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[Metaphorical Web] Will Wall Street Tremors Bring Another IT Recession

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  • Kurt Cagle
    Greetings, one and all. I m bowing to a reality here that Google, in its oh so infinite search engine wisdom, is still finding this particular website more
    Message 1 of 1 , Nov 27, 2007
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      Greetings, one and all. I'm bowing to a reality here that Google, in
      its oh so infinite search engine wisdom, is still finding this
      particular website more often than it is my Drupal
      (www.metaphoricalweb.org) site. For the moment, I shall maintain both
      sites, and see if perhaps something comes of it one way or
      t'other.Lately, I find that far more of my reading has centered on
      economic news rather than upon technical, though to be honest the
      intricacies of many of the "investment credit vehicles" that have been
      foisted off on the public frankly put the Obfuscation C Coding Contest
      winners to shame. In most cases, when a financial fraud is perpetrated,
      one of the hallmarks that jurors use as evidence is the degree to which
      illicit cash flows are threaded above, below, and through more mundane
      transactions. The intent of fraud is simple - make people believe that
      they are financially safe when in fact their life savings are being
      purloined.What your seeing each day in the big financial papers is
      disclosures of "write-offs" of hundreds of billions of dollars of money
      by banks, mortgage institutions, hedge funds and similar financial
      players, largely because these organizations had become engaged in the
      practice of ... well, fraud.Mortgage brokers initiated liar loans with
      people who clearly had no means of paying back even the teaser rates,
      then got those loans off their books and into "structured investment
      vehicles" that sliced and diced these shaky loans and, with the
      assistance of ratings organizations turned these loser portfolios into
      alchemical gold by building highly leveraged hedges against them.The
      banks that purchases these would then get them off their books by
      selling them to investors, who generally had no idea that the "risk"
      that they were buying was not safe, conservative debt but rather
      investments into millions of loans that had about 50/50 chance each of
      going into default.Not surprisingly, while many of the mortgage
      companies and investment banks that perpetrated this nonsense are
      either in bankruptcy or in financial distress, most of the CEOs who
      should have put on the brakes early have reaped hundreds of millions of
      dollars and golden parachutes that will likely see them well into their
      retirement years.Of course, the same practices that made this possible
      also have laid the same insidious seeds within most other credit
      companies, including credit card issuers and corporate paper investors.
      As the domino of subprime mortgages fall, its already begun to press
      auto loan issuers, and there are indications that the commercial credit
      market is also seizing up as dubious corporate investing also is
      beginning to look ominously diseased.Now, I am not an economist - I'm a
      programmer. While I find this a fascinating exercise to watch in system
      theory, ultimately the questions that I'm having to ask have more to do
      with the simple question of how it will affect me, my clients, and the
      IT industry in general.Five years ago, the Tech Recession hit. If you
      were in financial services, you might be forgiven in saying "recession?
      We're in a recession?!" The effects on most other sectors was
      comparatively light, though it was devastating if you happened to be in
      IT. Fully 40% of IT jobs were shed at the height of the recession,
      programmers who had been buying Starbucks coffee and making six figure
      incomes suddenly found that the paper options they'd been paid in were
      worthless, they'd given the best, most productive years of their lives
      and their most innovative works for comparative peanuts, and they were
      living in their parent's spare bedroom.Not surprisingly even now, five
      years later, a lot of programmers have become skittish about accepting
      stock options and they have become considerably more parsimonious about
      how they spend their money (and what jobs they accept in the first
      place) - and there are comparatively far fewer people entering into the
      IT field. They've also become very good at watching economic trends,
      and most programmers that I know who went through that period are
      getting rather twitchy about now.Right now, the ill winds of recession
      are blowing most heavily through the housing sector, especially in the
      US. One of the things to consider about most recessions is that it is
      actually quite rare for a recession to affect the entire economy.
      Instead, in most cyclic recessions, what you have is a situation where
      supply has temporarily exceeded demand, and the excesses of that supply
      need to be worked off.The IT recession of 2002-2004 was a fairly
      classical one - there was too much investment in IT, both in terms of
      jobs and in terms of technology, and it took about eighteen months and
      some fairly severe slashing before demand could catch up with supply.
      By 2004, even though tech was still technically (sorry) in a recession,
      there were already signs that things were beginning to recover, and the
      market very quickly went from too few jobs for the number of workers to
      too many - to the extent that finding good, qualified people is
      becoming quite challenging.The housing sector is going through its own
      recession, but unfortunately it will take more than eighteen months for
      demand to catch up with supply; there are a number of reasons for this,
      from speculators flipping houses who are now left with too many
      properties and no buyers, to houses going into foreclosure due to
      onerous adjustable mortgage rate resets, to a longer term demographic
      switch away from large, costly-to-heat houses in the face of higher
      energy costs and shrinking families.Yet by itself, the recession that
      results from this will also would be at least somewhat self-contained,
      if an oversupply of houses was in fact the only real problem.
      Unfortunately, what is now emerging is that this is the domino falling
      that seems to be catching other dominoes with it. Risk is being
      repriced much higher, because the same lending practices that made it
      possible to get a loan for a half-million dollar house with an income
      of less than $20,000 was also at work in the hedge-fund space, the
      commercial paper space (which affects corporate buy-outs, business
      expansion), credit card paper, student loans, re-insurers ... indeed,
      just about everyone out there is suddenly discovering that the
      foundations that they were building on was made not of concrete, but
      quicksand, which has many of the same properties but a rather
      disturbing tendency to be lethal.This is the real recession, and the
      last time that something even vaguely similar happened, Herbert Hoover
      was president. Credit, which has replaced cash in just about every
      transaction that occurs today, is rapidly disappearing. Indeed, it is
      worth it to understand that credit is itself simply a measure of
      risk. "I will let you take out a loan because I believe you to be a
      trustworthy individual," the banker should say, "you pay back your
      loans on time and reliabily, you have open accounting, you have shown
      good judgment in how you spend your money. "The problem comes with the
      next part - "Even the most reliable person occasionally runs into
      problems. As a banker, I should be compensated for the small chance
      that you will be unable to pay your loan under the terms you and I set
      out. That compensation is the interest on the loan."So what's a
      reliable rate of interest? This is where things get tricky. The more
      risky the investment, the higher the rate of return should be, so the
      higher the rate of interest, and the harder it becomes to qualify for a
      loan. The problem of course is that the banks make money on that
      interest, and in good economic times it becomes easy to fudge the
      credit-worthiness of an individual or two, if higher returns is the
      desired goal. Of course, once risk becomes high enough, it becomes far
      more profitable to initiate the transaction (be it mortgage, credit
      card application, or small business loan) then sell off that risk to
      someone else. That proved SO profitable that the process got repeated
      many times, with the same questionable risks getting packaged and
      repackaged to the point where there was no real way of determining
      where the risks were - or, more to the point, what they were.Now, that
      whole edifice is going through a slow motion crash, and despite
      everything you hear in the Wall Street Journal or CNN/Money, it is
      going to continue to crash into other sectors. Right now, it really
      hasn't fully impacted the consumer (though there's another factor
      working there) but it will. If no one has any idea what the real value
      of risk is anymore, no one will initiate loans. Companies are already
      finding it increasingly difficult to get funding that used to be
      routine. Companies can't expand beyond the reserves that they already
      have on hand, and already accountants at many companies are beginning
      to question just how stable those reserves are. More than one company
      has been forced to delay even paying their employees or their accounts
      because their banks have frozen all accounts.In the late 1930s, the
      FDIC was established in order to avoid a credit crunch like the one
      that wiped out the economy in 1929. It stipulated that banks always
      maintain a fixed percentage of assets (originally 10% of total capital
      lended) in order to insure that in the event of a bank run, there was
      enough operating capital to keep the bank afloat until help could be
      arranged. Additionally, many banks were required to honor the first
      $100,000 of deposited funds. The problem is that lax regulatory
      oversight has effectively eviscerated most of the FDIC's mandate, to
      the extent that it is unlikely that most banks could in fact meet 1% of
      total capital extended if they had to.Of course, in order to look like
      they were in fact complying with these strictures, many financial
      institutions put much of their assets off the books into secondary
      corporations that were not then subject to the limitations, meaning
      that the actual debt that a financial institution had was generally far
      greater than what they showed on the books. So long as no one looked
      too closely (and when the money was great enough people would not look
      too closely) this meant that banks could make incredible returns by
      lending money that, for all intents and purposes, didn't really
      exist.The problem is a Schroedinger Cat crisis. In quantum mechanics,
      there is a classical thought experiment in which a single atom of
      uranium is placed in a special trap that would, when the atom decayed,
      release a toxic gas that would kill a cat locked in a box. Quantum
      theory states that what is at work here is a wave function, and as
      such, the cat could simultaneously be both alive and dead, and the only
      way that you could actually tell (well, besides the obvious yowling of
      a pissed boxed cat) was to open up the lid. Once you had opened the
      lid, then you had collapsed the wave function, and there could be only
      one solution.The banking industry has been build on the same wave
      functions, and so long as no one looked in the box, then there could be
      an infinite amount of money there. Once you open the box,
      unfortunately, reality steps in, and the reality is considerably more
      disappointing than anyone could have hoped.So what happens this time
      around to IT. The credit crunch will hit in a number of ways:
      - No money available for expansion of companies, beyond existing funds.
      Too many companies have been "living beyond their means", using their
      existing reserves as collateral against loans. As those loans begin to
      dry up, they are forced into using those reserves, which often may be
      tied up in existing investments and thus are less than completely
      liquid. When you are forced to sell to meet costs, you often get a far
      less than ideal value for your assets, especially when everyone else is
      doing the same thing.
      - Illiquid third party investment. VCs and other investment companies
      will have more demand on their moneys from more traditional sources,
      which may be good for the VCs (in the short term) but it also dries up
      much of the money that IT startups in particular count upon. Moreover,
      many of those VCs represent funds that may also be fairly heavily
      hedged, and so the same repricing of risk that is going on in the
      commercial sector will make it harder for them to pull together the
      funds necessary to complete deals.
      - Strapped consumer spending. Don't pay too much attention to all of
      the sighs of relief after Black Friday sales. People are strapped for
      cash, and they are as attracted to a bargain as anyone. The problem
      will come soon enough, as people can no longer take out much money via
      a second mortgage, will be facing stagnant wages and unemployment in
      December (one of the highest months for force restructuring) and will
      find it difficult to get credit extensions on their credit cards. I
      expect that consumer spending will plummet in the next couple of
      months. Sales from Walmart are done from last year, but so are the
      sales from high end luxury brands. This will mean that spending on
      consumer software and hardware will also in general be declining pretty
      dramatically in the next few months, which directly impacts people in
      - Declining dollar. As the economy becomes more distressed, calls will
      be made increasingly to cut interest rates. The problem with that is
      that the dollar's value is declining relative to other currencies as
      rates go down, making American goods and services cheaper ... but also
      making American companies cheaper. This will reduce the attractiveness
      of outsourcing (a definite plus for developers, who've often had to
      compete with foreign developers) but will make it more likely that
      companies in other countries may start outsourcing to American IT
      workers. On the other hand, this will likely only happen once American
      wages become competitive with those in countries like China or India,
      which means that programmer's standards of living will likely be
      dropping for some time before you see a massive influx of capital, and
      that capital will likely mean that the "parent company" of your company
      is not even in your hemisphere.Note that the carry trade in currencies
      will likely intensify as people move money out of both hard assets
      (short term, commodities will likely stall somewhat, though the long
      term outlook is still somewhat bullish) and financial assets (nearly
      all classes, long term) but seek even some returns. The downside is
      that this will likely lead to greater instability in the currency
      markets, with the possibility that one or more countries could "crash"
      - the US being at a very real risk of this.
      - Energy costs. IT has generally been a net consumer of power, though
      that's changing. In many ways, IT has been working towards applying
      technology to reduce their energy footprint for financial reasons
      rather than ecological ones, but of all departments in a given company,
      IT is often the "greenest". On the other hand, a significant amount of
      energy costs are due to a declining dollar (along with considerations
      for peak oil and other geopolitical issues) which means that the
      relative cost of oil (and hence gas) will affect the prices of goods
      that need to be transported (nearly everything at this stage) and hence
      will mean that computer infrastructure (which has generally been
      declining at a rate consistent with Moore's Law) will likely start
      getting more expensive again relatively speaking (though it may end up
      spurring additional investment into local hardware production
      infrastructure such as chip fabrication plants).The cost will also
      accelerate the decade long trend of distributing the corporations into
      islands of loosely connected individuals who may actually work half a
      world away from where they live. If your workers are spending four
      hours a day on the road and are forced to pay an increasing premium for
      the privilege, they will go elsewhere where they can telecommute
      - No (immediate) bloodbath in IT. Corporations are going to be
      considerably more loathe to trim their IT staff, in part because that
      staff has only begun to recover from the last bloodletting, and in part
      because in many cases existing infrastructure has been pushed for about
      as long as it can be, so the imperative for improving core
      infrastructure will likely remain strong even in the face of slowing
      sales. On the other hand, its unlikely that you will see a lot of
      companies do anything beyond low cost pilot projects for R&D,
      especially after the first quarter of next year. As the recession
      spreads to other industries, I think that IT could be vulnerable on an
      industry by industry basis, but some of that may be mitigated by
      investment from foreign investors seeking firesale prices on companies.
      - Shakeout of vulnerable companies. There are a fair number of
      mid-sized IT companies in certain sectors that managed to survive the
      Tech Winter, but that are increasingly becoming vulnerable. Even a year
      ago, these companies would likely have been bought up by larger or more
      successful companies, but as the available moneys for buyouts dry up,
      what will more likely happen is that the less successful of these will
      be forced into bankruptcy instead, without the "Get Out of Jail" card
      that seems to be the privilege of companies in other sectors.The irony
      is that a lot of new startups may actually end up surprising relatively
      intact. While there is some fluff in the startup space, it never
      reached the level of 1999, and a lot of the companies that started in
      the last five to six years are generally very lean (and fairly heavily
      open source-based, from all indications) and for the most part are
      considerably more pragmatic about the market. On the other hand, there
      will be relatively few IPOs for the next several years out of this
      sector (though this has been a trend since around 2000).In the face of
      all of this, what can the astute developer do? Having gone through this
      a few times now, I've found the following strategies can help.
      - Save money when you can, and reduce spending on extravagances. If you
      currently have any debts (especially credit card debt) pay it off and
      get out of those cards, highest interest first. Debt ties you down and
      reduces your cash-flow, which will be threatened at the best of times.
      - Stay as liquid as possible, and if possible diversify your funds out
      of US dollars, at least for the next year or so. If you can land one or
      more clients that are out of the US, even better, though try to
      negotiate in funds out of US dollars if at all possible. It's likely
      that 2008 won't be quite the rout for the dollar that 2007 has turned
      out to be, but it is also likely that you still will likely turn out
      better in foreign funds, even with conversion rate charges.
      - On a similar note, for the short term, if you are invested in
      equities, resource and energy stocks will likely be the most solid for
      the foreseeable future, though you are looking there less for
      significant gains but to minimize losses.
      - Diversify your client list as much as possible - and be fairly
      ruthless in negotiating. They will be. Assume the likelihood of a
      default by one or more clients is at least a possibility, and plan
      accordingly ... its possible that all of your clients may go belly-up
      at once, but in most instance, if you have three or four clients, you
      should be able to maintain steady work. On the other hand, work hard to
      deliver as promised ... the ones that do survive generally are ones you
      want to keep.
      - If you do find yourself between clients, spend that time getting
      caught up on skills that you didn't have the chance to work on while
      you were too busy with clients. Unless you are fairly new to the
      programming field, you're best served by increasing the depth of your
      skill rather than the breadth, unless the shift to the new field is
      part of a larger move into that technology as a base. Be thinking a
      year ahead in terms of where tech will be.
      - In boom-times, programmers generally find recruiters to be pests. In
      bust-times, recruiters find programmers to be pests. Find a few good
      recruiters at various companies and get to know them, even refer people
      to them when you're offered a job you can't or do not want to take.
      They'll be more inclined to use you when times get tough.
      - Recessions generally happen for reasons that you have little or no
      control over, but it is easy to become stressed, bitter, depressed or
      angry during those times, often making it harder for you to get
      motivated to work or look for work if there isn't any. It's worth
      remembering that programmers in general usually tend to have very
      desirable skill sets. If you have the time, join and contribute to open
      source projects - not only will you keep your skills up to date and
      work on interesting (and occasionally even useful) projects, but you
      stand a better chance of making contacts, developing your interpersonal
      network and gaining early proficiency in new technology by doing so. It
      will also let you combat the tendency to want to crawl up in a ball and
      whimper all day. Indeed, staying connected in general is a good idea.
      - Keep alert and informed. In general, diversify your news sources
      (especially economic and political) and verify what's going on with one
      from another. Assume that no one knows the exact timing of when
      the "recession" or "recovery" first hits until after it has
      happened.This was not meant to be a doom and gloom post. The coming
      recession is much like a Class 5 hurricane - it's coming, it will
      almost leave quite a trail of damage in its wake, but it will also have
      cleared the air enough for some major reforms to get instituted, and
      life will go on.-- Kurt Cagle

      Posted By Kurt Cagle to Metaphorical Web at 11/26/2007 08:40:00 PM

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