoft and Samsung with Echo and Alexa is just like four successive Ali jabs followed by his signature uppercut. This is especially true for Google which is reputed to have a huge lead in voice recognition and artificial intelligence.

“At Amazon, we’ve been engaged in the practical application of machine learning for many years now. Some of this work is highly visible: our autonomous Prime Air delivery drones; the Amazon Go convenience store that uses machine vision to eliminate checkout lines; and Alexa, 1 our cloud-based AI assistant. (We still struggle to keep Echo in stock, despite our best efforts. A high-quality problem, but a problem. We’re working on it.)”

High Velocity Decisions

Mr. Bezos respects Day 2 competitors for making high quality decisions, but suggests they make them way too slowly. He sees the Day 1 culture as having four horsemen of innovation:

• Differentiate between reversible and irreversible decisions – so what if your wrong;
• Being slow is worse than being wrong – don’t wait for all the information;
• Disagree and commit; and
• Escalate misaligned viewpoints.

Check Out His Stock Price

Mr. Bezos closes his letter with an invitation to read his 1997 Letter to Shareholders. He believed then, as he clearly believes now, that taking the long view to profitability is the right business model. While Amazon is still chasing its first profitable year, it is clearly not being penalized by an unusual business model.

Rob McCrearyBezos Rocked Me Like Muhammad Ali

Kashkari and Dimon Debate Too Big To Fail

By Rob McCreary

I was inspired by another archived podcast I heard on Planet Money about former Goldman Sachs partner Neel Kashkari. As interim Assistant Secretary of the Treasury For Financial Stability, Mr. Kashkari is best known for overseeing the TARP program in 2008 and 2009 under his former boss, Hank Paulson. Mr. Kashkari is now President of the Minneapolis Federal Reserve. Neel grew up in Stow Ohio and attended Western Reserve Academy in Hudson. According to Wikipedia, Neel’s grades were not good enough to apply to top tier universities. He made up for that later by attending the Wharton School of the University of Pennsylvania.

We all owe Neel a debt of gratitude. He correctly surmised in 2008 that the US Banking system would fail if TARP funds were not administered to replace worthless residential mortgages (a gift from Barney Frank and Fannie Mae) with liquid treasury securities. He oversaw the process by which the banking system was recapitalized and determined which banks got relief and how much. He was close enough to the potential meltdown to understand the real pressure points of the banking system.

Kashkari and Dimon Disagree

Recently, Mr. Kashkari challenged Jamie Dimon about his assertion that “Too Big to Fail” restrictions were curtailing loan growth at JP Morgan Chase. While Mr. Dimon may be right about bank balance sheets improving under Dodd-Frank, he has a hard time explaining why he has used billions of bank capital for stock buybacks instead of loans. According to Charley Crowley and our friends at Boenning & Scattergood, a well-regarded investment banking firm serving the middle market financial services industry, there has been meaningful balance sheet progress under Dodd-Frank with tangible capital as a percentage of total assets moving from a low of 4.28% in 2008 to 8.50% in 2016. This is as high as I ever remember.

However, Mr. Crowley also sees an unintended consequence of Dodd-Frank being forced small bank consolidation. The little guys simply cannot meet the regulatory hurdles of a 22,000-page attempt to legislate good banking processes. Mr. Crowley explains it as follows:

“One unintended consequence of Dodd-Frank and other aspects of the regulatory pendulum swinging is that consolidation has been very active, and the too-big-to-fail issue has certainly not gone away. Twenty years ago, the top 10 banks controlled an aggregate of 23.6% of the nation’s deposits.  According to the most recent data, it is now 52.9%. Community banks (generally speaking) had virtually nothing to do with the financial and real estate crisis, and yet they have been paying a heavy toll in terms of increased regulatory costs and the presence of ever-stronger competitors.”

Kashkari- 70% Chance of Bank Failure This Century

Neel Kashkari is even more adamant about” Too Big to Fail”. In a recent interview on Fox, he told its viewers that the only way to insure bank safety and soundness is doubling the minimum equity capitalization of large banks. He confirms Mr. Crowley’s belief that a strong banking system is challenged by the consolidation of the smallest banks and the concentration of depositors. His bottom line is “Too Big To Fail” has not been solved. Mr. Kaskari initiated his message for an impressive story on Planet Money in its podcast on May 26, 2016. Mr. Kashkari claims he is not angling for Janet Yellen’s job, but each of his impassioned “Too Big To Fail” speeches have a familiar populist twang. He is channeling the same anger that pogoed Trump to the White House. With Neel’s rising popularity, can we expect Trump is going to dump Janet Yellen and bring in the son of immigrants and a fellow refugee from the fly over zone as the next chairman of the Federal Reserve?

Rob McCrearyKashkari and Dimon Debate Too Big To Fail

A Swing and Miss Business Model

By Rob McCreary

In 2001 and 2009 the investment world was introduced to Nicolas Taleb and his two blockbusters “Fooled By Randomness” and “The Black Swan”. Arguing that some investment styles only work in certain conditions and not to confuse skill with luck, the first book schooled investors to look at a manager’s process not just his results. The second book told the story of explorers in Australia discovering black swans when the prevailing wisdom was that all swans were white. Mr. Taleb introduced us to his investment theory of making small bets on rare and highly unlikely events which is exactly what he did before the correlated market meltdowns in 2008 and 2009. In many ways the venture capital business model is a mini-black swan strategy. VC firms make a series of small bets on emerging business models fully expecting to lose all their investment 70% of the time. Whether it is venture capital or black swan six sigma hedge strategies, the common elements of the business strategy are a multiplicity of bets with a low probability of success, low investment amounts and massively high payouts.

Did Blum Read The Black Swan?

I was really excited last week when I listened to Planet Money’s podcast about Jason Blum entitled “The Business Genius Behind Get Out”. Mr. Blum is a movie producer who has introduced a new business model to Hollywood:

  • produce an endless supply of really low budget films quickly
  • distribute the film only if it has a chance to sell $25 mil of tickets
  • leverage movie industry talent who will trade pay for equity

Take, for example, his first major success which is a horror movie called “Paranormal Activity”. According to Planet Money that movie cost $15,000 to produce but grossed more than $193 million at the box office and generated four sequels. Mr. Blum’s share is estimated to be in excess of $20 million! The really exciting part of the business model is Blum often syndicates risk. If he cannot afford Jennifer Lopez’ salary he will offer her equity. According to “The Hollywood Reporter” in an article by Kim Masters  Mr. Blum “has become as polarizing as he is prosperous” with many of his talented partners feeling unrewarded:

“While Blum has put films into production at lightning speed, there is disappointment from some who have worked on them for below-market prices. Many were well aware of Blum’s successes but also knew that he runs no-frills productions. What they found, at least in some cases, were work conditions worse than they had anticipated and, when the films went unreleased, no worthwhile credit. Still, Blum continues to attract directors — many veterans — with a promise of creative control. Blum takes pride in being straightforward with cast and crew: The productions are bare, the pay is low, and no movie is guaranteed a release.

Some Tape Measure Home Runs

There are some really great success stories. In addition to “Paranormal Activity” there are at least 6 movies where the multiple of invested capital is at least 25x. According to Ms. Masters these are some of the big winners:

“Paramount Studios, faced with increased pressure to cut bloat and release more profitable films, salivate over the three franchises Blum has launched in the past four years: Insidious (a $1.5 million price tag) grossed $97 million worldwide; Sinister ($3 million) grossed $77.7 million; and The Purge ($3 million) grossed $89.3 million.”

To Live With The Classes, Sell to the Masses

Most interesting for me, however, is Mr. Blum’s profits waterfall. According to “The Hollywood Reporter” many of the actors and technical talent who produce these low budget films take significant reductions in their normal compensation in return for big shares of the outlier profit returns. It appears that the intermediate returns (2-10x) are often shared with the director and actors. Of course, as a good self-promoter Mr. Blum gets 12.5% of the first dollar gross which is significantly greater than “even A -list producers get”.

Every venture capitalist in silicon valley would salivate at a 12.5% promoted interest on the first dollar of revenue. Every private equity manager I know would be perfectly happy with taking an outsized performance feature on intermediate returns rather than last dollar participation. What Mr. Blum has stumbled on is a highly scalable industry where profits from the masses intersect with an artistic community where production credit for a big hit may often be more important than making money. I immediately think of adjacent territories for music celebrities like Taylor Swift and fiction writers like J.K. Rowling (Harry Potter) and George Martin ( Game of Thrones). Possibly Jason Blum read page 28 of “The Black Swan”—which by the way was published the year he produced his first movie in 2007– where Dr. Taleb talks about scalable professions and identifies recording artists and movie actors: “You let the sound engineers and projectionists do the work; there is no need to show up at every performance in order to perform.” Before Jason Blum, however, the movie industry was locked into a paradigm where a movie’s worth was often tied to its cost as a weighty indicator of success. Notwithstanding great directors, famous actors and magnificent special effects, there were simply too may “Water Worlds” in Hollywood.

A Swing and Miss Model for the Ages?

Mr. Blum has hit a few Joey Gallo dingers in the last six months. First, he is projected to gross $200 million on “Split” which cost only $9million to produce (20x) and maybe as much as $175 million on “Get Out” which cost only $4.5 million to produce (30x). It has probably dawned on Mr. Blum that his business model will invite competition and the barriers to entry cannot be that high. In this case, the first mover advantage might land Jason Blum in the Forbes 500. And while he is obviously hitting a number of impressive home runs, he strikes out 5 times as much as most of the home run hitters in my fantasy baseball league and gets paid even more handsomely for failure than the best clean up hitters. Let me know if you see any more opportunities like this. I am all in.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

Rob McCrearyA Swing and Miss Business Model

Why Not Write an Investment Cookbook?

By Rob McCreary

My wife is a good cook. She claims it is all about following directions and has little to do with inspiration or special talents. While I doubt her modesty I do see her following closely the step by step recipes for dishes from Ina Garten, Giada DeLaurentiis, Mario Batali and James Beard that run from the mundane (roast chicken) to the exotic (Merguez). It is a miracle to me that these recipes produce superb food every time.

It made me wonder why there is not a definitive cookbook for investing like the “Good Housekeeping Guide To Asset Classes”? Maybe it is because investing is not like cooking? Maybe it is because the common ingredients are not available to all? Or, possibly, it is because the investment world is all about fee for service and there is little sharing of investment secrets?

Who Will Publish “Joy of Investing”

There are great investment books and articles. There are also letters to shareholders and investors. You occasionally get a glimpse of the mindset of the most successful hedge fund managers like Ray Dalio (Bridgewater Pure Alpha) and George Soros (Quantum Endowment Fund), Peter Lynch (One Up On Wall Street), Graham Dodd (Security Analysis), Seth Klarman (Margin of Safety) Lawrence Cunningham (The Essays of Warren Buffet), Robert Kiyosaki and Sharon Lechter (Rich Dad, Poor Dad), and Robert-J-Shiller (Irrational Exuberance). However, there are no cookbooks for how to invest in high yield securities or when to use mutual funds or ETFs to buy into a sector of the economy. I am still searching for the “Joy of Investing” which would be the investment equivalent to the only cookbook my mother owned (The Joy of Cooking). If you can prepare complex sauces and intricate desserts with step by step direction, why can’t you buy stocks, bonds, investment real estate, mutual funds and ETFs from a Cookbook?

Possibly the intersection of Artificial Intelligence (“AI”) and Supercomputing will provide my answer. If computing power can decode the human genome and beat chess champions consistently, it surely can help me decide what kind of corporate bond to buy? While the vocabulary of the bond world is off-putting to even the most sophisticated investor (duration, yield to worst, and inverted yield curve), I am sure there is a computer somewhere that can tell a 65-year-old with a net worth of $1.0 million comprised of a 401K plan of $250,000, a home worth $300,000, social security monthly benefits of $525 and dividends and interest of $25,000 per year what to do. AI makes it even easier because a computer can interact by voice in the customer interview. I think you may find many fewer high commission products like variable annuities and load mutual funds and more lower fee alternatives like the Vanguard family when “HAL” is doing the investing?

Shovel Ready Project

This would be a perfect public works project. It makes tons of sense rather than making stock brokers fiduciaries. It will actually liberate the retirement generation from the world of high fees for common investment advice. You also see some robo advisers emerging now from companies like Wealthfront and Betterment, but, in general, the world of investments is not like cooking. A hamburger from Wall Street is just going to be much more expensive than one from Michael Symon’s cookbook.

How About a Robo Advisor?

I was curious about the early days of the Robo Advising Business and defaulted to a source of unbiased financial news, and found it with Arrielle O’Shea from the NerdWallets. In an article published in January 2017, Ms. O’Shea looked at the leaders. She likes Betterment and Wealthfront. As expected there is a group of financial all-stars behind these products. Here is a summary of her product comparison:

Wealthfront is a key force in the online advisor industry, and offers competitive fees, free management of balances under $15,000 (with NerdWallet’s reader promotion) and one of the strongest tax-optimization services available from a robo-advisor. It’s also one of the only online advisors that have remained strictly a robo-advisor, with no human advice offering. The comparison to Betterment — which recently launched two plans that include interaction with human advisors, both with higher management fees and higher account balance requirements — hinges on what kind of advice you’re looking for and which type of account you have. Wealthfront is likely the best choice for taxable accounts and clients who don’t need or want human advisors.”

 Since I always follow my own investment recipe which includes the proscription for “playing with live ammo” I am going to sign up for Wealthfront. I want to see how the computer does against some of my high touch, high fee account managers and whether it can beat my own approach. I will report at a later date, but in a persistent low return environment where fees matter I am betting on the computers to be competitive.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

Rob McCrearyWhy Not Write an Investment Cookbook?

Despite Advantages, Family Offices Won’t Put Us Out of Business

By Rob McCreary

The Wall Street Journal recently focused on the rise of family offices as significant disrupters of the private equity model. In an interesting article by Anupreeta Das and Juliet Chung entitled “New Force on Wall Street: The Family Office” the authors confirm a trend we have been seeing for the last 10 years. Increasingly, wealthy families are collaborating for advantage. That advantage may be direct investments where fees and carried interest are side stepped completely or it may take a form of uncompensated side car investments where the important family uses its networks, wealth and access to assist private equity sponsors. In return for the extra help, these families are often allowed to invest in “friends and family” vehicles or directly into a specific portfolio company without paying management fees or carried interest. As Ms. Das and Chung observed:

“Wealthy families have always found ways to protect and build their money, and the savvier among them have pursued their own business deals, from acquiring farmland to seeding hedge funds to buying companies. Today their ranks are ballooning, and many, put off by the high fees and sometimes weak performances of Wall Street money managers, are shifting to investments they can pursue directly through family offices.”

In October 2014 I wrote a blog entitled “Family Offices Are a Protected Species” about another advantage a family office has; exemption from SEC registration.  As you may recall Dodd Frank requires private equity firms and hedge funds with more than $150 million under management to register with the SEC. This almost always triggers an audit where manager compensation, cybersecurity, valuation of portfolio companies, record keeping practices, governance and self-dealing are scrutinized. The same registration burden, however, does not apply to family offices with a common ancestor even if they hire internal managers who are paid performance compensation. As long as the managers do not own and control the fund they are managing, they can be incented with performance compensation. I guess the logic is that a single investor family office is sophisticated enough to fend for itself and, more importantly, no ERISA governed assets are at risk.

The scale of these disrupters is what caught my attention.  According to the authors, the family assets rival the managed wealth within the entire PE asset class:

“Research shows family offices hold assets of more than $4 trillion. That approaches the cumulative $5.7 trillion of private-equity firms and hedge funds, as estimated by data provider Preqin, though there is overlap because family offices sometimes invest in private-equity and hedge funds.”

Secrecy May Be the Biggest Advantage

The authors also note a big advantage family offices bring to the investment world – SECRECY. Many private or public company management teams do not want the world to know who owns them or if; in fact, there has been a change in ownership at all. In addition, we have seen that certain families like the Koch Brothers have become political targets for their activism. Secrecy about where they are investing removes one less possible objection. It also helps disguise investment themes or strategies. I have always believed that the Wizard of Omaha, Warren Buffet, often shares investment wisdom when he is conditioning the market. For example, he’s often quite bullish on investments like U.S. Air and Salomon Brothers while he is an owner but more whimsical once he has exited.

Family Offices Are Not a Real Threat

However, even with these advantages, the family office has yet to dominate private equity. There may be five big reasons:

  1. Taxation of carried interest
  2. Career path for younger employees
  3. Total compensation
  4. Lack of owner urgency
  5. Alignment for portfolio company managers and rollover owners

No Carry

On the first point it is typically hard to compensate family office managers with anything other than phantom equity because a good company may be owned for multiple generations. Without an exit to set value and create a capital transaction the inside manager may settle for the equivalent of stock appreciation rights. Typically, this phantom equity is treated as ordinary income.

Lateral Employment

On the second point, the family office will never provide the same lateral employment opportunity as a private equity firm in a city with a vibrant practice. For example, Cleveland has a robust PE community where the breakup of a PE firm can lead to multiple new entrants with opportunity to own their own management company, raise capital and recruit managers who are blocked at other firms. That entrepreneurial pull is strong.

Total Compensation

The third disadvantage is total compensation. If the family is supplying the capital, the managers may command a much smaller share of the upside.


The fourth disadvantage is urgency. In the PE model in order to raise successive funds you must demonstrate an ability to realize returns in all markets. This means deploying capital, growing companies and having successful exits in all markets. Many PE firms have proven they can repeat the formula over 50 years and as many as 9-10 funds. The family office already has uber wealth and often does not have to deploy capital for self-preservation.

No Second Bite

While a family office can offer immortality for a patriarchal business and continuing employment for loyal employees, it struggles to provide long term gain opportunities for management that has not had a “pay day” as well as owners who want a “second bite” of the apple. The alignment of managers and former owners is a powerful inducement as well as an important risk mitigant that you are buying a business that is running out of gas.

In short, I really don’t know any PE managers who would quit their job to work for a family office. Until that happens the private equity firms will win the recruitment war.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC
March 22, 2017

Rob McCrearyDespite Advantages, Family Offices Won’t Put Us Out of Business

$30 Trillion of Debt Doesn’t Worry Anyone

By Rob McCreary

Every year the US Government releases its Annual Report to its citizens. It is always interesting to see where we stand. Chart 4 below shows a 2016 balance sheet for the U.S. government. The assets are $3.4 trillion comprised mostly of student loans. The liabilities are $22.75 trillion comprised of two thirds federal debt (principal and accrued interest) and one third federal employee and veterans’ benefits. If I were Secretary of Treasury, Jacob Lew, I might have discounted that student loan asset inasmuch as most of that receivable is either in arrears or non-performing. I also wonder why the government does not treat Medicare, Medicaid and Social Security Benefits as a debt net of the corresponding trust fund asset. The explanation is that $5.5 trillion trust fund liabilities are off the “big balance sheet” because they are offset by assets on Agency balance sheets. I guess they wash which means that all these programs are fully funded?  In fact, agency debt is de facto guaranteed by the taxpayers.  So I don’t understand why they don’t just consolidate into the US balance sheet and round it up to $30 trillion?

When Will We See Profits from Operations

The U.S. Balance Sheet might be a little frightening but the trend line for receipts and disbursements should induce panic. The chart below is a little hard to interpret, but I can help. I have been looking at this report long enough that I actually get it now. The BLACK LINE is total receipts. The Color Bars add up to total non interest spending on categories like defense, Social Security, Medicare and Medicaid. The blue line is historical and projected total spending (which includes interest) from 1980 to 2090.  In a sleight of color, Mr. Lew shows the real problem in white hoping that it will be ignored.

Prior to the crash of 2008, receipts and non interest spending were pretty closely matched with a wonderful period prior to the dot com crash where receipts even exceeded total spending including interest! During the last 8 years receipts plunged and non interest spending hemorrhaged, Thank goodness we have the world’s reserve currency and were able to control interest costs. Of course, we see a projection that by 2020 we will be back in balance with no primary deficit.

If one of our managers gave us this kind of rosy projection, we might ask to see the historical trend line supporting that wonderful future and we might also ask what is the interest rate assumption underlying the growth in net interest expense.

 Look At the Net Operating Deficit

As shown below the government managers want us to believe they were on the right path for a believable turnaround until last year. The budget deficit fell from $1.089 trillion in 2012 to $438 billion in 2015. In 2016, however, the budget deficit spiked to $587 billion on the back of a 50% increase in net operating costs. In another interesting sleight of color, Mr. Lew portrays the budget deficit in red and the net operating deficit in white. In fact, the budgeting process for this management team is worthless and we as owners should just look at the net operating deficit. Our managers have overspent their income in every year since 2012 and they doubled the loss from 2015 to 2016. Since 2012 they have cumulative net operating losses of $4.45 trillion. So why would we believe anything in the projection from this management team about the future primary deficit and return to normalcy by 2020.

Interest Is Toxic

An even more important question is the cost of debt. Every year I look for the assumptions underlying the projected cost of capital and cannot find the assumption. This is a really important variable especially in a rising rate environment where the cost of funding accrued interest will keep rising. If we ever return to a 1980 environment where the cost of 10 year government debt was  close to 20%, our creditors will basically own America.

Why Don’t We Care?

When I talk to even the most sophisticated financial people about this debt trap I get a lot of eye rolling and yawns. It dawned on me that no one cares. Is it the law of large numbers? Is it a “kick the can down the road?” Is it confidence in our ability to reschedule the debt because the U.S. Dollar is the reserve currency? Is it because the politicians plan on swapping the Grand Canyon for Chinese debt? Or is it because we are all hooked on this heroin masquerading as legitimate finance? Maybe it is an intellectual recognition that $30 Trillion of debt is a problem – BUT NOT MY PROBLEM.

My finance teachers always taught there are only 3 things you can do with debt, default on it, render it worthless by printing money or hyper-inflating or rescheduling it. There is one thing for sure that distinguishes governments from its citizens, they will never pay it back!!!!

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

March 7, 2017

Rob McCreary$30 Trillion of Debt Doesn’t Worry Anyone

An Obituary for Democracy and Capitalism

By Rob McCreary

The Economist has an interesting journalistic twist. Several of its opinion columns like Schumpeter, Buttonwood and Bagehot are named for inflexion point economists, political theorists or iconic events. For example, Schumpeter is named for Joseph Schumpeter who published a 1942 best-seller called “Capitalism, Socialism and Democracy”. Mr. Schumpeter was not bullish on the capitalist model preferring the socialist model advocated by Karl Marx. He saw the end of capitalism coming when the intellectual class overpowered the “creative destruction” of entrepreneurs and capital risk takers. Buttonwood is a column that explores the dynamics of financial markets. It is named for the buttonwood tree on Wall Street where brokerage activity was once conducted. Bagehot is named for the man who was the editor of The Economist from 1861 to 1877 and it explores politics in Britain. In all three cases the reigning journalist is anonymous.

I normally don’t pay any attention to Schumpeter or Bagehot and often just surf through Buttonwood but the December 24, 2016 copy of The Economist drew me to the Schumpeter column because its anonymous author had announced he was delivering his last thoughts as Schumpeter.  He would be reincarnated as Bagehot in April. Figuring his last would be his best, I read with interest a pretty gloomy outlook for capitalism and democracy. The Economist must agree because they announced that “the Schumpeter column will return in 2017 with a new (and possibly more optimistic) author”. So here are the cliff notes in the form of excerpts from the column and the thesis for his sour outlook.

Schumpeter’s Doom Loop

  • “His biggest worry (the real Schumpeter) was that capitalism was producing its own gravediggers in the form of anti-capitalist intelligentsia. Today, that very elite, snug in Los Angeles canyons and University departments, has expanded… The liberal sort of academic (meaning the type that favors big government) far outnumbers the conservative kind by five to one according to one recent study.”
  • Government, regulations and big business are all growing and they force out entrepreneurs by creating “red tape” that favors incumbent big bureaucracies.
  • Business is now owned by institutions who hire safe managers “whose chief aim is to search for safe returns, not risky opportunities.”
  • Democracy is becoming more dysfunctional and endlessly content to allow governments to overspend their means.
  • Populism is ascendant “As economic stagnation breeds populism, so excessive regard for the popular will reinforce stagnation.”

I can find great examples of each of these elements that Schumpeter sees as creating a death spiral: “The result of this toxic brew is a wave of populism that is rapidly destroying the foundations of the post-war international order and producing a far more unstable world.” Without suggesting any remedy The Economist then signs off. “These comforting thoughts are the last this columnist will offer you as Schumpeter.”

Smart, Compelling, But Anonymous

This guy is pretty smart and maybe he should not retire to write about Brexit. He is right about the smug elites, big bureaucracies, safe managers, dysfunctional politics and Trumpeteers. They are indeed a toxic brew and Trump is proving badly matched to more polished opponents. The more he blusters and attacks the more he creates uncertainty and polarization. That leads to status quo. While it is exciting to think the populist agenda can rally change, the new regime is quickly discovering that kind of dramatic, entrepreneurial, and permanent reordering may be stymied by incumbents that will deflect and distract; as Peggy Noonan has recited in her weekly column on Friday February 17, 2016 “a government within the government that hates the elected government”.

The two forces that may be able to break the doom loop are external threats/war and unbridled prosperity. These forces rarely co-exist. The stock market is signaling great confidence in the latter while North Korea, Iran and Russia are tilting the answer towards the former. In any event I simply can’t respect a genius journalist like Schumpeter who anonymously describes the American future as a toilet bowl and then quits his janitorial job to report on an even larger looming vortex in Britain.

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

February 23, 2017

Rob McCrearyAn Obituary for Democracy and Capitalism

Why Do You Want Your Fridge To Be Smart?

By Rob McCreary

In a nation of chronically obese and out of shape citizens why does anyone want a smart refrigerator? Based on my superficial and uneducated experience with other smart devices like cellphones, autos, iPads, computers, and Fitbits I have formed an opinion that smart devices are way too needy.

Take the iPhone; I get a notice every day that my phone cannot be backed up in the cloud because I don’t have enough storage room in the cloud. What does that mean? I have tons of excess capacity on my iPhone because I have never been any good at taking pictures and because transferring my music library is hard. I don’t have any videos on my phone either. This supposedly smart device is smart enough to know that if you send me Message #1 “You know your iPhone has not been backed up since 2011” I will freak out and sign up for cloud storage at the cost of $1.00 per month. The only reason I have not done that yet is because I also get Message #2 that says I can back up my phone by entering my password, locking the phone and having it tied to a power source after 10pm. This smart phone understands that I have been dutifully trying to back up my phone via Message #2 without success and that Message #1 ( a revenue producer for Apple) will finally get me to sign up for a cloud subscription.

It is pretty ironic that I have enough storage capacity on my iPhone to download the Library of Congress but no storage in my cloud. Speaking of my cloud, I guess every device will have its own cloud so I should expect a message soon from Subaru or Fitbit that I have not backed up my info on their cloud? Why would I want to save info about the times I was slacking at the gym or speeding in my car? Why do I want a smart device at all?

Get Ready For National Food Lockdown

This is certainly true for refrigerators. Why do you want your celery and carrots to have equal rights with ice cream and bagels? I can envision the optimal diet getting downloaded into my fridge and facing a denial of service because I have 3 bags of Arugula wilting in the crisper drawer when I have exceeded my daily dose of red meat for 8 months in a row. How about the fridge that takes your vital signs and BMI (body mass index) when you grab the handle? America would be on immediate food lock down as smart refrigerators across the nation sensed a six sigma event. Everyone’s BMI would be at least 6 standard deviations worse than the norm. Getting a smart device that has any influence over your daily intake of food would be horrible.

Even worse would be the smart wine cooler or a smart beer fridge. As my son-in-law admitted when I got him a 2 year gift subscription to Wine Spectator, “I am certainly better at consuming than spectating”. Your little secrets about daily consumption would certainly end up in the cloud where they would be hacked or, more likely, transported to your children who are monitoring your intake and plotting an intervention. Pretty soon your family physician would know that “two drinks a day” really means polishing off several cases of beer and a few bottle of wine each week.

Graduating To a Nest

Just imagine when your cloud is so full you need a “nest” so the internet of things enables your smart devices to all talk to each other in the cloud. The human profile that emerges would be so frightening you probably would go off the grid and never return. The car tells the cloud that you exceeded the speed limit all day while also exceeding the allowed decibel levels on your car speakers because you kept replaying AC/DC songs  which in turn alerts your wife, children and doctor that you are probably going deaf and have a “failure to launch” problem. The fridge gives everyone your vital signs and a chart showing wintertime consumption of Ben and Jerry’s Chubby Hubby. The Fitbit doesn’t tell the cloud anything because you are not working out and your BMI is 45 and your blood pressure is 159 over 98, and your pulse is 95. Your car won’t start because the nest signals you are about to die. No more trips to the wine store even though both the beer and wine are gone. While the cloud might register that you have given up beer and wine, you have actually graduated to Jose Cuervo. You can’t eat because of fridge lockdown and the car won’t start. You have a bad profile with UBER from the nest. Meanwhile you are longing for that blissful anonymity before you migrated to the cloud for $1.00 a month just to get rid of those annoying messages from Apple. The Stones saw this coming in 1967 when they composed Get off My Cloud:

“Hey! You! Get off my cloud

Don’t hang around ‘cause two’s a crowd

on my cloud, baby”

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

February 2, 2017

Rob McCrearyWhy Do You Want Your Fridge To Be Smart?

Don’t Let Your Business Get IPA’ed

By Rob McCreary

With a title like this you are probably thinking PE4Fams committed the cardinal sin of good journalism, a typo in the headline. Not so fast my proofreading friends, this blog is about disruptive technologies and the pervasive onslaught of India Pale Ales.

The Economist Editorial staff produced a really interesting history of IPA’s in its Dec 24, 2016 Double Holiday Issue: “A child of Britain’s industrial revolution and imperial expansion that rose to world-straddling greatness, IPA went on to be humbled by its upstart rival, lager. It had all but banished when plucky supporters restored it to life and once more put the world at its feet. Here is beer with a back story.”

I immediately thought about analogous banishments like suspenders, bell bottoms, and fondue pots but realized that these fashion and lifestyle faux pas could never have the rebound potential or manifest destiny of a product as seductive as India Pale Ale. How could an almost dormant taste morph into ales with seductive names like “Blind Pig”, “Hop, Drop and Roll”, a “Whiter Shade of Pale”, “Modus Hoperandi”,  “Effinguud” (phonetic) and “Kilt Lifter”? How can any 21st century discerning beer drinker go for monosyllabic offerings like Bud, Coors, Lite, and Pabst?  Maybe the mystery of a “PBR” offering should compete with the promise of “Elysian Space Dust”, “Hoppy Ending” or “Beard of Zeus”, but the competition stops when the alcohol content exceeds 8% and a double or triple IPA is named “Alimony Ale” with a tag line “The bitterest brew in town”

The Economist is right, however, about the back story. IPA monopolized the beer industry in the 18th century on the back of Britain’s Hogdon’s Bow Brewery and the miracle of coke fired ovens that imparted a pale and more consistent product which began to compete with darker porters and stouts. The heavy, bitter hops counteracted the sweeter malt and preserved flavor and punch over the long voyages to India where it became the tipple of the British Army in India. Hogdon’s monopoly based on generous credit terms to ship owners for promoting the brand eventually gave way to well-known British competitors like Bass, Worthington, Tennets and Charrington. As The Economist explains: “As IPA conquered taste buds in India it spread across the world turning up in America, Australia and Southeast Asia…Bass’s Ale (in style, an IPA) made it Britain’s biggest brewery and its red triangle logo appeared around the world- some call it the world’s first global brand.”

Like all monopolies, though, the dominant brands caught the attention of politicians who believed it was fair to impose an excise tax on strong alcohol content which was IPA’s hallmark. World War I also led to the commandeering of grains that supported the brews. The rout of IPA was so severe that the leading breweries in England were mothballed.  Taxes, war, prohibition in the U.S. and the growth of mixed drinks all conspired to end IPA hegemony.

For those of us who are baby boomers, the brands of our youth were national lagers like Budweiser, Miller and local brands like Stroh’s and Carling. With time, the dominant national brands in the U.S. began to consolidate all of the capital intensive, limited distribution local brands. New techniques for preserving quality brews and the onslaught of grocery stores and regional distribution all favored hub and spoke manufacturing and distribution models. The beer wars increasingly were won by publicly traded, well capitalized, marketing savvy national and international brands. Local beers, like Stroh’s and Carling, feeling the press of extinction, surrendered quicker than the France facing a Panzer division. Eventually, even Augie Busch sold out to In Bev. But just about the same moment I was burning my bell bottoms, hiding my suspenders and jettisoning Gordon Gecko hair gel, craft brewing began a quiet comeback.

Today when I travel, I routinely ask every bartender and waitress whether they serve a local IPA. Places like Mt Airy Virginia (Hoptimization”), Damariscotta Maine  (“Farmhouse” by Oxbow), Hartford Connecticut (“From The Ashes”), Springfield Missouri (“Gravel Bar”), Ft Wayne Indiana (“Funky Wild Ryed”)and Dayton Ohio (No brewery for 50 years – “Double or Nothing”) all have a local favorite and sometimes two or three. Cleveland now has three or four thriving local breweries with fantastic offerings. As The Economist also points out there is a subculture of inclusion that is driving these flavorful favorites. There are local hops growers, the second best “off the grid” cash crop that make the local hops in Mt Airy a little like terroir in Napa. There is an immediate camaraderie around eliciting local pride for their local favorites. You are united by hops in a way that national lite beers simply cannot. If you had to choose between being skinny or drinking IPA which would you choose? Effinguud (phonetic) or Hop, Drop and Roll?”

The business model implications for oligopolists like Miller and In Bev are frightening. The local barriers to entry for craft beers are low and often powered by hobbyists. Local pride and word of mouth provide free marketing. The cool factor fuels the craze and makes the brands travel. Most perverse is any craft brand that succeeds on a national scale has to be bought. So oligops pay twice for national insurgents like Lagunitas, once when Lagunitas takes your market share in bars and specialty stores and again when you have to buy them out at 12x to regain share and remove competition.  After In Bev has brought you into its family, it is really not cool any more to drink their brand. This happened to Sam Adams after it was sold to In Bev. Lagunitas makes great beer buy the suggestive pleasure of Hoppy Ending will always be worth a shot.

Remembering Porter’s five forces- barriers to entry must be sustainable. When an old world product that used to be a monopoly based on taste and punch is resurrected in an era of low capitalization, high quality craft brewing, watch the oligopolies fall. Can you think of one or two more business models that might be disrupted? How about print and television media? How about book publishing? How about Department Stores and Big Box retail?

Your Insights Are Welcome

Periodically we will circulate this blog to a target market that includes successful families, wealth advisors and middle market business owners.

Please send us emails, articles, YouTube videos, tweets or even old-fashioned means of communication like voicemail’s, mail or a phone call on the topic of Private Equity For Families. All ideas are welcome.

Rob McCreary, Chairman
CapitalWorks, LLC

January 26, 2017

Rob McCrearyDon’t Let Your Business Get IPA’ed