What appears as the lead in the Huffington Post this morning?
“What a Waste: Companies Using Piles of Cash to Buy Back Stock, Not Generate Jobs!” This headline points to an article in the Washington Post: http://www.washingtonpost.com/wp-dyn/content/article/2010/10/06/AR2010100606772.html?hpid=topnews.
It was the lack of discipline that got this country where it is now. The recipe that some people are pushing for is “more of the same!”
The United States has been a show case for the “lack of discipline” over the last fifty years. The credit inflation initiated by the federal government has grown and expanded to almost every sector of the economy. Almost everyone, public and private, has leveraged up to the hilt over this time period.
The question remains: did we reach levels of debt that were unsustainable and had to be reduced?
Other questions follow: Have we misdirected resources in ways that have left one out of every five people of employment age untrained for employment in today’s workforce? Have we, like Japan, created surplus capacity in industry through fiscal stimulus and excessively low interest rates? Have we provided incentives that the wealthy can take advantage of, which the less-well-off cannot?
And, the problems swirl around us.
Elizabeth Warren pointed to the 3,000 commercial banks in the United States that are seriously in trouble and face enormous pressures due to the commercial real estate loans that are coming due or re-pricing over the next 12 to 18 months.
There have been numerous articles over the past week or so about the fiscal woes that cities face. (See the New York Times article “Fiscal Woes Deepening for Cities, Report Says”: http://www.nytimes.com/2010/10/07/us/07cities.html?ref=todayspaper.)
“The nation’s cities are in their worst fiscal shape in at least a quarter of a century and have probably not yet hit the bottom of their slide,” states a report by the National League of Cities.
What about the financial health of the states? “Right now there isn’t really anywhere to turn” as many states are now cutting aid to cities, says Christopher Hoene, one of the authors of the report. “The state budgets are in a position where they are more likely to hurt than to help.”
And, this doesn’t get into the problems individuals are having holding onto their jobs or homes.
Who seems to be doing well and positioning themselves to move into the future? Well it seems as if large companies and large banks are doing all the positioning at the present time. (See my post http://seekingalpha.com/article/228507-corporations-are-hoarding-cash-and-keeping-their-powder-dry.) Corporations buy back stock to better position themselves for future moves in the acquisition area. A higher stock price gives them more bargaining power when they are negotiating a “for-stock” transaction.
We are just seeing the tip of this iceberg. In August, acquisitions were unusually high in the manufacturing area for this time of year. We have not seen the September figures yet, but we are seeing lots of movement.
How can one doubt this movement with headlines like this one that appeared this morning in the Wall Street Journal: “GE Goes On Binge For Deals” (http://professional.wsj.com/article/SB10001424052748703735804575535872986083474.html?mod=ITP_marketplace_0&mg=reno-wsj).
In the article, John Krenicki, chief executive of GE Energy is quoted as saying, “This is another sign we’re playing offense.” There are “lots of choices organically and inorganically to grow the business.”
The article goes on: “GE Vice Chairman John Rice said last month the company has the firepower to spend about $30 billion on acquisitions over the next two to three years.” He added, however, that “we’re not going to run out and buy something just for the sake of buying it.”
But, this is not going to add jobs to the economy and it is not going to produce a lot of investment expenditures, both of which would help to spur on an economic recovery.
The United States is re-structuring. It appears as if more discipline is being exercised by those in a position to move forward. It also appears that those that are “under water” are scrambling to get their lives back under control.
The correction will not be comfortable or easy. But, calls for people and businesses to forget their efforts to bring discipline back into their lives will just postpone the fact that discipline will, at some time, have to be brought back into their lives. In fact, we may have reached the point where there is no going back…the thrust of the last 50 years may not be able to be sustained…and discipline will be re-established.
There is no question that this re-structuring is going to be very, very hard on some people. But, that is why one needs to be disciplined in what one does, even in the go-go years. Getting back the discipline is always hard. Perhaps the hardest part is to realize is that some, in the go-go years, were pushed to go beyond what they could really achieve at the time: these individuals were given incentives to put aside their discipline with the impression that their lack of discipline would not come back to haunt them.
The lesson that apparently needs to be learned over and over again is that, ultimately, a lack of discipline catches up with you. Discipline then has to be re-established. Re-establishing discipline is painful. But, there is no such thing as a free lunch.
Showing posts with label financial discipline. Show all posts
Showing posts with label financial discipline. Show all posts
Thursday, October 7, 2010
Thursday, November 12, 2009
Discipline is Needed for Real Economic Performance
There is an interesting article inside the Wall Street Journal this morning comparing the fortunes of Brazil and Argentina. (See “Argentina Falters as Old Rival Rises,” http://online.wsj.com/article/SB125798960525944513.html#mod=todays_us_page_one.) In the article a research paper published in Argentina is quoted: “Since the middle of the last century, Argentina’s economy has endured a notable decline relative to the rest of the region, falling into ‘insignificance in the international context.’”
During this time period the government of Argentina followed a very undisciplined approach to economic policy while it kept itself in power and suppressed dissent. In 2001, Argentina declared the largest sovereign debt default in history. Things have not gotten much better since.
Brazil’s government, on the other hand, after years of self-serving activity started to get its act in order about 15 years ago under the leadership of former President Fernando Henrique Cardoso. Runaway inflation was brought under control and more orthodox and conservative economic policies were put into place. The current president, Luiz Inảcio Lula da Silva, has maintained these policies. (See ”Olympic Accolade Sets Seal on Progress” in Financial Times: http://www.ft.com/cms/s/0/d16a27a6-c8d9-11de-8f9d-00144feabdc0.html.)
The central bank in Brazil is treated as independent and the stability that has been created has brought about lower interest rates and a growing mortgage market that has stimulated a construction boom. An emerging middle class has emerged and has supported the effort to obtain the Olympics and other international initiatives that will lead to a vast expansion of the Brazilian infrastructure in upcoming years.
Over and over again we see examples of the benefits of discipline in economic and financial affairs. We also see that the loss of discipline does nothing but eventually lead the undisciplined into undesirable situations in which all of the alternative options that are available to correct the condition are undesirable. In other words, there are no good choices to get one out of the difficulty in which one finds oneself.
Inflation represents a loss of discipline that always ends up hurting a large number of people. Furthermore, the consequences of inflation can leave a wreckage in which policymakers are left with no good alternative policies to follow. Often, the path of least resistance in such situations is to reflate.
Historically, governments have always excelled in spending more than they could bring in through taxes and other levies. Thus, going into debt is a normal governmental activity. Other than outright default on debt, governments got very good at inflating themselves out of excessive amounts of debt. And, the ability to inflate was helped in the twentieth century by developments in information technology: so governments got better and better at inflating their economies. (See “This Time is Different” by Reinhart and Rogoff: http://seekingalpha.com/article/171610-crisis-in-context-this-time-is-different-eight-centuries-of-financial-folly-by-carmen-m-reinhart-and-kenneth-s-rogoff.)
Philosophically, this bias toward inflation was supported by Keynesian economics as the argument was made that twentieth century governments could not allow wages and prices to fall. (See http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell.) (Also see op-ed piece in Wall Street Journal “The Fed’s Woody Allen Policy”: http://online.wsj.com/article/SB10001424052748704402404574529510954803156.html.) So the twentieth century saw not only an improved technology to inflate but also a respected philosophy that supported a government policy that had a bias toward inflation.
The point is that inflation creates an incentive for economic units to grow and to take on greater and greater amounts of risk. This is, of course, because inflation favors debtors versus creditors. It pays individuals and businesses to take on more and more debt. And, this policy is particularly successful, at least in the early stages, when the central bank forces interest rates to stay excessively low.
Risk is minimized because inflation creates a situation of moral hazard by “bailing out” people who take on large amounts of exposure to risk. For example, one rule of thumb that floats around the banking world from time-to-time is that “In a time of inflation, anyone can become a contractor for building houses. One only learns who is bad at it is when inflation slows down or stops.” The idea can be expanded to say that in inflationary times, anyone can appear to be successful. As Citigroup’s CEO Charles O. Prince III blithely stated: “As long as the music is still playing, we are all still dancing…” Risk takes a back seat.
Second, size becomes all important! Since inflation reduces the real value of debt it becomes silly for individuals or businesses not to leverage up. What is it to create $30 of debt for $1 of equity you have? And, why not $35…or, $40? Using such leverage magnifies performance! Using such leverage magnifies bonuses! Using such leverage allows us to reach a size where we become “Too Big to Fail”!
Finally, inflation allows individuals and businesses to forget about producing good quality goods and services and diverts attention to “speculative trading” and “financial games”. Since outsize rewards and bonuses go to areas that prosper during inflationary times, more and more “talent” moves into areas connected with finance or with trading. Less and less emphasis is placed upon production and quality because rising prices contribute more to profits than does improvements in what goods and services are offered. As a consequence, the composition of the nation’s workforce becomes tilted toward finance and the financial industries.
In effect, inflation destroys discipline. And, once discipline is reduced, problems occur and until discipline is renewed the problems just cumulate and re-enforce one another. This happens in families, in businesses, and in governments.
But, as is usual in economics, the consequences associated with destructive incentives are not always easy to identify. (See “Feakonomics” or “Superfreakonomics”: http://seekingalpha.com/article/166993-the-power-of-unintended-consequences-superfreakonomics-by-steven-d-levitt-and-stephen-j-dubner.) It is so much easier to blame executive greed for the troubles we have been experiencing. This explanation covers so much territory: the growth of finance in the economy relative to “productive” jobs; the taking on of more and more leverage; the taking on of more and more risky deals; the emphasis on speculative trading rather than productive producing; and the payment of excessive salaries and bonuses.
In fact, it is often hard to identify the benefits of greater discipline unless examples of that discipline are placed alongside examples of a lack of discipline. This is why the Argentina/Brazil contrast caught my attention.
Such stories, however, cause one to worry about whether the United States will once again be able to regain its economic discipline. The fear is that as long as governmental policies contain an inflationary bias, the solution to the problems caused by this inflationary bias will continue to be re-flation. If this is so, discipline will continue to be lacking in this country, both personally and corporately. Maybe it is not so surprising that Brazil won the voting for the Olympics over the United States!
During this time period the government of Argentina followed a very undisciplined approach to economic policy while it kept itself in power and suppressed dissent. In 2001, Argentina declared the largest sovereign debt default in history. Things have not gotten much better since.
Brazil’s government, on the other hand, after years of self-serving activity started to get its act in order about 15 years ago under the leadership of former President Fernando Henrique Cardoso. Runaway inflation was brought under control and more orthodox and conservative economic policies were put into place. The current president, Luiz Inảcio Lula da Silva, has maintained these policies. (See ”Olympic Accolade Sets Seal on Progress” in Financial Times: http://www.ft.com/cms/s/0/d16a27a6-c8d9-11de-8f9d-00144feabdc0.html.)
The central bank in Brazil is treated as independent and the stability that has been created has brought about lower interest rates and a growing mortgage market that has stimulated a construction boom. An emerging middle class has emerged and has supported the effort to obtain the Olympics and other international initiatives that will lead to a vast expansion of the Brazilian infrastructure in upcoming years.
Over and over again we see examples of the benefits of discipline in economic and financial affairs. We also see that the loss of discipline does nothing but eventually lead the undisciplined into undesirable situations in which all of the alternative options that are available to correct the condition are undesirable. In other words, there are no good choices to get one out of the difficulty in which one finds oneself.
Inflation represents a loss of discipline that always ends up hurting a large number of people. Furthermore, the consequences of inflation can leave a wreckage in which policymakers are left with no good alternative policies to follow. Often, the path of least resistance in such situations is to reflate.
Historically, governments have always excelled in spending more than they could bring in through taxes and other levies. Thus, going into debt is a normal governmental activity. Other than outright default on debt, governments got very good at inflating themselves out of excessive amounts of debt. And, the ability to inflate was helped in the twentieth century by developments in information technology: so governments got better and better at inflating their economies. (See “This Time is Different” by Reinhart and Rogoff: http://seekingalpha.com/article/171610-crisis-in-context-this-time-is-different-eight-centuries-of-financial-folly-by-carmen-m-reinhart-and-kenneth-s-rogoff.)
Philosophically, this bias toward inflation was supported by Keynesian economics as the argument was made that twentieth century governments could not allow wages and prices to fall. (See http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell.) (Also see op-ed piece in Wall Street Journal “The Fed’s Woody Allen Policy”: http://online.wsj.com/article/SB10001424052748704402404574529510954803156.html.) So the twentieth century saw not only an improved technology to inflate but also a respected philosophy that supported a government policy that had a bias toward inflation.
The point is that inflation creates an incentive for economic units to grow and to take on greater and greater amounts of risk. This is, of course, because inflation favors debtors versus creditors. It pays individuals and businesses to take on more and more debt. And, this policy is particularly successful, at least in the early stages, when the central bank forces interest rates to stay excessively low.
Risk is minimized because inflation creates a situation of moral hazard by “bailing out” people who take on large amounts of exposure to risk. For example, one rule of thumb that floats around the banking world from time-to-time is that “In a time of inflation, anyone can become a contractor for building houses. One only learns who is bad at it is when inflation slows down or stops.” The idea can be expanded to say that in inflationary times, anyone can appear to be successful. As Citigroup’s CEO Charles O. Prince III blithely stated: “As long as the music is still playing, we are all still dancing…” Risk takes a back seat.
Second, size becomes all important! Since inflation reduces the real value of debt it becomes silly for individuals or businesses not to leverage up. What is it to create $30 of debt for $1 of equity you have? And, why not $35…or, $40? Using such leverage magnifies performance! Using such leverage magnifies bonuses! Using such leverage allows us to reach a size where we become “Too Big to Fail”!
Finally, inflation allows individuals and businesses to forget about producing good quality goods and services and diverts attention to “speculative trading” and “financial games”. Since outsize rewards and bonuses go to areas that prosper during inflationary times, more and more “talent” moves into areas connected with finance or with trading. Less and less emphasis is placed upon production and quality because rising prices contribute more to profits than does improvements in what goods and services are offered. As a consequence, the composition of the nation’s workforce becomes tilted toward finance and the financial industries.
In effect, inflation destroys discipline. And, once discipline is reduced, problems occur and until discipline is renewed the problems just cumulate and re-enforce one another. This happens in families, in businesses, and in governments.
But, as is usual in economics, the consequences associated with destructive incentives are not always easy to identify. (See “Feakonomics” or “Superfreakonomics”: http://seekingalpha.com/article/166993-the-power-of-unintended-consequences-superfreakonomics-by-steven-d-levitt-and-stephen-j-dubner.) It is so much easier to blame executive greed for the troubles we have been experiencing. This explanation covers so much territory: the growth of finance in the economy relative to “productive” jobs; the taking on of more and more leverage; the taking on of more and more risky deals; the emphasis on speculative trading rather than productive producing; and the payment of excessive salaries and bonuses.
In fact, it is often hard to identify the benefits of greater discipline unless examples of that discipline are placed alongside examples of a lack of discipline. This is why the Argentina/Brazil contrast caught my attention.
Such stories, however, cause one to worry about whether the United States will once again be able to regain its economic discipline. The fear is that as long as governmental policies contain an inflationary bias, the solution to the problems caused by this inflationary bias will continue to be re-flation. If this is so, discipline will continue to be lacking in this country, both personally and corporately. Maybe it is not so surprising that Brazil won the voting for the Olympics over the United States!
Thursday, August 6, 2009
Bank of America and the Appointment of Sallie Krawcheck
This continues to be a trying time for the finance industry. Articles like the one that appeared this morning in the Wall Street Journal just do no good for the stature of those who admit to working in finance in one way or another. The article I am referring to is “Behind BofA’s Silence on Merrill,” http://online.wsj.com/article/SB124952686109510009.html.
The problem is one similar to that described by John Plender, the Chairman of Quintain PLC, in the Financial Times yesterday, “Ditch Theory and Take Away the Punchbowl,” http://www.ft.com/cms/s/0/e8b88624-8107-11de-92e7-00144feabdc0.html. Plender presents the folksy strategy for central banking ascribed to William McChesney Martin, former Chairman of the Board of Governors of the Federal Reserve System. Martin is reported to have said that the task of a central banker was to take away the punchbowl before the party got out of hand.
To me, the role a financial officer, especially a Chief Financial Officer, is similar. A financial officer ultimately must be the naysayer in an organization. If the financial officer does not act out this role in an organization then the Chief Executive Officer is not going to be well served by the finance function and the organization is going to be exposed as it grows and considers alternative business options!
No one else in the organization performs this function. A “good” Chief Executive Officer wants a strong person in this position because without someone there to say “no” from time-to-time, the CEO will be like the emperor that is wearing no clothes. A “good” CEO knows this. One thing I look for in evaluating a management team is the strength of the people a CEO surrounds him- or herself with, especially the strength of the CFO.
A strong Chief Financial Officer knows that there is no such thing as a free lunch. That is, when it comes to finance, you never get something for nothing. If you want a greater return on your assets, you can take on riskier assets, or you can increase you financial leverage which, of course, increases risk, or you can mismatch the maturities of your assets and liabilities which, of course, increases risk. Of course, we can extend the idea of “no free lunch” to proposals coming from marketing, or information processing, or purchasing as well, but I am sticking with financial issues because that is where the concern is today.
In the euphoria of the credit bubbles that took place in the 1990s and the 2000s, CFOs and other finance people that believed that there was “no fee lunch” and acted upon this belief seem to have fallen out of favor with CEOs seeking to make bundles of money in the bubbles. Of course, not everyone acted in this way but a significant number did and we are all paying the price for this today.
When one sees articles like the one in the Wall Street Journal mentioned above, you can understand why people on Main Street and why Senators and Representatives in Congress can pick on bankers and others who are in the finance profession. It certainly seems as if a trust was broken and greed ruled the kingdom.
The hiring of Sallie Krawcheck by BofA is, therefore, a hint that maybe BofA understands that it needs to build up its credibility. Krawcheck has a reputation for openness and integrity that has stayed with her throughout her career. The argument is that this trait got her in trouble with the CEO of Citigroup, Vikram Pandit, and cost her the position of CFO which she held at Citi. Taking over responsibility for BofAs global wealth and investment management business in not the same as becoming CFO of the institution, but it indicates that BofA is pulling in someone that is not only talented and capable in finance, but also will add some credibility to the organization in terms of honesty and transparency.
One can learn a lot about leaders and the organizations they lead by observing how they respond to people that possess these qualities, especially in times of trouble. Citigroup seems to have a history of releasing top people that question how financial affairs are being handled. Richard Bookstaber comments on how Citi operated in the area of risk management in his book “A Demon of Our Own Design”. We also see that Jamie Dimon was asked to leave Citi when he began to clash with the leadership of that organization on issues of risk and management. (See my review of a book about Dimon: http://seekingalpha.com/article/148179-book-review-the-house-of-dimon-by-patricia-crisafulli.) It seems as if Citigroup worked hard and long to get itself into the position it is now in.
Of course, BOA and Citi are not isolated cases. One can name any number of organizations from Bear Sterns to Lehman Brothers to AIG to Wachovia to Countrywide to so and so and on and on. The depth and breadth of the problem just indicates how far the finance profession has lost credibility.
That is why I would advise at this time that investors look even more closely at the people, especially the finance people, that the leadership of an organization brings on board. Strong financial leadership is needed within an organization, leadership that stresses telling the truth, reporting asset values at realistic levels, and leadership that rejects accounting rules that only muddle if not mislead investors and regulators.
In this regard I would argue that we have to get back to mark-to-market accounting. To me, people only kid themselves when they finance long term assets with short term liabilities in order to capture additional return and cry and whine when they have to mark down the values of their longer term assets if the market goes against them. They are brave enough to gamble on this mismatch of maturities. They also need to be brave enough to accept the consequences of their actions. There is no free lunch!
In my experience there is one thing that financial integrity does: it causes people to act earlier than they would otherwise. The situation I saw over and over again in doing bank turnarounds was that people postponed doing anything about a bad position because they were not forced to recognize a problem early on. As a consequence they put off doing something about the bad situation and put it off until the problem grew into a much larger problem where they could not postpone action any longer. Good management recognizes problems and deals with them early on.
Hopefully, the hiring of Sallie Krawcheck is a sign that organizations are recognizing the need for strong financial leadership. Then, in hiring more people like her, maybe emperors won’t have to go out into crowds to discover that they don’t have any clothes on. The absence of clothes will have been discovered long before then and the situation will have been corrected.
The problem is one similar to that described by John Plender, the Chairman of Quintain PLC, in the Financial Times yesterday, “Ditch Theory and Take Away the Punchbowl,” http://www.ft.com/cms/s/0/e8b88624-8107-11de-92e7-00144feabdc0.html. Plender presents the folksy strategy for central banking ascribed to William McChesney Martin, former Chairman of the Board of Governors of the Federal Reserve System. Martin is reported to have said that the task of a central banker was to take away the punchbowl before the party got out of hand.
To me, the role a financial officer, especially a Chief Financial Officer, is similar. A financial officer ultimately must be the naysayer in an organization. If the financial officer does not act out this role in an organization then the Chief Executive Officer is not going to be well served by the finance function and the organization is going to be exposed as it grows and considers alternative business options!
No one else in the organization performs this function. A “good” Chief Executive Officer wants a strong person in this position because without someone there to say “no” from time-to-time, the CEO will be like the emperor that is wearing no clothes. A “good” CEO knows this. One thing I look for in evaluating a management team is the strength of the people a CEO surrounds him- or herself with, especially the strength of the CFO.
A strong Chief Financial Officer knows that there is no such thing as a free lunch. That is, when it comes to finance, you never get something for nothing. If you want a greater return on your assets, you can take on riskier assets, or you can increase you financial leverage which, of course, increases risk, or you can mismatch the maturities of your assets and liabilities which, of course, increases risk. Of course, we can extend the idea of “no free lunch” to proposals coming from marketing, or information processing, or purchasing as well, but I am sticking with financial issues because that is where the concern is today.
In the euphoria of the credit bubbles that took place in the 1990s and the 2000s, CFOs and other finance people that believed that there was “no fee lunch” and acted upon this belief seem to have fallen out of favor with CEOs seeking to make bundles of money in the bubbles. Of course, not everyone acted in this way but a significant number did and we are all paying the price for this today.
When one sees articles like the one in the Wall Street Journal mentioned above, you can understand why people on Main Street and why Senators and Representatives in Congress can pick on bankers and others who are in the finance profession. It certainly seems as if a trust was broken and greed ruled the kingdom.
The hiring of Sallie Krawcheck by BofA is, therefore, a hint that maybe BofA understands that it needs to build up its credibility. Krawcheck has a reputation for openness and integrity that has stayed with her throughout her career. The argument is that this trait got her in trouble with the CEO of Citigroup, Vikram Pandit, and cost her the position of CFO which she held at Citi. Taking over responsibility for BofAs global wealth and investment management business in not the same as becoming CFO of the institution, but it indicates that BofA is pulling in someone that is not only talented and capable in finance, but also will add some credibility to the organization in terms of honesty and transparency.
One can learn a lot about leaders and the organizations they lead by observing how they respond to people that possess these qualities, especially in times of trouble. Citigroup seems to have a history of releasing top people that question how financial affairs are being handled. Richard Bookstaber comments on how Citi operated in the area of risk management in his book “A Demon of Our Own Design”. We also see that Jamie Dimon was asked to leave Citi when he began to clash with the leadership of that organization on issues of risk and management. (See my review of a book about Dimon: http://seekingalpha.com/article/148179-book-review-the-house-of-dimon-by-patricia-crisafulli.) It seems as if Citigroup worked hard and long to get itself into the position it is now in.
Of course, BOA and Citi are not isolated cases. One can name any number of organizations from Bear Sterns to Lehman Brothers to AIG to Wachovia to Countrywide to so and so and on and on. The depth and breadth of the problem just indicates how far the finance profession has lost credibility.
That is why I would advise at this time that investors look even more closely at the people, especially the finance people, that the leadership of an organization brings on board. Strong financial leadership is needed within an organization, leadership that stresses telling the truth, reporting asset values at realistic levels, and leadership that rejects accounting rules that only muddle if not mislead investors and regulators.
In this regard I would argue that we have to get back to mark-to-market accounting. To me, people only kid themselves when they finance long term assets with short term liabilities in order to capture additional return and cry and whine when they have to mark down the values of their longer term assets if the market goes against them. They are brave enough to gamble on this mismatch of maturities. They also need to be brave enough to accept the consequences of their actions. There is no free lunch!
In my experience there is one thing that financial integrity does: it causes people to act earlier than they would otherwise. The situation I saw over and over again in doing bank turnarounds was that people postponed doing anything about a bad position because they were not forced to recognize a problem early on. As a consequence they put off doing something about the bad situation and put it off until the problem grew into a much larger problem where they could not postpone action any longer. Good management recognizes problems and deals with them early on.
Hopefully, the hiring of Sallie Krawcheck is a sign that organizations are recognizing the need for strong financial leadership. Then, in hiring more people like her, maybe emperors won’t have to go out into crowds to discover that they don’t have any clothes on. The absence of clothes will have been discovered long before then and the situation will have been corrected.
Sunday, February 1, 2009
Concerns about the Obama Stimulus Plan
As the Obama Stimulus Plan becomes more and more of a reality, many different people are asking many different questions about it. To me, there are four basic issues that need to be debated very seriously before any such plan is passed by Congress. The first question is…how fast do we really need to move in passing such a plan? Second…how big does the stimulus package really need to be? Third…how is all the debt created by such a plan going to be financed? And fourth, can the stimulus really be withdrawn once the crisis is over?
In terms of speed of enactment we hear over and over again that speed is of the essence. Things are really bad…and things are going to get a lot worse. We need to get into the game and do something as quickly as possible!
We heard this argument before, not too long ago. It was reported in the Wall Street Journal, that “Federal Reserve Chairman Ben Bernanke reached the end of his rope on Wednesday afternoon, September 17.” Bernanke was reacting to things falling apart in the financial industry. He called Treasury Secretary Hank Paulson and said that the administration had to move. Thursday September 18. Paulson responded that he was “on board”. Bernanke insisted that Congressional leaders had to be assembled…which Paulson set up for that Friday evening. Bernanke read them the riot act at that meeting and insisted that a bill…what became TARP…be enacted no later than Monday or everything would fall apart. (For more on this see my post on Seeking Alpha of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?”) The bill was not enacted that Monday and the last half of the TARP money was not released until just recently.
Now we are hearing the call again. We must hurry. The Obama Stimulus Plan has been put on the fast track…and the pressure is on to get the plan enacted by Congress by President’s Day, February 16. But, does this plan really need to be enacted that quickly? Is it better to have any plan by President’s Day or is it better to have a plan that works?
It seems to me that the pressure to get something done quickly has important implications for the second question asked above. Since so little is known about how effective the plan will be…the issue becomes…MORE IS BETTER! Given the uncertainty of how the plan will work, it is important to throw as much as possible against the wall in the hopes that some of it will stick.
Wow! What a way to run a government! But that is what Bernanke/Paulson did.
And, this approach gives rise to the new justification for the program…confidence. The argument goes that “If the government shows that it is serious in ending the recession and this seriousness is reflected in the size of the stimulus package…this will spur on an increase in confidence…which is just what the economy needs right now!”
Let me get this straight. It doesn’t really matter whether or not the stimulus plan works…what is important is that the stimulus plan be very large…so that people will regain confidence.
And, if this is the underlying theory behind the stimulus plan…how is this going to raise the confidence of the world wide investment community…which relates to the third question presented above…to invest in the debt of the United States government?
Oh, well…the United States dollar is the world’s reserve currency and the United States debt is the place for world investors to go when there is a “flight to quality” in world financial markets. Given this fact, people will continue to flock to United States Treasury issues. No doubt about it!
As Alice Rivlin, economist of the Brookings Institution, former member of the Board of Governors of the Federal Reserve System, First Director of the Congressional Budget Office, and Director of the Office of Management and Budget (a cabinet position and appointed by President Bill Clinton a Democrat) recently testified before Congress…”We seem to be counting on the Chinese to keep investing to pay for this (the U. S. deficits) and we’re assuming that the rest of the world isn’t going to lose confidence once we use this moment to spend on a whole range of programs. And, I’m not sure that’s the right assumption.”
Rivlin also has something to say about the fourth question…the question about what happens in the long run. She states that “Because we’re doing this outside the budget process, it means that no one has to talk about what the long-term effects of any of this might be.” That is, what is going to happen beyond the short run if much of this expenditure is still going into the economy as the economy begins to grow again. No one is anticipating how this situation might be dealt with.
As Niall Ferguson, who shares his time between Harvard University and Oxford University, stated recently at Davos…and I am paraphrasing…the new administration seems to believe that by creating an impressive amount of new leverage that it can resolve a financial crisis created by an excessive amount of leverage.
So, I go back to the first question…do we really need to rush so quickly? Yes, I agree with President Obama…he won…he gets to set the table. But, does he want to do it right…or does he just want to do it?
The Congress is supposed to be a deliberative body…it is supposed to mull things over…kick them around…debate and dialogue with one another. Isn’t it better to get something right…than to not do something well…or to do something that may not work?
Projects should not just be put into a stimulus plan…just because they are a “good idea” or because “they are something we want to do and they are available.” Projects, to be included, need to have some real justification for their inclusion in such a plan…the benefit of the project (the whole flow of benefits accruing from the project) should exceed the social cost of the project. Questions should be asked about the timing of the project and when the expected benefits are expected to be received. The Congress should be very intentional about what it is going to do…how much it is going to spend. Success of execution should be the key criteria as to whether a project gets included in the plan…not just the speed of passing the bill.
If Congress were to judge the plan…the whole plan as well as the components of the plan…in this fashion, then something more specific could be said about the size of the plan. Given that every element of the plan could stand up to some form of cost-benefit analysis then the size of the plan would be less of an issue. We would have some rationale for the size of the plan…it would not be a question of hoping some of the material thrown against the wall would stick! The parts of the plan would be chosen because they work…not because they make the plan “large”.
There still will remain questions about financing a stimulus plan. A plan constructed as suggested above would still result in the creation of a lot of new debt the United States government would have to issue. But, the investment community would have more justification to “trust” the plan because the Congress has done its homework…and, if the Congress had done its homework there would be something to say about how the debt will be financed and paid down in the future. That is, the United States government would be acting like a responsible steward of its fiscal responsibilities, something world financial markets have not seen for eight years or so.
To me, this is a crucial issue the Obama administration and the United States government has to deal with…restoring confidence in the fiscal credibility of the United States…something that Bush43 fell far short of doing. Rushing into the fray with a hastily constructed, ill-conceived stimulus plan, one that relies on the Chinese and the rest-of-the-world to finance with no thought for the future is not going to resolve the financial and economic mess we are now experiencing.
In terms of speed of enactment we hear over and over again that speed is of the essence. Things are really bad…and things are going to get a lot worse. We need to get into the game and do something as quickly as possible!
We heard this argument before, not too long ago. It was reported in the Wall Street Journal, that “Federal Reserve Chairman Ben Bernanke reached the end of his rope on Wednesday afternoon, September 17.” Bernanke was reacting to things falling apart in the financial industry. He called Treasury Secretary Hank Paulson and said that the administration had to move. Thursday September 18. Paulson responded that he was “on board”. Bernanke insisted that Congressional leaders had to be assembled…which Paulson set up for that Friday evening. Bernanke read them the riot act at that meeting and insisted that a bill…what became TARP…be enacted no later than Monday or everything would fall apart. (For more on this see my post on Seeking Alpha of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?”) The bill was not enacted that Monday and the last half of the TARP money was not released until just recently.
Now we are hearing the call again. We must hurry. The Obama Stimulus Plan has been put on the fast track…and the pressure is on to get the plan enacted by Congress by President’s Day, February 16. But, does this plan really need to be enacted that quickly? Is it better to have any plan by President’s Day or is it better to have a plan that works?
It seems to me that the pressure to get something done quickly has important implications for the second question asked above. Since so little is known about how effective the plan will be…the issue becomes…MORE IS BETTER! Given the uncertainty of how the plan will work, it is important to throw as much as possible against the wall in the hopes that some of it will stick.
Wow! What a way to run a government! But that is what Bernanke/Paulson did.
And, this approach gives rise to the new justification for the program…confidence. The argument goes that “If the government shows that it is serious in ending the recession and this seriousness is reflected in the size of the stimulus package…this will spur on an increase in confidence…which is just what the economy needs right now!”
Let me get this straight. It doesn’t really matter whether or not the stimulus plan works…what is important is that the stimulus plan be very large…so that people will regain confidence.
And, if this is the underlying theory behind the stimulus plan…how is this going to raise the confidence of the world wide investment community…which relates to the third question presented above…to invest in the debt of the United States government?
Oh, well…the United States dollar is the world’s reserve currency and the United States debt is the place for world investors to go when there is a “flight to quality” in world financial markets. Given this fact, people will continue to flock to United States Treasury issues. No doubt about it!
As Alice Rivlin, economist of the Brookings Institution, former member of the Board of Governors of the Federal Reserve System, First Director of the Congressional Budget Office, and Director of the Office of Management and Budget (a cabinet position and appointed by President Bill Clinton a Democrat) recently testified before Congress…”We seem to be counting on the Chinese to keep investing to pay for this (the U. S. deficits) and we’re assuming that the rest of the world isn’t going to lose confidence once we use this moment to spend on a whole range of programs. And, I’m not sure that’s the right assumption.”
Rivlin also has something to say about the fourth question…the question about what happens in the long run. She states that “Because we’re doing this outside the budget process, it means that no one has to talk about what the long-term effects of any of this might be.” That is, what is going to happen beyond the short run if much of this expenditure is still going into the economy as the economy begins to grow again. No one is anticipating how this situation might be dealt with.
As Niall Ferguson, who shares his time between Harvard University and Oxford University, stated recently at Davos…and I am paraphrasing…the new administration seems to believe that by creating an impressive amount of new leverage that it can resolve a financial crisis created by an excessive amount of leverage.
So, I go back to the first question…do we really need to rush so quickly? Yes, I agree with President Obama…he won…he gets to set the table. But, does he want to do it right…or does he just want to do it?
The Congress is supposed to be a deliberative body…it is supposed to mull things over…kick them around…debate and dialogue with one another. Isn’t it better to get something right…than to not do something well…or to do something that may not work?
Projects should not just be put into a stimulus plan…just because they are a “good idea” or because “they are something we want to do and they are available.” Projects, to be included, need to have some real justification for their inclusion in such a plan…the benefit of the project (the whole flow of benefits accruing from the project) should exceed the social cost of the project. Questions should be asked about the timing of the project and when the expected benefits are expected to be received. The Congress should be very intentional about what it is going to do…how much it is going to spend. Success of execution should be the key criteria as to whether a project gets included in the plan…not just the speed of passing the bill.
If Congress were to judge the plan…the whole plan as well as the components of the plan…in this fashion, then something more specific could be said about the size of the plan. Given that every element of the plan could stand up to some form of cost-benefit analysis then the size of the plan would be less of an issue. We would have some rationale for the size of the plan…it would not be a question of hoping some of the material thrown against the wall would stick! The parts of the plan would be chosen because they work…not because they make the plan “large”.
There still will remain questions about financing a stimulus plan. A plan constructed as suggested above would still result in the creation of a lot of new debt the United States government would have to issue. But, the investment community would have more justification to “trust” the plan because the Congress has done its homework…and, if the Congress had done its homework there would be something to say about how the debt will be financed and paid down in the future. That is, the United States government would be acting like a responsible steward of its fiscal responsibilities, something world financial markets have not seen for eight years or so.
To me, this is a crucial issue the Obama administration and the United States government has to deal with…restoring confidence in the fiscal credibility of the United States…something that Bush43 fell far short of doing. Rushing into the fray with a hastily constructed, ill-conceived stimulus plan, one that relies on the Chinese and the rest-of-the-world to finance with no thought for the future is not going to resolve the financial and economic mess we are now experiencing.
Sunday, January 11, 2009
The Obama Stimulus Plan and the Dollar
All eyes, right now, are on the forming Obama administration and the economic plan they are constructing. We get the word that we can expect fiscal deficits in the neighborhood of one trillion dollars and we can expect large deficits for several consecutive years.
The Federal Reserve is doing all it can to push liquidity into the system and has thrown just about everything it can into the market to get banks lending again and the financial markets functioning. The Fed’s balance sheet has ballooned so significantly, one has to wonder how they can ever re-establish monetary discipline within a reasonable time period.
The concern is, of course, an economic recession or worse and the economic dislocation and misery that accompanies such an experience. As a consequence, very little attention is being given to the dollar.
I believe that the value of the dollar is something to watch, even at a time like this. The reason being is that the value of the dollar captures how international financial markets are interpreting the economic policies of the United States government relative to the economic policies of other nations. The importance of this price is underestimated and I continually go back to the statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership, (New York: Times Books, 1992), p. 232.)
The Bush 43 administration ignored the value of the dollar for most of its time in office and showed contempt for any fiscal or monetary discipline as the value of the dollar declined by more than 40% against a wide range of important currencies. This decline can be seen in the accompanying chart which presents the value of the dollar relative to the Euro. One can see that from 2001 until August 2008 the value of the dollar fell (represented by upward-moving curve).
Place chart here from St. Louis Federal Reserve Bank.
http://research.stlouisfed.org/fred2/series/DEXUSEU?cid=94
One can see that once the world financial crises escalated in September 2008 through the fall that the value of the dollar rose (the value of the Euro falls in this chart) as there was a world wide flight to quality…a movement to the United States dollar. Only recently have we seen some decline as the Federal Reserve has let short term interest rates in the United States fall toward zero and has attempted to further push liquidity into banking and financial markets.
The concern is going forward. How are world financial markets going to accept the Obama team and the monetary and fiscal policies that will be implemented by the new administration? With projections for such huge amounts of federal government debt hitting the market and the stance taken by the Federal Reserve system to basically monetize large portions of this debt, there is concern about what will happen to the value of the dollar and the place of the United States dollar as the world’s reserve currency.
Bush 43 was helped considerably by the willingness of the rest of the world…especially China, India, Japan, Middle Eastern countries and others…to finance the huge deficits it created. The Federal Reserve produced negative real rates of interest and private debt soared, much of it placed off-shore. The United States relied on the savings of the rest-of-the-world to pull off its debt binge. But, international investors responded to this debt bubble by selling the dollar.
It seems as if there are three possibilities for the value of the dollar given the projected large federal deficits. These are:
1. Foreign investors will continue to acquire the debt of the United States and will continue to use the dollar as a reserve currency;
2. Foreign investors will avoid, to one degree or another, absorbing the new debt of the United States and will flee the dollar;
3. The Federal Reserve will have to monetize a major portion of the new debt issued by the United States government and this will not be good for the dollar.
One hopes that the first of these alternatives will come to pass. Unfortunately, with the experience of the last eight years, the international financial community does not have too much faith in the ability of the United States government to act with appropriate discipline. Therefore, it is important to keep an eye on the value of the dollar and see how the world community is evaluating the new administration.
I have said nothing here about the potential effectiveness of the forthcoming Obama stimulus plan. There are still many questions that remain about how effective the plan might be. No one knows for sure. And, no one has an idea about when the banks might start lending again and when the financial markets might thaw. One hope that these policies will have some degree of success.
Still, we need to keep an eye on the value of the dollar. Discipline in Washington, D. C. has been absent for the last eight years. And, as I have said many times, once discipline has been lost…decisions makers don’t have any really good options that are left them. Bush 43 acted as if the rest of the world did not matter. The Obama administration, as much as it would like to throw everything it can at the economy, must not lose sight of how the rest of the world is reacting to what it is doing. A continuing decline in the value of the dollar not only will weaken the role of the United States in the world, but it will also place more and more American physical assets on the sales block to be scooped up by foreign interests.
The rest of the world already is saturated with American debt. How it receives the massive amounts it is going to receive is anybody’s guess. I think watching the value of the dollar will give us a clue.
The Federal Reserve is doing all it can to push liquidity into the system and has thrown just about everything it can into the market to get banks lending again and the financial markets functioning. The Fed’s balance sheet has ballooned so significantly, one has to wonder how they can ever re-establish monetary discipline within a reasonable time period.
The concern is, of course, an economic recession or worse and the economic dislocation and misery that accompanies such an experience. As a consequence, very little attention is being given to the dollar.
I believe that the value of the dollar is something to watch, even at a time like this. The reason being is that the value of the dollar captures how international financial markets are interpreting the economic policies of the United States government relative to the economic policies of other nations. The importance of this price is underestimated and I continually go back to the statement of Paul Volcker: “a nation’s exchange rate is the single most important price in the economy.” (Paul Volcker and Toyoo Gyohten, “Changing Fortunes: the World’s Money and the Threat to American Leadership, (New York: Times Books, 1992), p. 232.)
The Bush 43 administration ignored the value of the dollar for most of its time in office and showed contempt for any fiscal or monetary discipline as the value of the dollar declined by more than 40% against a wide range of important currencies. This decline can be seen in the accompanying chart which presents the value of the dollar relative to the Euro. One can see that from 2001 until August 2008 the value of the dollar fell (represented by upward-moving curve).
Place chart here from St. Louis Federal Reserve Bank.
http://research.stlouisfed.org/fred2/series/DEXUSEU?cid=94
One can see that once the world financial crises escalated in September 2008 through the fall that the value of the dollar rose (the value of the Euro falls in this chart) as there was a world wide flight to quality…a movement to the United States dollar. Only recently have we seen some decline as the Federal Reserve has let short term interest rates in the United States fall toward zero and has attempted to further push liquidity into banking and financial markets.
The concern is going forward. How are world financial markets going to accept the Obama team and the monetary and fiscal policies that will be implemented by the new administration? With projections for such huge amounts of federal government debt hitting the market and the stance taken by the Federal Reserve system to basically monetize large portions of this debt, there is concern about what will happen to the value of the dollar and the place of the United States dollar as the world’s reserve currency.
Bush 43 was helped considerably by the willingness of the rest of the world…especially China, India, Japan, Middle Eastern countries and others…to finance the huge deficits it created. The Federal Reserve produced negative real rates of interest and private debt soared, much of it placed off-shore. The United States relied on the savings of the rest-of-the-world to pull off its debt binge. But, international investors responded to this debt bubble by selling the dollar.
It seems as if there are three possibilities for the value of the dollar given the projected large federal deficits. These are:
1. Foreign investors will continue to acquire the debt of the United States and will continue to use the dollar as a reserve currency;
2. Foreign investors will avoid, to one degree or another, absorbing the new debt of the United States and will flee the dollar;
3. The Federal Reserve will have to monetize a major portion of the new debt issued by the United States government and this will not be good for the dollar.
One hopes that the first of these alternatives will come to pass. Unfortunately, with the experience of the last eight years, the international financial community does not have too much faith in the ability of the United States government to act with appropriate discipline. Therefore, it is important to keep an eye on the value of the dollar and see how the world community is evaluating the new administration.
I have said nothing here about the potential effectiveness of the forthcoming Obama stimulus plan. There are still many questions that remain about how effective the plan might be. No one knows for sure. And, no one has an idea about when the banks might start lending again and when the financial markets might thaw. One hope that these policies will have some degree of success.
Still, we need to keep an eye on the value of the dollar. Discipline in Washington, D. C. has been absent for the last eight years. And, as I have said many times, once discipline has been lost…decisions makers don’t have any really good options that are left them. Bush 43 acted as if the rest of the world did not matter. The Obama administration, as much as it would like to throw everything it can at the economy, must not lose sight of how the rest of the world is reacting to what it is doing. A continuing decline in the value of the dollar not only will weaken the role of the United States in the world, but it will also place more and more American physical assets on the sales block to be scooped up by foreign interests.
The rest of the world already is saturated with American debt. How it receives the massive amounts it is going to receive is anybody’s guess. I think watching the value of the dollar will give us a clue.
Tuesday, November 25, 2008
The Need for Discipline
When a person or an organization is disciplined, they usually have plenty of options…many of them good ones.
When a person or an organization is undisciplined, options are usually limited…and none of them are good!
We are seeing or have seen quite a few examples of the second of these statements in recent days and in recent months. Where does one begin?
· The auto industry…
· The financial industry…
· The housing industry…
· And the list goes on…
Discipline starts at the top…and if the discipline is not there and this lack of discipline spreads…others began to see that “lack of discipline” is the standard of the day and they too began to feast on the beast. And, the lack of discipline spreads throughout the land.
My biggest disappointment is that financial discipline broke down in a major way. My background is in finance and I was brought up with the idea that finance people were the ultimate arbiters of discipline, both in terms of individual behavior as well as organizational behavior. The first CEO I worked for told me that, as the CFO, I had to speak up strongly for the discipline of finance for if I didn’t…there was no one else in the organization that would take that position!
Well, we have seen that when the financial standards break down…there is no one left to maintain discipline.
That is the past. We now have to deal with the future. The options are not good for anyone!
Let me reiterate the statement I made above…
The culture of an organization starts at the top!
So here we are…and we still have to do something…invest our money…run our businesses…live our lives…
There are several things that I believe have to take place…
First, we have to re-establish discipline…individually…in our families…in our businesses…in our government.
Second, we have got to retrench. Here we have conflicting objectives. On the one side, we have to get back to basics, strengthen our balance sheets, and focus on what we do best. In this we have to do the best that we can…and we should not assume that someone is going to bail us out. If we do…we are bound for disappointment.
The other side of this is that retrenchment weakens the economy because the basic plan is to “pull back”, cut spending, reduce debt, and, if we can, save. This is the other side of the lack of discipline. It is fun on the upside when discipline is eased…it is tough on the down side when discipline is being re-established. This leads to the third point.
Third, we must also be community focused, locally, regionally, nationally, and internationally. While we are establishing discipline once again, we must not isolate ourselves and refuse to talk with one another. We must engage one another, talk and dialogue about what is needed, and work together to introduce solutions that build up communities in this time of trial. This will include government programs to stimulate the economy. This will include new regulations to improve the process of finance and economics. This will include new efforts at international cooperation to help us to work together and support one another. This must include the acceptance of change because the world that is coming is going to be different from the world that we have left behind.
But, this effort is going to require leadership and it is going to require leadership at the very top.
On another note, we still have much to be thankful for…so let us give thanks for what we have.
Everyone…have a Happy Thanksgiving!
Mase
When a person or an organization is undisciplined, options are usually limited…and none of them are good!
We are seeing or have seen quite a few examples of the second of these statements in recent days and in recent months. Where does one begin?
· The auto industry…
· The financial industry…
· The housing industry…
· And the list goes on…
Discipline starts at the top…and if the discipline is not there and this lack of discipline spreads…others began to see that “lack of discipline” is the standard of the day and they too began to feast on the beast. And, the lack of discipline spreads throughout the land.
My biggest disappointment is that financial discipline broke down in a major way. My background is in finance and I was brought up with the idea that finance people were the ultimate arbiters of discipline, both in terms of individual behavior as well as organizational behavior. The first CEO I worked for told me that, as the CFO, I had to speak up strongly for the discipline of finance for if I didn’t…there was no one else in the organization that would take that position!
Well, we have seen that when the financial standards break down…there is no one left to maintain discipline.
That is the past. We now have to deal with the future. The options are not good for anyone!
Let me reiterate the statement I made above…
The culture of an organization starts at the top!
So here we are…and we still have to do something…invest our money…run our businesses…live our lives…
There are several things that I believe have to take place…
First, we have to re-establish discipline…individually…in our families…in our businesses…in our government.
Second, we have got to retrench. Here we have conflicting objectives. On the one side, we have to get back to basics, strengthen our balance sheets, and focus on what we do best. In this we have to do the best that we can…and we should not assume that someone is going to bail us out. If we do…we are bound for disappointment.
The other side of this is that retrenchment weakens the economy because the basic plan is to “pull back”, cut spending, reduce debt, and, if we can, save. This is the other side of the lack of discipline. It is fun on the upside when discipline is eased…it is tough on the down side when discipline is being re-established. This leads to the third point.
Third, we must also be community focused, locally, regionally, nationally, and internationally. While we are establishing discipline once again, we must not isolate ourselves and refuse to talk with one another. We must engage one another, talk and dialogue about what is needed, and work together to introduce solutions that build up communities in this time of trial. This will include government programs to stimulate the economy. This will include new regulations to improve the process of finance and economics. This will include new efforts at international cooperation to help us to work together and support one another. This must include the acceptance of change because the world that is coming is going to be different from the world that we have left behind.
But, this effort is going to require leadership and it is going to require leadership at the very top.
On another note, we still have much to be thankful for…so let us give thanks for what we have.
Everyone…have a Happy Thanksgiving!
Mase
Subscribe to:
Comments (Atom)
