OMG, Mr. Paulson Agreed with Us Twice in One Week!
Posted: November 19th, 2008, by Andy Spero
E-mail this post
We hope that his earlier actions haven’t caused irreparable damage, but we’re doubtful.
This is a longish post that covers several aspects of the ongoing financial crisis and, for the convenience of new visitors, contains plenty of reference links to earlier posts.
In our mind, until last week, the current Treasury Secretary had an incredibly long and unbroken string of wrong decisions and actions. Starting in March if not earlier, and through early November, in almost every important decision, when Mr. Paulson zigged we would have zagged, and vice versa.
Well, actually, we wouldn’t have zagged or zigged as that requires effort. Instead, we hope our rhetorical flourish illustrates our opposition to many of Mr. Paulson’s decisions. We would have done what we have advised all along, and what Mr. Paulson finally, finally seems to be doing: nothing.
As we advised in September, particularly in the posts Overreaction and Moral Hazard: Now That Will Be a Crisis and Public Bailout? Why Rush or Do It at All? among others, we recommend Mr. Paulson to vigorously do nothing, and advice Mr. Obama and the next Treasury Secretary do the same: nothing or more precisely, nothing much.
We italicize the “much” because we continue to (1) offer our private, non-governmental solution to the mortgage crisis, which the government has yet to address since TARP become law, and (2) offer advice on the best way to mitigate the bigger and more worrisome liquidity crisis, and that will require a bit of aggressive government action to motivate remaining bank managers to act or sell. See, we don’t think that the government should act (much), but we do think that banks and shareholders should.
In general, we’re strongly in favor of an economic version of the Hippocratic Oath: do no harm. Thus, we advise: do very little for which there will be few unintended consequences. (Although we do have two specific recommendations in mind that we’ll mention later.)
So little time, so many mistakes: what’s the point?
The Treasury’s earlier insidious approach of getting the government’s many, spindly, little fingers on all of its Vishnu-like arms into hundreds of firms will likely have no end, ever. (Our prediction: they’ll renegotiate rates when taxpayers are supposed to reap the benefit of rate increases.) It was so very disappointing—not surprising, but so very disappointing—to see our federal officials act in such rushed and expedient manners.
Until last week there didn’t seem to be any thought—even an afterthought—of the havoc they were wreaking. Given shallowness their depth of thought, we would have been convinced that Mssrs Paulson and Bush were teenagers with Progeria had text-messaged their interviews and press releases.
What’s the point: when we taught decision-making to MBAs we heavily emphasized (1) knowing the decision criterion—the objective function—and (2) identifying relevant or incremental costs and benefits across alternative courses of action.
We saw no indication that our government’s leaders operated under such a framework, particularly in September and October of this year.
In other words, it should be very clear how to account for the federal government’s decisions and actions. One would hope that officials would have some metric by which they measure the effect of their actions, but that seems to have been beyond them.
What were Mssrs. Bush, Paulson, and Bernanke trying to accomplish? What were (or are) the costs and benefits of their feasible alternatives? Which categories of costs and benefits seemed to have the most reliable and firm estimates? What decisions were most sensitive to underlying variables and assumptions? Which decisions seemed the most robust across potential changes in the economic environment?
During the both the original mortgage crisis and the larger, ensuing and ongoing liquidity crisis, has the reader heard any government official speak in those terms? Or, until last week, when Mr. Paulson said, “Nyet,” were their statements more like: “Eek! We’ve got to do something! We don’t have time to think?” Yeah, it was a rhetorical question.
As regular readers know, we have very serious doubts about the effectiveness of various aspects of the government’s plan—although “plan” seems to be too thoughtful and organized a term to describe the government’s response to the crisis of 2008. Likewise, we have even greater doubts about its efficiency, or the ratio of benefits to costs. (Is it not approaching zero?) We mean that there are at least two issues to consider: (1) will the government’s response ultimately be successful? Will it be effective? And (2) If achieved, what will that “success” cost? Will it be efficient?
Unfortunately, so far, we’ve not heard a definition of success.
However, seven weeks after the approval of TARP, the results don’t look good. In fact, unless ”success” has been defined downward, the results look more like failure. The NASDAQ Index sits at roughly half of its twelve-month high, and has lost as much value since the passage of TARP—about 700 points—as it did in the period from its high last December to the end of September. Likewise, the S&P 500 has gone from about 1,524 last December to 806 today, with 366 points of that 718 point drop occuring since September 30. Ditto for the DJIA: down from 13,991 last December to today’s close three points below 8,000. It stood at 10,831 on September 30. Trillions and trillions of dollars of value destruction—both before and after TARP.
Thus, “success” however defined, seems doubtful. Moreover, any claim of success must be tempered by the very heavy cost bourne by taxpayers and investors. So, given those results, we’re very encouraged by Mr. Paulson’s newfound hestitancy to act. But is the too little arriving too late?
Don’t just do something. Stand there.
Given its similarity to our position, we very much enjoyed the recent opinion essay by our former Washington Univesity colleague, Russell Roberts in The Wall Street Journal. It was entitled, “Don’t Just Do Something. Stand There.” A month after our post, Out of Their Elements, and weeks after related posts like Well, This Is a Fine Mess You’ve Gotten Us into…., Mr. Roberts makes similar points, and he draws similar, discouraging, and almost depressing conclusions about the future. Unfortunately, that doesn’t give us even a quantum of solace.
Fortunately, however, it does seem that Mr. Paulson may have read Mr. Roberts’ column during the second weekend of November, internalized it, and vowed swift inaction in the turbulent financial markets.
Finally: doing nothing! But why did it take so long?
We write that because last Tuesday, November 11, Mr. Paulson rebuked the automakers and their advocates seeking TARP funds, and news reports both last week and this week note that the Treasury have no plans to buy troubled assets or implement new schemes. (Last Wednesday, in response to the news, we wrote Taking the TA out of TARP, and ungraciously gloated over the fact that we had correctly predicted the law’s ineffectiveness and potential harm nearly six weeks earlier.)
Last Monday, the day before Mr. Paulson denied TARP funds to the auto industry, we wrote Patience Please! They Just Need More Time!, which noted that the car manufacturers had 35 years—that’s THIRTY-FIVE YEARS—since the first oil crisis to change their ways. It seems that through the entire time—almost the life expetancy of a Russian male—management, the unions, and the dealerships have been locked in an interminable game of “chicken” with each waiting for the other swerve to avoid collision and death to reap the prideful spoils of victory.
While in some ways, Chicken seems like an apt metaphor, it ignores the fact that over the past 35 years, with each myopic decision the spoils have become smaller and smaller—and are now almost nothing. In that sense, the auto industry seems more like a black hole where a massive expanse (of warm sunshine and frenzied activity) has shrunken to a cold, shriveled, and nearly non-existent state. Yet, its mass—or more precisely, the mass of its liabilities—seems to warp and distort nearby space as it smothers and destroys everything within reach.
Unfortunately, the self-destruction of a once-vital and proud industry is not a game or a blackhole millions of ligh years away. It collapse is tragic and close and the collateral damage of the collective, short-sighted selfishness—measured in the hundreds of billions if not trillions of dollars and in terms of lives ruined—has been all too real. Moreover, the siutation is not interminable, but it finite, and the end is near.[1. We admit to being a bit overly harsh as it seems the ill-advised CAFE standards wouldn’t permit the Big Three to lever their competetive advantages with large cars and trucks. At one time, they did make the best large cars in the world (and we still love our Suburban.)]
So, in our mind, ignoring GM, Ford, and Chrysler seems to be both the efficient and just thing do, and we admire Mr. Paulson for admitting—even if only implicitly—that his earlier actions were mistakes. Clearly, we wish that he could have been a faster learner. It might have saved all of us hundreds of billions of dollars of cash and trillions of dollars of equity value.
It’s our view that The Government Will Save Us! Not!. Instead, we’d prefer that it get out of the way and provide incentives to private enterprise to act autonomously. In that spirit, we still propose A Better Solution (than a government takeover), which involves tax incentives for buyers of troubled assets. Those incentives could be implemented as investment tax credits or as extremely accelerated depreciation, and would provide large (30%-40%) and immediate tax savings that would cushion the downside risk of uncertain valuations. (The things are hard to value.)
Make an example: nationalize the worst one(s).
We’re generally almost libertarian in our free market approach to economics, but don’t get us wrong, we continue to urge the government to nationalize the worst capitalized banks: the very few, not the many. We’d much prefer the outright expropriation of the worst offenders both out of a sense of justice and as a warning to other firms to act quickly to save themselves rather than to wait for government handouts.
Just as importantly, with complete ownership of a few firms, it is much more likely that there would be many calls from many parties, especially competitors and potential investors, to re-privatize the nationalized institutions ASAP. That political pressure would prove to be very beneficial to reducing the government’s influence in financial intermediation.
Imagine if the government would have nationalized AIG, would the outcome have been any worse than what we’ve seen in the past two month? Would it have been any more expensive than it has already been? We’d argue—and have argued—that issues with collateral, including those related to AIG’s diminished credit rating, would have been mitigated through government ownership and creditworthiness.
Moreover, other than non-executive employees holding shares, we’d argue that none—not 10% nor 20%—of the old ownership structure should remain. That might induce shareholders in other firms to become a bit more activist and demand stronger and more knowledgeable representation on their boards of directors. (See our recent: The Failure of Boards to Direct.)
We’d prefer the frenzied, motivated efforts of bankers seeking creative solutions to their most vexing problem over the current scenario where hoarding of funds and waiting seem to be the preferred tactics. In that sense we as an economy, a nation, and a society are in no better position today than we were six or seven weeks ago.
We wrote about what has and continues to occur in Even A Perfect Bailout Will Fail and Financial Projection in a Crisis among other posts.
Unfortunately, the biggest difference between now and the end of September is that our collective equity holdings have lost about one third of their value, and new asset classes like CMBS are likely to depreciate like MBS already has. However, on the upside, it seems that Mr. Paulson is moving (or more accurately not moving) in the right direction.
In all seriousness, we do pray that our senior government officials take the right, reasoned, and thoughtful actions. We hope you’ll join us. Perhaps it’s working.
(This a long post; so, there are probably a number of typos, which we’ll correct during the coming days.)
