American Society

Hurricane Irene

We live in the Northeast and made it through Hurricane Irene virtually unscathed. We did lose power for nearly thirty hours. The experience made me think about politics, emergency preparation and modern society. I will present some thoughts in no particular order:

Unplugging from Civilization – When you have no power you are virtually unplugged from civilization. You lose internet, lights, land line telephone service if you use any type of phone requiring a plug to operate, refrigeration, television and other modern conveniences. You still have limited use of a cell phone, but the battery only has a limited charge. The same problem occurs with a laptop. It is kind of refreshing. We are way too dependent on electronic gizmos controlling our lives. Yes, there is a downside with spoiled food and not being able to watch the Yankees. However, there is an upside, some quiet time to read and think. Natural light is rediscovered as I moved around from rooms facing east to those facing west in order to read during the day.
Rediscovering Community – Suddenly, neighbors you barely know or speak to are providing information on tree damage, road closures and the state of power repairs. More people are on the street, just walking. Neighbors are happy to share food, water and help with tree limb removal.
Not Underestimating the Power of Nature – When the storm passed through on Sunday morning everyone breathed a sigh of relief. There was much scorn heaped on The Weather Channel and news outlets for “hyping” the storm because the winds fell short of hurricane force. The jubilation and finger pointing was short lived. Power failures started 12 hours after the storm hit. Tree damage and flooding were constant dangers for 3 days after the storm. As I write this blog five days after the storm, many local roads are still not open and many in my state still have no power.
Paying a Price for Deregulation – Local utilities (electricity, natural gas, telephone and water companies) are deregulated in my state. When these utilities were heavily regulated they were well-staffed. One could argue they were over-staffed, but there were always sufficient emergency crews to respond to a natural disaster. Starting my career with a regulated utility, I always thought we were at our best in the face of a hurricane or flood. In a deregulated world, with no ability to pass costs through in a “cost plus” regulatory model, staffing for such emergencies is a by-gone luxury and we the public now pay the price. Ask folks at the Jersey Shore or Westchester if they would like those bad old, regulated utilities back.
Feeling Vulnerable – There is nothing like a power blackout to heighten one’s sense of vulnerability. Sitting in a suburban home with no working alarm, fire detection equipment or street lights outside is a reminder that the house can be robbed and the occupants injured. Our small city did not change its policing of darkened areas. Few if any police patrols passed our home during the blackout. Suddenly, our quiet, peaceful neighborhood seemed a lot scarier and threatening. Further, who could be sure of a police response in the event we still were able to use a cell phone to call for help?
Relying On Our Government – The governor of my state and nearby states issued evacuation orders. These officials were later ridiculed for overreacting. As a corporate executive I learned the lesson that one can only operate on the best information available at any time. After the fact, one will always look either prescient or foolish. But, in matters of safety, it is better to be prudent. These governors should be commended for taking bold action. In the end, the flooding and power outages more than justified the evacuation decisions they made.

It is the current political fashion to bash government. I will leave you with a final thought drawn from a Biblical source, the Ethics of the Fathers: “Pray for the welfare of the government, for without fear of governmental authorities people would swallow each other alive.”

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Storytelling, Narratives, and Truth versus Fiction

Early on I heard lectures on trial presentation from Irving Younger and Judge Herbert Stern. Their approaches and strategies were similar to winning trials. Present a clear and concise story. Maintain constant credibility with jury and judge. Highlight the “bad facts” presented by one’s opponent. Defuse these bad facts. In essence then, trial presentation is a form of advanced storytelling, and a coherent narrative is crucial. Whoever assembles and presents the best and most credible story at trial wins.

I found these techniques equally valuable in speeches to employees or senior management. Importantly, the speaker must connect with the audience, be credible, coherent and passionate about his subject.

This brings us to the current plight of President Obama, who addresses the country on almost a daily basis. The public, however, appears to be tuning him out. His speeches are articulate and fact filled, but he is not connecting with his audience, the citizenry.

One Man’s Theory

Drew Westen, Professor of Psychology at Emory University, analyzes President Obama’s leadership and speechmaking. In a recent lead article in the Sunday NY Times, he asks, “What Happened to Obama?”

…watching…his inaugural address, I had a feeling of unease. It wasn’t just that the man who could be so eloquent had seemingly chosen not to be on this auspicious occasion… It was that there was a story the American people were waiting to hear — and needed to hear — but he didn’t tell it. What Happened to Obama?

Stories matter. They orient and inform us, transmit knowledge and impart values. The public was primed for a compelling story from President Obama on how we got into the financial crisis and, even more importantly, how he intended to get us out. Millions had lost their jobs and many more their savings. Westen continues with the story he wishes Obama had told:

“I know you’re scared and angry. Many of you have lost your jobs, your homes, your hope. This was a disaster, but it was not a natural disaster. It was made by Wall Street gamblers who speculated with your lives and futures. It was made by conservative extremists who told us that if we just eliminated regulations and rewarded greed and recklessness, it would all work out. But it didn’t work out. And it didn’t work out 80 years ago, when the same people sold our grandparents the same bill of goods, with the same results. But we learned something from our grandparents about how to fix it, and we will draw on their wisdom. We will restore business confidence the old-fashioned way: by putting money back in the pockets of working Americans by putting them back to work, and by restoring integrity to our financial markets and demanding it of those who want to run them. I can’t promise that we won’t make mistakes along the way. But I can promise you that they will be honest mistakes, and that your government has your back again.” What Happened to Obama?

The failure to identify the malefactors who created the crisis and the inability to create policies that correct those errors plagues the Obama Administration:

A story isn’t a policy. But that simple narrative — and the policies that would naturally have flowed from it — would have inoculated against much of what was to come in the intervening two and a half years of failed government, idled factories and idled hands. What Happened to Obama?

To paraphrase Professor Westen, a psychologist and not a politician, we needed to know that the new President Obama could “fix the mess.” Here was an untested politician with little leadership experience and no significant accomplishments, also a person of tremendous political charisma. So far, he has chosen to politicize, compromise and negotiate, but not to lead. Damningly, Professor Westen concludes:

….Barack Obama stared into the eyes of history and chose to avert his gaze. Instead of indicting the people whose recklessness wrecked the economy, he put them in charge of it. He never explained that decision to the public — a failure in storytelling as extraordinary as the failure in judgment behind it. … He would have offered them a counternarrative of how to fix the problem other than the politics of appeasement, one that emphasized creating economic demand and consumer confidence by putting consumers back to work. He would have had to stare down those who had wrecked the economy, and he would have had to tolerate their hatred if not welcome it. What Happened to Obama?

Leadership vs. Politics

Whether leading the United States or a corporation, sincere and forceful communication is vital. President Obama’s speeches feel like the lectures of a learned academic: an academic who is eloquent, but has taught the course too many times and has lost his passion and interest. He is reading his script, but we cannot tell if he believes it.

Americans thirst for a leader who can bridge the gap between government and their personal needs. Unfortunately, President Obama is more interested in being a smart politician than a good leader. In the movie The American President, an emotional aide beautifully describes the public’s need for strong leadership: “They want leadership. They’re so thirsty for it they’ll crawl through the desert toward a mirage, and when they discover there’s no water, they’ll drink the sand.” The fictional President replies, “…we’ve had presidents who were beloved, who couldn’t find a coherent sentence with two hands and a flashlight. People don’t drink the sand because they’re thirsty. They drink the sand because they don’t know the difference.”

A recent Gallup poll measuring Obama’s approval rating has dropped to a new low. The American public is catching on to the idea that something has gone terribly wrong. We are starting to understand the difference between the water and the sand. The basic structure of society is at risk. Will we continue to abide platitudes and mediocrity? I think we are better than that! We should be creating and defining and sharing our narrative, and then forcing it on a President and government who do not seem to know what is wrong.

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American Society / Business / Ethics / Financial / Political — 0 Comments
9
Aug 11

“My Word is My Bond”

A phrase I heard often from adults when I was growing up was: “my word is my bond.” I return to it often now, as it indicates to me not just a promise in a particular circumstance or business transaction, but rather a belief system. If we heard someone utter that phrase today would we believe it? Sadly these days, most likely we would believe that we were about to be defrauded or worse.

In my professional life, I have witnessed the steady decline in the bonds of interpersonal trust. The financial crisis of 2008, which has never really ended, demonstrated that trust between people has deeply eroded. It was not only the outright frauds of Madoff and other Ponzi schemers, but more mundane misbehavior as well: borrowers lying about their incomes and assets to obtain loans, and lenders deceiving borrowers, government regulators and their shareholders.

It is time to reflect on some biblical wisdom.

The Bible and Truth

Sir Jonathan Sacks, Chief Rabbi of the United Kingdom, in his weekly blog “Keeping Our Word,” examines the Bible’s attitude toward vows and oaths, and the interconnection of trust with freedom. As background he first examines adherence to the law. People obey laws for two reasons: (1) because of they are fearful of power and punishment or (2) it is to their self-interested advantage to do so. However, both power and self-interest frequently corrupt those who pursue them. And corrupt power will lead to loss of freedom. And corrupt self interest will lead to loss of social cohesion.

The Bible offers a third, more positive, reason for obeying the law:

… people obey the law because they have voluntarily undertaken to do so. This is a society based not on power or the pursuit of self-interest but on freely embraced moral obligation. Keeping our Word

We use words, performative utterances, to bind our future behavior, thus creating “an orderly future out of the chaos of human instincts and desires.” The Bible is telling us that words create:

…because words are holy: that is to say, they bind. When words bind, they generate trust. Trust is to society what predictability is to nature: the basis of order as opposed to chaos.

Social institutions in a free society depend on trust, and trust means that we keep our word. We do what we say we are going to do. If we make a vow, an oath, a promise, a verbal undertaking, then we hold ourselves bound by it. This means that we will actually fulfil our commitment unless we can establish that, due to circumstances unforeseeable at the time, we are simply unable to do so.

If trust breaks down, social relationships break down, and then society depends on law enforcement agencies or some other use of force. When force is widely used, society is no longer free. Keeping our Word

Stated simply, words, vows, oaths, promises and freedom are all intertwined. When trust breaks down, freedom is lost.

The Current Crisis in Trust

At the core of our current sad state of affairs is a lack of trust. We cannot count on our leaders to keep their word. Government statistics are constantly “massaged” and restated. When can we remember a business leader or politician telling us the truth? Truth rarely emerges until we reach the crisis stage.

A memory and observation from my working life: when I first started practicing law more than 35 years ago, I was routinely involved in corporate acquisitions and divestitures. A contract to sell a business with several hundred million in sales (a large transaction at the time) would run less than 100 hand-typed, double spaced pages. By the time I retired, a similar transaction would require massive teams of specialized lawyers: corporate, tax, employment, environmental, and more. The documents would run into the thousands of pages. At the end of such a transaction, I might receive several embossed, hard bound books for my library shelf (the size of a small encyclopedia). Why? I do not think we became more sophisticated. I believe we trust each other less. The same phenomenon occurs in federal regulations, with the Code of Federal Regulations filling an entire library wall. Do all these laws, regulations and words create more or less trust?

Perhaps if we had a little more trust, we would need fewer words. And when we uttered or wrote those words we would really mean them.

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5
Aug 11

The Meal Was Great…Part II

Dinner with friends included lots of discussion points that resonated and reminded us of our corporate working lives. While these points were clear to us as working persons, our perspectives from the outside render these points just as important. The revealing fact that hits home so closely is: Americans are being impacted by flawed policies and assumptions whether employed or not, or impoverished or not.

Financial Sector Dominance – Government policy encouraged the growth of the financial sector at the expense of the “real economy.” Glass Stegall, which separated banking operations from trading operations, was repealed by Graham-Dodd. Devilishly complex financial instruments became Wall Street fee generating devices at the expense of traditional lending. These firms became employers of choice for talented university graduates.
The Short Cut Society – Instead of saving for a house, a vacation or a new appliance we were happy to use credit cards or second mortgage lines for instant gratification. Instead of a boring career in manufacturing, better a Wall Street trader or hedge fund manager. CEOs expected huge compensation packages regardless of performance quality.
Spin vs. Truth – Shading of the truth became a national obsession. Instead of honest reporting of inflation statistics, hedonic adjustments lowered the consumer price index, depriving social security recipients and federal pensioners of earned cost of living adjustments. CEOs spun disappointing earnings results taking write offs, obfuscating the accounting or lowering earnings guidance so that when earnings were finally announced “they beat expectations.” Congress is no better, promising “smoke and mirrors” debt reduction plans with little, if any, real deficit reduction.
Lack of Political Leadership – The debt reduction exercise is one more example of the lack of leadership at the Chief Executive and Congressional levels. Politicians are more concerned about preening before cameras than serious statesmanship. Bipartisanship seems like a quaint relic of a bygone era.
Congress for Sale – Given the enormous cost of congressional races, representatives are in a constant search for dollars from corporations and other large contributors. Thus, we have Congress captured by special interests. Congress has long forgotten the middle class voter. The appearance is that Congress is totally beholden to the corporate sector and that corporations appear entitled to special relief any time they are in need.
Complexity – Complexity pervades every part of our political and economic system. Complexity is used to muddy rather than clarify. The tax code, Obamacare and financial reform are the latest examples of overly complex legislation and accompanying regulation. Only an army of lawyers can navigate through these legal minefields. Conveniently, citizens are kept in the dark and small businesses cannot afford to compete with larger enterprises.
Rise of the Nanny State – We recently had New York’s ridiculous attempt to regulate kickball, dodge ball, waffle ball and Red Rover as dangerous activities needing state oversight and a permit. See Classic Kid Games Like Kickball Deemed Unsafe by State to Increase Summer Camp Regulation. This is emblematic of a society which demands a legislative or regulatory solution to every problem. Businesses must be protected against failing (GM, Chrysler, Citicorp, AIG), employees must be permitted leaves for such mundane diseases as chronic sinus infections (Family and Medical Leave Act), and the public must be protected against carcinogens such as the sun and salt. Every aggrieved person must have a day in court. Spill hot coffee on oneself, bring a lawsuit against McDonalds. Play football and suffer an injury, sue the helmet manufacturer. Somebody is always to blame and our legislative bodies are all too willing to protect us against life’s vicissitudes.
Free Trade– Say it fast and free trade sounds like a great idea. Cheap foreign goods enrich our lives. Thus, Ross Perot was ridiculed for saying that NAFTA’s giant sucking sound was American jobs heading for Mexico. Mr. Perot sold American ingenuity short: American jobs are heading for China, India, Vietnam and a host of other low wage countries. These countries have few, if any, labor, anti- discrimination, family and medical leave, unemployment, child labor, environmental or safety laws. American workers are being asked to compete against workers who are paid subsistence wages and afforded no protections. Our politicians are only too willing to serve corporate interests at the expense of the American worker.
Immigration – Immigration is probably the purest example of selective enforcement of our laws. It is difficult for American workers to compete against Chinese or Indian workers. The problem is even greater as regards undocumented residents in our country. Further, the cost of medical, education and municipal services is underwritten by the American taxpayer. In places like Texas, Arizona and California this puts enormous strains on state and local budgets when education and medical services must be extended to undocumented residents.
Structural Unemployment – Technology and job outsourcing has added to shockingly high unemployment rates. It is not clear whether any of these jobs will ever return. As we pointed out, zero interest rates lead to use of more labor saving capital equipment at the expense of hiring workers. See The New York Times Finally Discovers Structural Unemployment. Hence, our employment problems may not be temporary but a permanent feature of the economic landscape.

All of the factors are intertwined. In fact, they are negatively synergistic. For example, a Congress that supports failed banks condemns savers and pensioners to miniscule return on savings, further compromising any incipient economic recovery. A below trend economic recovery only encourages the exile of more jobs overseas so that corporations can retain profitability.

Believe it or not, dinner was pleasant and more. But our conversational substance and concern for what is happening with our country and what is wrong with America indeed cast a cloud over all our thinking. Along with other “ways that we were,” optimistic was also one of them, and that is much diminished.

After all this postulating about what is wrong, clearly what should come next are some hypotheses about solutions that can work. A discussion for another blog.

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3
Aug 11

The Meal Was Great; Our Outlook, Not As Good

I had dinner the other day with two close friends, both former colleagues. We are, in parlance, “men of a certain age:” baby boomers, children of the sixties, sons of World War II veterans. We all began our work lives in our twenties, worked for giant corporations, and turned jobs into long-term careers. When first hired by our companies, we planned to stay just a couple of years and then move on to another company. With the benefit of hindsight now, and the need for false humility ended, we can each gratefully admit that we enjoyed significant professional success, although none of us thought we would rise to the senior executive levels that we did.

We now occasionally get together for dinner and discuss our families, our current pursuits, how our former employer is doing and the general state of things. Last time, we discussed what went wrong with America generally, why our children will not have long careers with large companies, and why they likely will not be as financially successful as we were.

We spoke about our fathers and the norms of their generation. They fought in the War, returned and worked hard, and had few expectations about success or wealth. They kept their noses to the grindstone and rarely complained.

We discussed the landscape of the corporations we went to work for. When I was hired as a junior attorney, the General Counsel barely made five times my salary. Bonuses were stingy and a modest number of stock options (in the hundreds of shares) were offered to a handful of our most senior executives. Interestingly, it was generally a harmonious and engaging work environment. In contrast, by the time I retired, the Chairman and CEO made more than 400 times what an average employee made. Employees were not nearly as engaged or happy.

The immediate catalyst for our wondering what has gone wrong with America was the current debate over the US debt ceiling. I started to think back to the blogs I had written and tried to put together some hypotheses. I caution the reader this is not a rigorous, but rather an impressionistic view of sociological, political and economic trends which shape the current state of affairs. If it is insightful, I give tribute to good dinner conversation and fine friendship:

Loss of Shared Sacrifice – Perhaps it was the “Me Generation” of the 1960’s, but America has lost its sense of shared sacrifice; that is, the notion that we are all in this together and we rise or fall as one nation. Instead we have an ethic of greed: I want what I want and I want it now, everyone else be damned.
Out of Control Military Spending – Too much of America’s resources are spent in our defense budget. Compounding this problem is a series of seemingly endless wars. While we deploy hundreds of thousands of troops to Iraq and Afghanistan, our allies deploy hundreds. Note that the German, Canadian, and Australian economies boomed, while ours stagnated.
The Volunteer Army – A volunteer army allows wars to be fought by other people’s children. Thus, the popular outcry against wars or military spending is diminished because our own (privileged) sons and daughters are less likely to be involved.
Too Many Laws – The Wall Street Journal highlighted the growth in federal criminal law. We over-criminalize too many areas of society. One commentator archly noted that someone violates some law each day, often unaware of his lawbreaking conduct. See As Criminal Laws Proliferate, More are Ensnared
Unequal Enforcement of the Law – Perhaps since the OJ Simpson trial, our citizens cynically believe that if one hires a good enough lawyer, one literally can get away with murder. This carries over to the belief if a corporation is big enough, especially a “too big to fail” financial institution, it will never be prosecuted.
Socialism for the Rich, Capitalism for the Poor – When the “too big to fail” institutions became insolvent, the Bush Administration, Congress and the Federal Reserve rushed in with a comprehensive program of TARP and zero interest rate lending. The Obama Administration has continued these policies from the beginning. Insolvent homeowners have been evicted from their homes, and many unemployed workers have exhausted their unemployment benefits.
Reckless Lending and Borrowing – The Federal Reserve was a major culprit in the growth of both public and private credit. Instead of accepting the economic consequences of the internet bubble crash, Alan Greenspan reduced interest rates to below market levels to encourage real estate lending. Subprime lending further inflated the housing bubble. Based on an inflated residential and commercial real estate market the economy boomed. Assuming that this was permanent prosperity, debt was taken on at all levels: states and municipalities, corporations, homeowners and the federal government. Now we cannot repay that debt.

While my dinner with friends continued all in one evening, Part Two will continue this discussion.

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American Society / Banking / Economics / Financial / International Finance — 0 Comments
19
Jul 11

Random Observations

What an exceedingly strange period in our economic and financial history! Amidst a non-recovery economic recovery we have below par growth and high unemployment. Coupled with economic weakness we have above trend inflation. Let us consider some of the odder stories from last week:

Ben Bernanke and QE3

The first two exercises in quantitative easing have had mixed to negative consequences. While the stock market has almost doubled from its low, the “real economy” has languished. We can further document the relationship between QE and poor economic performance with a look at price hikes in key commodities such as food and energy.

Yet here is Dr. Ben Bernanke before Congress, once again selling us a product repair that simply does not work. On Wednesday, he made it clear that QE3 was part of his thinking. And even he is not altogether sure. On Wednesday, he backed away from an immediate move to start a third round of Fed money printing and bond buying. See QE3 Guaranteed to Fail

Is there any reason that Dr. Bernanke still holds his job? While his supporters point to a rise in stocks, the “real economy” has suffered. Aren’t there better candidates for his job, who will try some new ideas? Are money printing and market manipulation the only ideas that any of our leaders can come up with? And to further the irritation with our Princeton economic guru, note that stocks used to rise and fall on company earnings and the economic outlook, not on which side of the bed the Fed chairman woke up on.

Don’t Worry Be Happy: Just Disregard Europe’s Problems

David Goldman in Inner Workings points out that the financial crisis in Europe will not be a rerun of Lehman’s 2008 meltdown:

Under the headline “A Fate Worse Than Banking Crisis” my friend John Dizard at the Financial Times points out that any run on Europe’s banks would be instantly countered by swap lines from the Fed and ECB. His point (one I have been making for some time) is that the scope of the European banking problem is well known and that mechanisms have long been in place to deal with the worst-case scenario. Not so with Lehman, where a sort of China syndrome applied: no-one knew the amount of contingent liabilities that might be affected. See Once Again: It’s Not Lehman II

Mr. Goldman continues to calmly assure us that European problems will not create another financial meltdown:

My conclusion: there is no reason to panic over the present kerfluffle, but there is no reason to own any exposure to southern Europe. Ever again. See Hopeless, But Not Serious: Once Again.

It’s too early to blow the “all clear” whistle on capital markets, but today’s recovery in the major US stock indices reassures me that this is not another financial crisis on the September 2008 scale, just a particularly nasty negotiation after which Italians, Greeks and Spaniards will end up poorer (along with Minnesota teachers, Wisconsin firemen and New Jersey policemen). It was amusing to see the usual suspects among the Street strategists issue dire warnings about increased tail risk just as markets turned around. See Ken Lewis, George Soros and Other Hedgehogs

So Mr. Goldman is assuring us of financial recovery based on one day of a US stock market rally? His prognostications eerily remind me of 2007 and the assurances from Ben Bernanke, Hank Paulson and other financial luminaries that the subprime crisis was well contained. Stock markets rallied then too, only to decline disastrously a year later.

Yesterday was a stark reminder of how unsafe Europe really is:

Greece 2 year interest rate on sovereign date: 34.5%
Portugal 2 year: 21.2%
Ireland 2 year : 23.3%
Italy 2 year : 4.65%
Spain 2 year: 4.55%

America is only marginally safer than Europe. American research firm Egan-Jones recently also downgraded US Treasury debt. See Europe is *Not* “Safe”

Are We Better Off Now Than In 2008?

We live in a financially interconnected world, and I am not at all reassured by Mr. Goldman. I doubt that anyone knows what the effect of a bankruptcy in Portugal or Italy would have on world financial markets. Could anyone have predicted that the 2008 financial crisis would take down AIG and Lehman and send US banks scurrying to the Treasury for TARP funds? Do we think the world and the major financial institutions can better weather a storm now than in 2008? While I may not know, I am more fearful that Bernanke, Goldman, Dimon and Blankfein do not know either, and they are out there making predictions and advocating policy.

Europe, China and the US have spent trillions of dollars trying to bolster their economies. What if we have used all our money-printing ammunition and the next crisis is even worse?

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6
Jul 11

Recycling Losers

A curious feature of institutional behavior is the tendency to hire or retain executives who have failed in their jobs. A prime example of such behavior is the hiring of baseball managers. Baseball is enthralled with the familiar. So it seems the best way to get a manager’s job is to be fired from one. Despite their undistinguished records, managers like Jim Fregosi (win/loss record 1028-1095); Jerry Narron (291-341); Grady Little (385-290); Dallas Green (454-478) and a host of others were fired by one club, and then hired by another. Many were given veteran clubs with proven stars, and yet they could not win championships. Anecdotally, baseball was often accused of recycling old white men. But recent reforms in baseball have demonstrated an equality of mediocrity if you will, as baseball has recycled minority managers with losing records.

The same dysfunctional thinking occurs in American business. After being fired in the wake of the Bank of America merger, John Thain went from leadership at Merrill Lynch to head the CIT group. Robert Rubin remained as Chairman of Citicorp after the financial crisis (although he resigned in 2009). Lloyd Blankfein at Goldman Sachs and Jamie Dimon at J.P. Morgan continue in their positions.

President Obama assembled his financial team and shamelessly recycled flawed people: Ben Bernanke (Federal Reserve Chairman); Timothy Geithner (Secretary of the Treasury); Lawrence Summers (Head of the Council of Economic Advisers); Robert Rubin (economic adviser) and Jeffrey Immelt (President’s Economic Recovery Advisory Board). Without cataloging their financial sins, clearly each of them contributed in a major way to the near collapse of the American financial system.

Failing Upward

In an aptly named article, Failing Upward, Yves Smith highlights the hiring of Madelyn Antoncic as Treasurer of the World Bank. Ms. Antoncic’s previous position was Chief Risk Officer of the bankrupt Lehman Brothers:

The World Bank has appointed Madelyn Antoncic as its new vice president and treasurer.

Ms Antoncic served as Lehman Brothers’ chief risk officer from 2002 to 2007 and following the collapse of the bank, stayed on for a year as managing director and senior advisor at the Lehman Estate, helping to maximise value for creditors….

Commenting on the appointment, World Bank Group president Robert B Zoellick, says: “Known for her forthrightness, I am delighted Madelyn is taking up this important role.” See Failing Upward

Ms. Smith concludes that large financial institutions are comfortable hiring familiar people for big jobs, no matter how poorly they have previously performed.

Forthright but Ineffective

Robert Zoellick praises Ms. Antoncic’s forthrightness. Another analyst comments that she “was likely the only person on Lehman’s executive committee who had any sense.” See World Bank Taps Ex Risk Officer as Treasurer. But we then learn that senior management knew that the firm was taking on too much risk. What was Ms. Antoncic’s role in controlling risk; indeed what did she know? Was not controlling risk essentially her job?

So where was Antoncic to reign in such risk during that time? Well, she was being kicked out of executive meetings where risk was being discussed. Antoncic, with her PhD in economics and a prior 12 year stint at Goldman Sachs, might have know Lehman was taking too much risk but her opinion was blatantly disregarded when she was removed from Lehman’s executive committee in 2007. See World Bank Taps Ex Risk Officer as Treasurer

So Ms. Antoncic, the lonely voice of reason, was kicked off the executive committee. I do not know Ms. Antoncic, but her behavior raises important management questions. Did she resign from Lehman? Did she inform the Board of Directors or government regulators that the bank was taking on too much risk and might collapse? No, she continued to collect her paycheck, a monument to her ineffectiveness and her questionable ethics. If she was one of my employees, I would have fired her. Forthright but ineffective just does not cut it.

Too Comfortable

Executives become too comfortable. Instead of hiring a challenging subordinate who can bring fresh ideas, they are more likely to hire a loyal unchallenging stalwart who can maintain the status quo. In a more cynical view of things, I would suspect that Mr. Zoellick found the right employee in Ms. Antoncic. She would be beholden to him, be loyal to a fault and never challenge his decisions. Unfortunately, these are valued traits in corporate America and in government and can be summarized: “go along and get along.”

In my own experience I watched poor performing executives fail and then be promoted to a larger assignment. I once quipped that you could not be promoted until you made at least a $500m dollar mistake. That would demonstrate that you were a real player. Obviously, Ms. Antoncic was a “real player.” It took a real talent to be part of team which bankrupted a major investment bank and nearly crashed the entire economy.

The financial crisis will remain intractable as long as we continue to recycle the same financial players and government advisers who got us into this mess. We need smart people with new ideas and different energy who can get us out this quagmire. It is going to take the truly exceptional Board of Directors, CEO or US President to get rid of the wrong people, locate and hire the right people, and break with the past. Perhaps it is time to afflict the too comfortable.

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3
Jul 11

All Millionaires are Not Created Equal

In Is Debt Ever Good? we contrasted productive debt and non-productive debt. There is a duality with millionaires as well. Some are productive and some are not.

At his Wednesday press conference, President Obama adopted what he figured would be the populist stance, and he vilified millionaires as a group:

Mr. Obama repeatedly mocked tax breaks that he said were for “millionaires and billionaires, oil companies and corporate jet owners,” saying that voters would not look kindly on Republican lawmakers who defended such breaks at the cost of cuts in popular programs like health care, education and food safety….

“If you are a wealthy C.E.O. or hedge fund manager in America right now, your taxes are lower than they have ever been. They are lower than they have been since the 1950s. And they can afford it,” Mr. Obama said. “You can still ride on your corporate jet. You’re just going to have to pay a little more.” See Obama: Republican Leaders Must Bend on Taxes

The financial press immediately declared this as “class warfare.” See e.g. Obama’s Case Against the Rich Rings Hollow. I would conjecture that the American public can distinguish between the good millionaire, who creates jobs and real wealth, and the bad millionaire, who becomes wealthy through political maneuvering or illegal activity.

The Productive or “Good” Millionaire

Americans applaud individuals from all backgrounds who have an innovative idea and are able to execute and create real wealth. Bill Gates (Microsoft); Sergey Brin and Larry Page (Google); Steve Jobs (Apple); Jeff Bezos (Amazon); Pierre Omidyar (EBay); Mark Zuckerberg (Facebook) and a host of other entrepreneurs identified a business need, created a new product or service, raised private capital and became wealthy. Even in the much maligned financial industry there were pioneers such as Charles Schwab who brought discount brokerage and other financial services to the average investor. These are thriving enterprises, which need no government assistance or special tax breaks to make money and create jobs.

The Non-Productive or “Bad” Millionaire

Unfortunately, we have too many examples of this type of wealthy interloper:

Failed Bankers – Richard Fuld (Lehman), Charles Prince (Citicorp) and Ken Lewis (Bank of America) are examples of bankers who drove their institutions into bankruptcy or made them wards of the state. Each of these individuals secured great wealth and suffered no compensation “clawbacks” or criminal prosecution.

Failed Corporations – During the financial crisis, companies like General Electric almost went bankrupt. When they should have diluted shares and jeopardized their own stock-based compensation through equity and debt offerings, crony capitalists such as Jeff Immelt called on their Washington “friends” to extend large, below market rate, irresponsible loans to GE.

Under- performing Corporations – Legions of CEOs collected large compensation packages while their businesses, employees and shareholders suffered. Instead of amassing their personal largesse at company expense, many an under-performing CEO should have been dismissed.

Criminal Enterprises – Ken Lay and Jeff Skilling of Enron and Scott Sullivan and Bernie Ebbers of Worldcom, among a long and undistinguished list of corporate malefactors, were able to deceive shareholders and bankrupt their businesses. And worse, each amassed a large personal fortune.

Defense Contractors – A small, tight knit cadre of defense contractors feed at the Defense Department trough. Many of these contractors have been accused of violating various bidding and other contracting rules, but are never disqualified from bidding on future contracts. Cost overruns, delays and malfunctioning systems occur far too often.

Why Are Americans Angry?

We are angry at millionaires who game the tax code, misrepresent the financial status of their businesses, and seek government bailouts while continuing to pay themselves outsized compensation packages. We resent non-performing CEOs who continue to be richly rewarded. We oppose government contractors with cozy Washington relationships. To the average American, these millionaires win because the game is rigged.

Americans applaud the honest entrepreneur because he or she fills a real societal need. Further, these individuals are the best examples of the American spirit and ethos of creative imagination, perseverance and hard work yielding a valuable result. Americans do not want to destroy these individuals; they want to be these individuals. Obama is overreaching when he paints all millionaires with the same brush. What Americans want is an end to the bailouts and special deals that destroy incentives for honest entrepreneurs and both create and protect the undeserving rich. Americans want a level playing field so they can compete and become wealthy, too.

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American Society / Oil / Political — 0 Comments
30
Jun 11

The Law of Opposites

In management settings, the law of opposites applies far more often than many executives would admit. On its face, the law is counterintuitive. One concentrates much energy and time on setting and achieving a certain goal and despite best efforts the exact opposite occurs. This paradoxical construct is closely allied to another behavioral law: that of unintended consequences. Writing about politics and government, Ron Paul gives us some insight and some examples:

Everyone is aware of the Law of Unintended Consequences. Most members of Congress understand that government actions can have unintended consequences, yet few quit voting for government “solutions” – always hoping there won’t be any particular unintended consequences this time. They keep hoping there will be less harmful complications from the “solution” that they currently support. Economics teaches that for every government action to solve an economic problem, others are created. The same unwanted results occur with foreign policy meddling.

The Law of Opposites is just a variation of the Law of Unintended Consequences. When we attempt to achieve a certain goal – like, “make the world safe for democracy,” a grandiose scheme of World War I – one can be sure the world will become less safe and less democratic regardless of the motivation. See The Law of Opposites

Opposites and Consequences in the Workplace

In the business world, both laws frequently apply. Oftentimes employees complain that they are not appreciated or promoted. Worse, they observe less qualified employees who are. My advice on promotion to any employee was: forget about it. Go back, do an outstanding job, and hope that excellence will be recognized and promotion will follow. Most of the time, the complaining individuals spent much of their time not doing excellent work because they spent way too much of their time complaining. These were the schemers, not the doers. Inevitably, the job performance of these employees suffered. These employees did not want to hear: “relax, go back, work hard and do a good job.” They felt there was some secret formula that I, the supervisor, was hiding from them. While it is naïve to think that everyone who does a good job gets promoted, it is a sure bet that needless complaining won’t get an employee there.

Similarly, friends and colleagues in conversation would often say how they wanted to be rich. Rarely does a person become quickly and safely rich. The fantasy goal in these conversations was usually some high risk, short term investment which would provide that mythical short cut to riches. Alas, the only short cut to riches isn’t that at all: it is hard work, thrift, consistency, perseverance, and perhaps a little luck. My best advice to these friends and colleagues is similar to the directives to my “underappreciated” employees: relax, save some money, invest wisely and grow rich over time.

Paradoxically, the more one focuses on a goal, the less the chances of success. It is much like the philosophy of Inner Tennis: Playing the Game: the more one focuses on the score and winning the game the less likely one will succeed. Relax, see the ball, hit the ball, success will follow.

Solving Economic Problems

This personal rumination brings me, once again, to the actions of the current administration. Somehow bailing out the banks and car companies, setting interest rates at zero, and printing money was going to solve our economic problems? What did we get by doing this? A slumping economy (euphemistically called a “soft patch”); falling house prices; 45 million Americans on food stamps, and soaring food and energy prices. While the goal of the Administration was not to destroy the economy, look at what has occurred. Speculators in stocks and commodities have thrived at the expense of taxpayers and millions of our citizens.

The latest Administration skirmish with the law of opposites was tinkering with the strategic petroleum reserve (SPR). On June 23, the International Energy Agency (IEA), with full support of the Obama Administration, released 60 million barrels of oil from its reserves. Fully half of these reserves came from the US. Republicans and others claim that this effort was done for political reasons to lower pump prices for beleaguered consumers before the 2012 election. See Global Oil Reserves Tapped in Effort to Cut Cost at Pump. The Huffington Post applauded this maneuver. While conceding 60 million barrels represents only 16 hours of worldwide oil consumption, prices dropped 6% and speculators were chastened. See Strategic Petroleum Reserve Release under Fire – For Being Effective.

But the strategy was transitory, ephemeral, and ineffective. By Tuesday, June 28^th, both crude and gasoline prices surged past the price they had been at immediately before the June 23^rd IEA release, a reprieve from higher oil prices of just five days.

Kevin Kerr, of Money and Markets predicts that the release will completely back fire, and will result in a dramatic spike in prices:

It’s another foolish rob-Peter-to-pay-Paul action by the imploding U.S. government.

The careless action taken by the IEA and President Obama, has now underscored how worried they actually are about global economic growth and tight supplies. So in essence this move could actually stoke the fire to drive prices much higher, much more quickly.

In a recent Bloomberg report, Caroline Bain, of the Economist Intelligence Unit, was quoted as saying:

“Although the immediate impact of the IEA’s reserve release will be to depress prices, in the more medium term, it could actually be bullish for prices. Reserves are finite and cannot be released forever.”

Unlike Uncle Ben’s printing press that never seems to run out of ink, oil supplies are not something the U.S. government can simply print more of.

To put the gravity of the situation in perspective, this is only the third time in the past 50 years that IEA has released strategic reserves. And in order to tap the SPR, President Obama had to authorize it.

Frighteningly, the prior two times resulted in super-spikes. And I think we can expect that record to hit 3-0 very shortly. See Why Obama’s Desperate Move Could Send Oil Prices Soaring

Once again, the Administration undertook a policy shortcut for political reasons and it backfired. Further, we have renewed speculation in a key commodity. Wouldn’t a more functional way to deal with high oil prices be to encourage supply increases through responsible exploration, and reduce demand through conservation?

Gimmickry

Unfortunately we live in the age of gimmicks. If we could only find the right interest rate, the most robust stimulus package, the most flexible accounting rules, a way to get the stock market to boom, or the right oil price our economy would be healed and we would again be prosperous. The law of opposites mandates that the longer we focus on the problem and tinker, the more those nasty, unintended, negative consequences will occur and move us further away from our goal. Only hard work, thrift and political integrity solve these intractable problems, yet the Administration and the Federal Reserve keep searching for the quick fix. As long as that is the case, we are doomed to more unintended consequences, shaky financial markets and a weak economy.

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American Society / Financial — 0 Comments
26
Jun 11

Is Debt Ever Good?

All debt is not created equal; some is productive and some is not. The subtle difference between the two types of debt eludes many economists.

But why is this important? Why do economic theorists and those who make decisions need to pay attention? Because the quality of the debt determines whether or not it can be re-paid. And if we cannot repay our debts in a productive way, we all suffer.

Productive Debt

Productive debt creates wealth. When we borrow to start a business, expand an existing factory, or purchase needed supplies at advantageous prices we create productive debt for a valid reason. The borrower is utilizing capital to generate returns in excess of the cost of capital. Further, prudent borrowing holds out the possibility of “sustainability”: meaning that the created wealth can be replicated. Borrowing to expand a semi-conductor factory spurs further production, creating jobs, orders for suppliers and tax payments. The lender has the security of a productive asset and a stream of income to ensure re-payment of the loan.

Non-Productive Debt

During the credit expansion of the last decade non-productive debt proliferated. Borrowing took place to buy automobiles, plasma televisions, appliances, single family homes and snowmobiles among other consumer items. Each of these “assets” depreciates rapidly and has attendant upkeep costs. The debt-laden purchase of any of the above items never led to increased wealth, it merely added another consumer trapped in a debt-ridden life. In the case of debt-laden purchases of single family homes consumers saddled themselves with mortgage, taxes, insurance and other upkeep costs. Lenders exacerbated non-productive debt through lax lending standards (lending to sub-prime borrowers) and innovative financial products (adjustable rate mortgages, 125% loan to value, second mortgages). Lenders believed that they would be bailed out of bad loans through ever-rising house prices. Unfortunately, we learned that this was a faulty assumption.

A second area of non-productive debt is equally pernicious. Ultra low interest rates have encouraged speculation in stocks and commodities. Leveraged investments de-stabilize the economic system through inflating asset values, spurring commodity inflation and ultimately creating bubbles and inevitable crashes.

The Shangri-La of Non-Productive Debt

Doug Noland characterizes the United States as the worst offending country in the making of nonproductive debt. In his analysis, he is critical of the loose policies of the Federal Reserve, which encourage unsound lending and have contributed to our bogus boom and inevitable bust:

First of all, booms create a fragile mountain of debt not supported by underlying wealth-creating capacity. Second, Credit Bubbles inflate various price levels throughout the economy, creating systemic dependencies requiring ongoing debt and speculative excess. And, third, the boom in non-productive debt will tend to foster consumption and malinvestment at the expense of sound investment in productive capacity. When the boom eventually falters, market revulsion to unsound debt, the economy’s addiction to uninterrupted Credit expansion, and the lack of capacity for real wealth creation within the (“Bubble”) real economy ensure a very severe crisis and prolonged adjustment period. These dynamics become critically important as soon as a government (finally) loses its capacity to perpetuate the Bubble (i.e. Greece, Portugal, Ireland, etc.)

As a crisis unfolds, the markets eventually must come to grips with a very harsh reality: There will be denial and it will take some time to really sink in – but the markets will come to recognize that too little of the existing debt is backed by real wealth. Non-productive Credit booms are, after all, essentially “Ponzi Finance” schemes. See The King of Non-Productive Debt

At this point, the Federal Reserve is faced with severe choices. It can risk economic implosion, or it can continue to mainline “the debt addict” with greater and greater infusions of new debt. As we are now witnessing, this money is going into speculation in the commodity and stock markets rather than into productive investment in the “real economy.” Real economic activity is suffering at all levels as income is diverted to debt re-payment and prices of key commodities soar.

Built on Sand?

A visual metaphor can help us understand how dangerous, unstable and fragile an economy becomes with a mountain of non-productive debt:

What makes sand piles so interesting is the usually seamless transition from stability to collapse. One can add grains to a sand pile for quite some time without disturbing its stability – it simply grows bigger and bigger. Alas, eventually the point is reached when one grain too many is added or is put in the wrong place, and an avalanche and collapse of the sand pile will ensue.

These sand pile dynamics appear to have a lot in common with the modern-day financial system – they serve at the very least as a good metaphor. Of course a crucial difference is that grains of sand do not exhibit purposive behavior, whereas the financial system is populated by thinking and acting human beings. Nevertheless, there are some interesting parallels. Just as a grain of sand near the bottom of the pile has no direct connection to one lying at the top, the various cogs in the financial machinery are likewise not necessarily connected directly with each other, but what happens in one area of the system nonetheless tends to reverberate through the whole system. See The Edifice of Debt

Collapsing Castles

There are two simple principles to consider in evaluating the ongoing financial crisis. First, does individual income, or tax collection generally, support our current level of outstanding debt? Second, is Michael Shedlock’s admonition true: “what cannot be paid back, won’t be paid back“? Fantasies of resolving our debt in creative ways, like selling national assets such as road systems or national parks, are just that – fantasies. Selling physical vestiges of our national heritage is not only soul-destroying and stupid, it just won’t work.

And yet we continue to accumulate non-productive debt at an alarming rate. Was the collapse of the sub-prime market the “grain of sand” that caused near systemic collapse? What will be the next grain of sand? What will be the consequences?

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Prophet Without ProfitThinking Non-Linear