Sunday, March 12, 2023

Monoculture and Silicon Valley Bank

Diversify, Diversify, Diversify!

I was reading an article online many years ago about the Irish Potato Famine.  There was a blight on the Potatoes and people starved to death as a result.  Also as a result, many of my ancestors boarded the Titanic and came to America - which is why we celebrate St. Patrick's day the way we do, drinking green beer and affecting very badly done Irish accents.

But why did the potato blight cause so much suffering?  Well, in part because it was the primary crop - perhaps the only crop - that many farmers planted.  The article I read posited that the problem with potatoes was that they were too easy to grow. I am not sure that is true, but it is what they claimed.  You thew a few potato eyes in the ground and then went down to the pub, drank a few Guinness, recited some maudlin poetry you wrote, get into a fistfight, go home and beat the wife, and procreate a dozen children - and all the other bad Irish stereotypes.  At the end of season, you dug up potatoes, and that was enough to live on for another year.  Crops like wheat took effort as you had to plow fields, weed, then mow the wheat down, bail it, separate the wheat from the chaff, grind it into flour, and then bake it into bread.  Effort!

I am not sure if that story is true, or just another example of prejudicial Irish stereotypes and slurs against my people.  But the point is, the farming there was a monoculture and thus very susceptible to anything, such as a blight, fungus, insect, or bad weather, that would affect that one crop.  Once that one crop was destroyed, the entire economy collapsed.

The same effect has occurred at other times in history.  The Bo Weevil wiped out cotton crops in an era where "Cotton was King!"   And today, well, we are planting corn like mad - a crop that uses a lot of water and a lot of nutrients.  The way we plant it is also problematic - using genetically engineered strains that increase yield and are immune to certain engineered pesticides.  The farmer soaks the field in these pesticides and it kills every damn living thing - except this special kind of corn.  If something comes along that kills this type of corn, a lot of farmers are in trouble - along with the rest of us.

It is tempting, when one crop is so profitable, to grow nothing but.  It is temping when one kind of investment is so profitable to invest in nothing but.  But if you invest in all-one-thing, you are in a heap of trouble when that one-thing goes bust, or even goes down just a bit.

A reader writes asking me what I thought about the SVB (Silicon Valley Bank) collapse.  The reader has invested in a number of college apartment rentals which are quite profitable, provided you manage the properties yourself and not rely on a management company.   I thought it was a bit ironic that the two were related, as they both represent a form of monoculture.

SVB, like a lot of specialty banks, went belly-up because they were invested in all-one-thing.  They specialized in financing and banking for Silicon Valley startups as well as venture capitalists.  If that industry - the "tech-that-is-not-tech" - goes bust, well, you've got nothing else to work with.

Back in the day, companies often formed conglomerates.  A company that made canning jars, for example, would also make communications satellites.  In the 1960's, this was not unusual - companies would comprise a plethora of divisions making all sorts of different products, often totally unrelated to one another.  When one business boomed, another was bust, but they overall cycle was such that the conglomerate made money consistently.

In the 1980's, this started to unwind.  Corporate takeovers were funded by debt taken on by the corporation.  It was akin to someone buying your house and asking you to take out a mortgage for them.  But one way these "corporate raiders" succeeded was by spinning-off divisions that were less profitable (at the time) and using the proceeds to pay off the mountain of debt pay themselves huge salaries and buy-back stock so they made million on their stock options.  When you dump a less profitable (or money-losing) division, the remaining company looks more profitable on paper even if the profit picture remains largely the same. Of course, this was not limited to corporate takeovers - even profitable corporations started playing this game.

So General Motors shed off minor divisions such as Frigidaire (which made some of the first trunk-mounted air conditioning units for cars in the 1950's before Delco replaced them with an under-the-hood solution) and Terex and Electromotive - as well as a plethora of parts suppliers including Delco as well.  GM went further into monoculture as the years went by, cutting product lines and closing factories until today, they make only SUVs and pickup trucks, for the most part.  They just have to keep hoping these vehicles never fall out of favor as they did in 2008 when gas shot up in price.

Of course, the biggest form of monoculture is mankind itself. Every day, it seems, another species is driven to extinction in what some biologists are calling a major extinction event.  Humankind is pushing the rest of the animal kingdom off the map to make room for more humankind.  Many on the far-right decry these newfangled forms of vegetarian or lab-grown meat, but if you think about it, it is the inevitable result of our increasing population on Earth and the trend to bulldozing more and more farmland to make room for housing for more and more mankind.  This is a predictable trend, not some aberration.  And yet, many on the far-right posit that the solution to our "problems" is to have larger and larger families, so there will be even more mouths to feed.  Go forth and multiply - indefinitely.

Our reader has his investments in a monoculture in that he is mostly invested in real estate.  Provided there is no downturn in that business, he will do well.  And being situated near a major university (located between two major metropolitan areas) it doesn't seem like he would be at much risk.  But others in a similar situation might be more vulnerable.

Small liberal arts and "historically black" colleges are going bust right and left as college enrollment drops, due to demographics as well as some young people failing to see the value in mortgaging their life for four years of partying.  These smaller schools are located in small towns which sometimes, like the old Mill Towns of New England, are largely dependent on these schools for a major part of their economic survival.  The college closes and that means that dozens of professors and administrators will be putting their houses on the market at once. College students disappear, which means the guy who rents apartments to them now is bust.  The local cafe and pub might not survive without the steady traffic from college students.  The town will have to find some other business or reason for existence.

In some cases, it makes little difference.  In my old hometown, the small women's college is going bust.  But the impact will probably be easily absorbed, as the town is a bedroom community for nearby Syracuse.  For other small towns, the impact may be more dramatic.  Wells College in Aurora, New York (the other Aurora, not the one near Buffalo) was saved by Pleasant Rowland, founder of the American Girl line of dolls.  If not for her rescue, the small village may have been decimated - the College owned and operated at least 50% of the land there, and other than a small hotel and pub, there wouldn't be much else left, other than a few locals.  More than half the economy there was college-related.

Of course, it is hard to avoid monoculture, either in planting crops or investments.  We all seek out the highest rates of return, whether it is in farming or investing, or whatever.  The farmer who hedges his bets by planting a plethora of crops might miss out when the price of corn skyrockets.  And given all the ethanol subsidies, it is no wonder corn is now king in the Midwest.  Similarly, people see giant gains in some tech stocks or gold or "crypto" and figure it is best to put all their eggs in one of those baskets.

Of course, the difference between us as investors and corporate farms and institutional investors is that we can't have a do-over and we can't afford to fail.  As we get older, in particular, our options become more limited.  At my age, it would be very hard to "start over again" if I lost all my money.  So I am not so much interested in leveraging my position with risky bets, but rather putting my money into fairly safe places.

This is where it gets tricky.  Like most Americans of my age group, I have my retirement money in the form of an IRA (rolled over from a 401(k)) and if I take money out, I get taxed.  So the name of the game is to keep the money in the IRA until it is needed and even then, taking out as little as possible to avoid being shifted to a higher tax bracket.

Problem is, most folks' IRAs are invested with brokerage houses, and into mutual funds that buy and sell stocks or bonds or whatever.  None of these are FDIC insured.  And while we may think we are "diversified" in a mutual fund or funds, it may turn out that these funds are all investing in the same or similar things.  And as previous recessions have illustrated, when the market goes down, it takes everything with it, as people panic and sell, or they have to sell, even profitable investments, because of other obligations.  Share price isn't based entirely on return on investment, but more on supply and demand.  And supply and demand are based on emotional issues.

So, at first, the SVB debacle seems pretty benign.  The small depositors will be covered by the FDIC (Thank you very much FDR and Democrats!  Boo, Republicans!) while the silicon valley vulture investors will lose everything (Good! They had it coming!) and no one outside of silicon valley will get hurt.

Or will they?

Because this blip on the radar is a sign of things to come.  I have noted time and time again that many of these tech-that-is-not-tech firms are just vehicles designed to enrich a few people and make a whole lot of other people a little bit poorer.  These "tech" companies which are really little more than an app to do something we've been doing for decades or even centuries, will fall by the wayside, as they were never profitable and had no real plans to ever be profitable.  Taxi services, food delivery, sending snarky notes to each other - these are not "business models" or "technology" and have never made money for their investors.  And you can't keep losing money indefinitely  To paraphrase Margaret Thatcher, "Eventually you run out of other people's money!"

Socialism or Vulture Capitalism - the end game is the same, when someone else has to pick up the bill.  Let's just hope the government doesn't do something stupid like bail out these knuckleheads!

So in the coming months, we will all be a little poorer.  The appraised value of my home will go down. My stocks and bonds will decrease in value - not by a lot, but by enough.   And it will make me more cautious about spending money, which means the local merchants will suffer, and so on down the line.  It will turn around, of course, faster than you think.  In the last recession of 2008 - which was a big 'un, the market pretty much recovered within a year or so.  Many still mourned their lost equity and how much more the market could have made - but you can't morn when overvalued property and equities come back down to earth.  In fact, it is a reason to celebrate, unless you bought it right at the peak.

Our reader who rents student housing might see his net worth decline, as real estate drops in value (as it already has, nationwide) but so long as the students keep enrolling in college (or people need a place to live), the rental income should stay pretty steady.  And property values will once again ratchet up, in a year or so.

Even a tech crash has a silver lining.  After previous tech crashes, office space, server capacity, and fiber optic networks came on the market for cheap - enabling a new generation of tech entrepreneurs to realize new products and innovations that might not have made sense, if they had to pay full price for infrastructure and services.

The run on SVB isn't quite the end of the world.  But it is a sign of troubles to come.  Hang on, it's going to be a bumpy ride!