Spero Consulting

Posts Tagged ‘Decisions’

Update (01−20−09): now that Mr. Paulson’s term as Trea­sury Sec­re­tary has ended, we must admit that the small bit of opti­mism we exhib­ited in this post was sadly and unfor­tu­nately mis­placed. It was out-​of-​character for us, but we’re a hope­ful pes­imist. He quickly reverted to his behav­ior of Sep­tem­ber and Octo­ber, and for that, the mar­kets, the nation, and the world have and will con­tinue to suffer.

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.)