Breaking News: Market Share Stolen by Hackers!

A Wall Street Journal article today carries the following quote:

Chinese state television has broadcast footage of what two experts on the Chinese military say appears to be a military institute demonstrating software designed to attack websites in the U.S.

DailyTech blog captured screenshots including the image below.

This further supports my prediction in a January 2010 blog post What Will Tomorrow (Today?) Bring: Virtual War.

"Make no mistake, this is
Cyber Warfare."

It is now undeniable: we are engaged in a new Cyber Cold War which represents the most unconventional and asymmetric war the world has ever seen. Control is extremely decentralized. Weapons are easily acquired. The risk of retaliation is low. Battles are waged remotely. The prosecutors and victims of the war can be anyone or any group of people. Governments, individuals, and businesses are all players, like it or not.

The WSJ article shows, however, that more conventional power structures are now on the battlefield. Many in the LulzSec group may have simply been bored, over-caffeinated students who wanted some celebrity. However, security insiders increasingly see hard evidence to support the WSJ's case: governments, particularly those of Russia, China, and the US are quietly backing attacks.

Many people would laugh at the notion that a foreign military might wage an online attack on a US financial institution. Consider, however, two factors which might give them motivation:

1. Sovereign Wealth Funds (SWFs) increasingly own debt and equity of governments AND businesses. This gives them a financial interest in the success (or failure) of certain companies as well as economies. Hack a bank, leak a headline, and watch the share price drop until a buying opportunity has emerged.
2. Many emerging market countries have discovered that they don't have to create an economy as big as the US in order to have companies which compete on a global scale. These companies can be jump-started with some quiet government support. As a result, it has become common policy to support "national champions" which successfully compete against the largest and most mature global (though still mostly US-based) companies. Government-sponsored hackers might help these champions by hacking the competition and stealing trade information or by creating bad headlines.
   

Like it or not, we have to acknowledge that certain governments have the means, the motive, and the opportunity to commit cyber attacks against financial institutions. In all likelihood, this has been going on for at least several years. Consider a March 2009 Telegraph.co.uk article:

"A vast Chinese cyber-espionage network, codenamed GhostNet, has penetrated 103 countries and infects at least a dozen new computers every week, according to researchers ... [GhostNet] is the latest sign of China's determination to win a future 'information war'... In 2003, the Chinese army announced the creation of 'information warfare units'."

Fox News added to the story:

"The Chinese government on Monday denied it was behind GhostNet"

Banking has the notion of security at its core. Think of a bank branch and you'll instantly visualize vaults, armed guards and video surveillance. Behind the scenes, banks all have hardened ATMs, teller stick-up procedures, passwords and permissions. In other words, security is tightly integrated with their physical channels.

It is also tightly integrated into their physical products through watermarks, microdot printing on checks, serial numbers on other financial instruments, signature specimens, etc.

Ironically, banks have been dangerously slow to understand how this relates to the online world. Today's banks are dot-coms. Online banking is now a core product. Moreover, it is the "face of the bank" for many customers. It is the gateway or channel through which all other products and services are offered.

Dot-com execs have an advantage in the realm of security and fraud inasmuch as their core product is a piece of technology which intrinsically has a set of permissions and security controls built in. The tools their engineers use also have permissions and security controls at their core. Bank execs need to think like dot-commers. Online security and fraud prevention are just as intrinsic to their core products as signature cards, credit scores, personal relationships, and armed guards once were.

The logical conclusion is that banks need to be organized, staffed, and run more like dot-com businesses to survive in the current Cyber Cold War. Security must be "baked in" to everything they do, just as credit scores and ratings have been baked into lending and trading decisions for decades. Executives should make no mistake: on the current battlefield, market share is not stolen by a bank down the street who might lure customers away with better rates and free toasters. Market share is "stolen" by hackers who ruin the bank's reputation or steals clients' identities and thus causes customers to flee.

It is no longer a sci-fi fantasy that these hackers may be shadow agents of a competitor or even a government intent on manipulating markets, economies, or even specific businesses.

Follow Up: What Type of Investors are SWFs

Well, if Nicky Sarkozy gets his way, they'll be the worst kind. Apparently he has fallen off the wagon along with the rest of our world leaders. He wants a Europe-wide SWF which has the following stated goal:

"buy stakes in companies with low share prices and protect them from foreign predators"

Strange, back in those naive, silly days of capitalism, a low share price indicated that the company had poor prospects and thus was not a good investment. Back then, the share prices suggested that these companies faced quaint capitalist problems like overbearing competition, bad management, too much debt, bad products, or litigation.

Thankfully, the New World Order has seen the light. They've finally recognized that economies following Marx, Engels, Lenin, and Stallin have always been so wildly successful and stable precisely because they outlawed those nuisances above. Just like the pickled corpse of Lenin in Red Square, they insisted on preserving their rotting businesses at the expense of focusing money and effort on fresh, vital ones.

Yuck.

What Will Tomorrow Bring: Black Ink for Everyone!

Putting my conspiracist hat on...

Isn't RTC2 (aka TARP) shaping up like a back-door SWF ... only on borrowed money, since that's the new American way?
Aww, you shouldn't have. I always wanted the US to have a SWF! And this one's a bee-ute!

Perhaps this is just a big surprise present to future generations ... kinda like how High School seniors give the school a parting gift before graduation. Just think ... Paulson, in all his wisdom, and with his near-zero cost of capital, buys up major chunks of US assets.

He lets them ripen.

He sells them for twice the purchase price. He pays off the national debt, puts Social Security on sound footing, and even has left-overs for Obama's gazillion-dollar social and healthcare programs.


Merry Christmas, 2058!

What Type of Investors are SWFs

News today that QIA and another Qatari SWF will become Barclay's largest shareholder. Close behind are the SWFs of Singapore and China.

This really represents the nexus between my latest Idle Shareholders blog; my recent discussion about SWFs in Follow Up #3: You've heard of the Illuminati, right? and my coverage of Boone Pickens' concern in Follow Up #3: Power. Perhaps we've found the epicenter of my own personal blogosphere.

The action, itself is nothing earth-shattering. SWFs have been on the prowl for quite some time. The intensity of their hunt has grown just as rapidly as the price of oil. Banks have been on the rocks for over a year. Not surprising, but it calls our attention to interesting questions:

What type of investors are SWFs? Will the QIA be absentee like your average mutual fund manager? Will they be politically activist? Will they quietly drive the company? If so, toward what goals? Stability? Sharia Law? Profitability? Long-term or short?

Will the US be the next England or Rome? If $5/gallon gas isn't enough incentive for us to get off foreign oil, how about the realization that we're giving other countries the money they're using to buy up our (economic) treasures. Middle Eastern and Central Asian countries are getting rich off our insatiable demand for oil. They're awash in Dollars and Euro and must find a productive place to invest. Hence the SWF boom. Happy serendipity for them: US stocks are all on fire sale. If they own our most productive enterprises ... they own the future revenue streams which those enterprises produce. We labor and they profit. Meanwhile we exhaust our remaining wealth to maintain our world influence. One day we wake up as England circa 1950: Broke and Inconsequential.

Will we be able to respond? Hopefully, arguments like mine above will scare many people into looking for a solution. I'm chronically optimistic about the US and our ability to respond in the face of challenge. We have resources of all kinds ample for the effort. Being a democracy, though, we have to go through a period of cacophony and debate where suggestions are raised, debated, and informally voted on.

One popular inclination will be to suggest we take our toys and go home ... hiding behind a wall of protectionism and xenophobia. Prevent them from coming here. Prevent them from owning our shares. Unilaterally refuse to recognize their ownership of our assets. This is Iran's favorite trick. Only if we want to end up like them in 50 years should we pursue such an option.

Another popular inclination will be to hand the whole problem over to governments. Socialism for everyone. In fact, let's make a single worldwide communist state so that we can steal China's and Qatar's wealth to feed our starving faces.

Surely many will say "that's capitalism!" and roll over on their backs to show subservience to the inevitability of the markets. This would be nothing more than an excuse. Capitalism is not Imperialism. Empires fail when freedom is removed (more on this coming soon to a blog near you!). Capitalism is survival of the fittest ideas; it's a framework for making decisions (another blog coming attraction!). The true capitalistic response to a challenge like this is counter-attack with better ideas. This shouldn't be hard. Countries like Qatar, Saudi, Russia, Iran, and even Chile are not becoming wealthy on the backs of a million citizen-entrepreneurs with a hundred million value-creating ideas. To the contrary - their wealth comes from the lucky happenstance of living atop a commodity we all want.

As I am wont to do, I'll leave you to cogitate on these for a bit. I'll be back shortly to share my thoughts.

Follow-up #3: You've heard of the Illuminati, right?

For one of my first blog entries I chose to assert that the mythological illuminati were real. I argued that it was not a group of overstuffed old European men swilling cognac as Hollywood would have it. Rather, it was a global group of investment houses which owned a surprising share of world assets. These were the New Illuminati who had replaced the original European aristocracy variety. It appears it's time to update that blog. We have a third generation on our hands.

At the time, I took the long-term view that the European variety was a relic, clawing for relevance in a more transparent modern world. From the days of monarchs and peasants controlling the known world, we've undertaken a 5-century march toward power decentralization. This has swept in a 4-century economic miracle of wealth democratization, compounded in a virtuous cycle by technological progress. I still hold that long-term view; tides that big don't just flip a U, but they also don't flow smoothly. They progress just like a wave on the beach: crashing forward and then receding back ... only to crash forward a teeny bit further the next time around. By analyzing the fluid dynamics of countless micro-forces partially reinforcing and partially countermanding each other, we can try to predict where the water will be at any future moment. Even with a supercomputer, our predictions are seldom accurate ... but even a whelk knows the water's rising.

I would suggest that we are entering a period of several such forces which will, on net, create a pause in the long march.

#1 - Sovereign Wealth Funds. The populists fear-monger with xenophobia, since many of these funds are not trusted allies of The West. To that, I say: grow up. The world is, indeed, too flat for that. Truly open markets are color-blind, and as such I'm all for letting SWFs join the party without a bunch of government intervention. The liquidity they provide will be a net benefit on the world economy.

At the same time, however, we must keep our eyes open to the unique risks SWFs present. These funds are notable first for their relative enormity. Sometime when you're bored, draw up a bar-chart of the assets under management for the largest mutual funds, hedge funds and retirement funds. Then add SWFs to the chart. I hope you're not afraid of heights because they will tower over the rest, and they're growing fast. These funds are notable second for the fact that as government entities, their motivation is at risk of being hijacked for political power, especially in less-than-democracies. SWFs might engage in economic warfare even if that means the fund loses some money. The same would never be done by a privately-owned, profit-motivated fund.

Put differently, SWFs amount to an concentration of economic power in the hands of a tiny group of governmental aristocrats. To wield influence in this context, one need not appeal to the masses democratically; just get a half dozen of new illuminati to collude and you can have a transfer of power the size of the 1970's oil shocks. True, market forces will eventually countermand these disruptions, but an adept strategist could ride the crest of the wave and then permanently lock in their gains at the high-water mark.

#2 - The Sage of Omaha. For a short stint in history, certain Americans have risen to a level of wealth that bought them influence similar to that of the illuminati. Unfortunately, all Yanks are ADD-afflicted cowboys. Generation after generation of Americans produce self-made men with no respect for precedent, lineage, continuity, or legacy. Canegie, Rockefeller, Getty, Hughes, Wilson, Gates, and many others have sat at the table, but few have stayed long. None of these men has been invited to participate in the control structures the illuminati use to protect and control European enterprise.

That's why it will be highly interesting to see if it will be any different this week as the Warren Buffett pays house calls on as many illuminati as he can find. Berkshire Hathaway's pitch is logical; they have one of the longest track records of investment success around. More importantly, he believes in the rare long-term value investing strategy (as do the SWFs BTW). This allows those thousand-year-old Euro dynasties to sleep at night knowing they won't wake up next to a wrinkly, hideous old cur like Icann, Ickes, or "Chainsaw" Al Dunlop ready to test out Schumpeter's creative destruction on their family empire.

Buffet has to convince the families of the hopeless future ahead for the stagnating Euro economy. He then has to sell the notion that the only way for their dynasties to survive the next 100 years is to introduce a teensy bit of his American youth and exuberance. They will fear that one cannot dip only the toe in the pool. They may be right. Buffet's number one goal, after all, is not to preserve European gentry. It is to continue market-beating returns on investment year after year after year. Loading up the Berkshire portfolio with a couple billion dollars of stagnant Euro businesses will not help in that regard unless change is on the horizon. The key question is How. Does Warren think he can break into this world of old money and introduce American business and finance models? Perhaps even unwind some of those share cross-holdings? Does he think he has enough political weight (and buddies with the same) to lean on national and EU governments to loosen the legislative straightjackets? Either would unlock tremendous value, but neither seems to me likely in the short-to-medium term.

I can only speculate that his objective is threefold:

• Ensuring that, in the very long-term, he is well-positioned to take care of the European liberalization
  
  
• Buying his way into the enormous and under-utilized pools of capital held by those families
  
  
• Picking up some large shareholders in BH who share his stable, long-term view. He might even give them a few board seats to protect himself from the chance of an Icann or Ickes invasion.

Follow up: Triple Play in the FT Today

Good to see great minds are interested in some of the same topics I've been writing about. The FT Comment page today carries pieces on not one, not two, but three of my recent blog topics:

• Abbie Hofman writes about i-bankers and their role in our recent credit market problems ("The binge culture of banking must be changed") just as I did in "Levers, Gears, Pulleys..." She's better with the word than I about those topics common to her piece and mine. For example, I listed "clouding" as one of the i-bankers bag-o-tricks. She uses the more formal "obfuscation." She goes beyond just agreeing with me, though. She astutely points to compensation structures and Jones-man-ship ("if another bank sells the product, so must we") as areas which must change in order to avoid another period of i-banking pain. She correctly points out that we need more directors who come from the industry and can understand the concepts being bantered about in board meetings. Here's a great quote-of-a-quote: "...we have been told that bankers were paid so much because you were cleverer than the rest of us. Now it turns out you were not..."
  
• Leszek Balcerowicz talks about the natural tension between collectivists and free-marketers ("Free marketers must fend off the statists"), very much in the vein of my recent blog on the government interference behind the Bear Sterns work-out ("Move Over Eagle ..."). I particularly appreciate his Eastern European viewpoint. He and his generation are probably the world's best experts on the topic of statism vs. capitalism. It's no surprise he's such a staunch advocate of the latter.
  
• And finally staff writer Gideon Rachman takes on the SWF issue ("Do not panic over foreign wealth") summing up the message that I had provided background for in my "Yabba Dhabi Doo" series. His take is spot-on: these guys are not going to invest billions in a US firm only to topple it, or the US economy at large. To the contrary, I would argue that they, by investing their national treasure in global companies, will finally and perhaps unwittingly cure one of the major causes of their cultures' historic religiously-based and paranoia-fuelled stances toward the rest of the world -- the haves vs. the have nots -- the evil empires hell-bent on domination -- the imperialists looking for conquest -- the hell-bound hedonists who must be slaughtered. By participating in the world economy, they suddenly have a very direct and clear motivation to do what's in its best interest, thus aligning their national interests more closely with ours. As he says, "... if governments ... have large investments in the US and EU, then they also have a direct stake in the continuing prosperity of Ameria and the EU ... it surely must make it less likely that political differences will escalate into conflict..." It's also nice to see that a British FT staff writer agrees with Dubya: protectionism in the West is a cloud on the horizon ... one of locusts to be taken very, very seriously.

Follow up: Yabba Dhabi Doo

Here are some stats for ya:

Yabba Dhabi Doo

From the press this week, news that investment funds in the United Arab Emirates have taken MAJOR equity holdings in two of the largest global companies: Citigroup ($7.5 billion / 5%) and Sony ("substantial). This atop several other recent SWF investments in AMD (8%), Apollo Management (9%), and Airbus.

Worldwide, something north of $2.5 trillion sits in sovereign wealth funds. Abu Dhabi's fund is purported to be the largest, at $625 billion, but by no means are the Oily Arabs the only ones throwing their government cash around private markets. The second largest fund is purported to be Norway's at $330 billion. And in asia, Singapore has well over $200 billion in various funds. Even communist China owns stocks -- Blackstone Group is now 10% held by the Chinese government. France and Germany don't have specific funds ... that would create perhaps too much trancparency for them. Make no mistake - they're deeply invested in companies in their own countries. Airbus, for example, would not even exist did it not receive a steady "reverse dividend" from it's shareholders, the European governments.

While dollar markets are deep and wide enough to absorb these purchases without lurching overall, outsized SWF investments in other national markets have caused significant trauma ... and they've only begun to dip their toes in the water. Just wait 'till one of 'em tries to get a seat on the board of an American company or otherwise flex their ownership muscle.

Ya can't blame 'em really. All these emerging market countries are flush with cash (mostly in Dollars) from exports, primarily those of commodities, and those primarily of oil. Holding all that money in treasuries which (of late) don't even keep up with the rate of Dollar depreciation, just doesn't make sense. Think about it in domestic terms -- if Congress found out they could add a new massive revenue stream from investments, how long would they be able to keep from doing that? The money'd be spent before the investments had even been made. They might even lower taxes if faced with enough pressure.