I had the opportunity early yesterday to do some volunteer work on the Paediatric Oncology floor at the hospital which I work. During a good number of tours in wheelchairs, read books & expansion of beads on bracelets and necklaces, I found myself playing some childhood games with a few of the kids. There were bursts of laughter, tears of joy and the occasional “I WIN”, “NOT AGAIN” and “WATCHOUT, IT’S GONNA FALL”. Two such games sparked my interest enough that I felt they applied somewhat to investing.
See…the success or failure of a business at times can be directly linked with the strategy, vision and tactics that one might employ in order to achieve an objective. A business might live or die simply from what actions a CEO takes in directing a company, the addition risks employees take in trying to achieve greater profitability or trying out some of the best ideas that always turn out to be the worst.
After playing a dozen rounds of this game, I came to think that this might be one game the management teams at both Citibank & CIBC might have never played around the boardroom table after an expensive lunch and presentations.
You start off with 54 slim wooden blocks that are built upon one another to form a tall structure. At each turn players pull a single piece from the tower and place it on the top and the game continues if the structure doesn’t collapse. This goes on until at some point a player loses by pulling from the wrong section and the structure weakens enough to collapse into a pile.
When you start the game everything appears fine, but as you slowly begin to pull pieces from the foundation of the structure and areas not easily seen by other players, the entire structure weakens considerably. Holes begin to open up and as the building grows in height, each player becomes prouder and prouder of their accomplishments. At some point the tower is so impressive that you begin to forget just how unstable it really is. The problem is that the pieces you take away you can only replace at the top – weakening it further. The elegance of the game is the inevitable end and the transfer of weight to the top (weakness) from the bottom (strength). See, you can use strategies such as distraction, deception or weaken the tower enough in the hopes that the next player loses on the final attempt. But at some point no matter how high you can make it, it always falls.
Kerplunk is a similar game of strategy and inevitable demise of one of its players. Instead of blocks weakening the structure and collapsing upon it, the objective of Kerplunk is to pull out sticks and minimize the number of marbles that fall that the sticks support hanging in mid-air. It’s very uncommon for no player to receive at least one marble, but usually near the end as gravity takes hold, one player ends up getting dumped on with the most. Instead of losing all your marbles, you gain too many. The problem is; no one else ever wants them either, so you’re stuck.
The subprime mortgage lending habits of some large North American banks isn’t that much different than the game of Jenga. These financial institutions at some point began weakening the foundation of their businesses by taking risks that they hoped would add to the height of their profitability and growth. But just as in Jenga, over time the foundation weakens enough that the tower threatens to crumble beneath its own weight.
Through dividend cuts, capital infusions and significant share dilutions these companies are attempting to continue building on the perceived strength of their business by adding to the top of the tower. The only difference here is that with the fireplace fuelled by burning so much shareholder equity is creating so much heat, that they can’t feel the subprime fire burning the foundation of the building beneath their feet.